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If you make a down payment of less than 20% on a home purchase, you may have to pay private mortgage insurance (PMI) or another form of mortgage insurance. This is in place to safeguard the lender in the event you default on your mortgage loan.
Fortunately, mortgage insurance can be removed under the right circumstances.
Learn more about how private mortgage insurance works, how much PMI can cost you, the different types of mortgage insurance charged based on loan type, the steps you’ll need to take to eliminate mortgage insurance, and how a mortgage refinance can get rid of PMI.
Private Mortgage Insurance (PMI) Explained
PMI is a form of insurance protection for your mortgage lender that you will be required to pay if you put down less than 20% on a conventional mortgage loan backed by Fannie Mae or Freddie Mac. This insurance safeguards the lender in case you can’t repay your mortgage debt and default on the loan.
“Think of PMI as a fixed monthly fee that is added onto your full monthly mortgage payment. As you continue to make mortgage payments and earn more equity by paying down your principal balance, you get closer to the ability to eliminate PMI payments,” explains Brian Shahwan, vice president of mortgage banking and a broker with William Raveis Mortgage in New York City.
Your loan-to-value (LTV) ratio will help determine if and when PMI can be eliminated. LTV indicates your mortgage loan amount versus the appraised value of your home.
Let’s say you make a 10% down payment on a home purchase. That means your LTV ratio is 90%.
Lenders prefer an LTV of 80% or less, but will still let you borrow funds if you meet other requirements, although conventional loan lenders will require that you pay PMI until your LTV improves.
Once your LTV reaches 78% (which typically means you’ve earned 22% equity in your property), the fee you pay for PMI should be automatically eliminated from your conventional loan. You can even attempt to remove PMI earlier – once you reach 20% equity (more on this later).
Note that your LTV can also decrease, getting you closer to removing PMI, if your home appreciates in value, which can occur if you make effective home improvements.
How Much PMI Can Cost You
The actual PMI fee you will pay each month will be based on different factors, including the size of your loan, your LTV ratio, your credit score, and more.
“On average, PMI can cost between 0.3% to 1.5% of your original loan amount annually,” explains Joseph Melara, a personal finance expert and owner of Residential Brokers in Palm Desert, California.
Jeff Rose, a certified financial planner in Nashville, says your monthly PMI payments can be more costly than you think.
“Let’s say you bought a home worth $300,000 and put down 10% – $30,000. Here, your loan amount would be $270,000. If your PMI rate is 1%, you’d pay $2,700 per year, or about $225 per month in PMI,” he adds.
» MORE: See today’s refinance rates
The difference between PMI and other types of mortgage insurance
PMI specifically applies to conventional mortgage loans not backed by the federal government. But you may also have to pay a form of mortgage insurance if you have a different kind of mortgage loan.
“For example, borrowers opting for an FHA loan are required to pay an upfront mortgage insurance premium (MIP) equal to 1.75% of your loan amount. You’re also obligated to pay an annual MIP payment of 0.55% of your loan amount,” Shahwan points out. “And unlike PMI, your annual MIP will not automatically fall off when the FHA loan reaches a certain LTV – in many cases, that premium is required to stay on for the life of the loan. But if you put down at least 10% on an FHA loan, the MIP is required to remain in place for only the first 11 years, after which time it will fall off automatically.”
USDA loans – which can be had for no money down – don’t have a mortgage insurance premium. But they do charge a guarantee fee, which functions like mortgage insurance because it helps guarantee the financing.
You’ll pay an upfront one-time guarantee fee of 1% of your loan amount, plus an annual guarantee fee (paid monthly) that equates to 0.35% of your loan amount, which you must pay over the life of the USDA loan.
VA loans also don’t charge PMI or any other form of mortgage insurance. But, as with a USDA loan, you’ll have to pay a one-time funding fee equivalent to between 0.5% and 3.30% of your loan amount (although some VA borrowers are exempt).
The steps involved with canceling PMI
Again, your conventional loan PMI will automatically drop off once you reach a 78% LTV.
But you can also contact your lender and request that PMI be removed early if your principal loan balance reaches 80% LTV (typically meaning you have earned 20% equity in your property).
“This can happen if your equity and your home’s worth improves, such as if you’ve made extra payments toward your principal, made significant home improvements or renovations, or benefitted from properties in your area appreciating in value more quickly than expected,” says Rose.
To determine your LTV and make a case to your lender, however, you’ll need to have your home professionally appraised, which can cost a fee. Ordering and paying for an appraisal on your own can set you back at least $400, depending on the size and location of your residence.
But that price tag can be worth it if you learn that your LTV ratio is now 80% or lower, in which case your lender should cancel PMI premiums upon request.
Before contacting your lender to ask that PMI be canceled, consider the requirements you likely have to meet first, per the Consumer Financial Protection Bureau:
- You must request in writing for the cancellation of your mortgage insurance.
- You must have a great payment history and be up-to-date on all your payments.
- You may have to show that you don’t have any other mortgages on the home.
- You may have to get an appraisal that proves that your loan balance isn’t more than 80% of the current value of your home.
“Once you submit your PMI cancellation request and fulfill the lender’s guidelines, your lender will review your case and, if you meet their criteria, they will cancel your PMI,” says Shahwan.
Eliminating PMI with a mortgage refinance
Here’s another viable path to canceling PMI: Refinance your mortgage loan.
“If you attempt to refinance a conventional loan with a new loan amount that meets the 80% LTV requirement, there will be no PMI added to the new loan. For example, say your property value has increased and you’ve paid down your principal balance to 80% LTV or lower. If so, you won’t have to worry about paying PMI on the new loan,” Shahwan adds.
If you have an FHA loan, especially one that charges a mortgage insurance premium for the life of the loan, or a USDA or VA loan that charges a guarantee fee or funding fee, it could be worthwhile to refinance to a conventional loan; with the latter, you can automatically eliminate PMI once you reach an LTV of 78%.
The bottom line
It’s important to weigh the pros and cons of a PMI elimination strategy. Yes, you can eventually remove PMI if you pay extra toward your principal to lower your LTV, or if you pull the trigger on costly home improvements to increase your home’s value.
“But sometimes holding onto PMI for a bit longer and investing the money you would use on home improvements or accelerated mortgage payments may be a smarter financial move,” Rose notes.