Lenders offset the risk of financing borrowers with minimal equity in their home by offering them private mortgage insurance, or PMI. The coverage benefits your lender, allowing it to file a claim and gain reimbursement if you default and your lender can't sell the home for enough money to recoup its losses. Your lender considers your home's closing price, or original loan balance, and its appraisal price, or value, before it agrees to cancel PMI.
The original loan balance you obtained upon closing the loan with PMI matters to your lender when considering you for PMI cancellation. Your lender is interested in how much equity you have actively built in your home by paying down your loan balance. Lenders can also cancel the coverage based on the equity gained from rising home values, as determined by a formal appraisal. Because this is a weaker indicator of your ability to successfully repay the debt, lenders are usually less willing to cancel PMI based solely on a new appraised value.
The loan-to-value ratio, or LTV, represents the percentage of a home's appraised value that is financed. To determine the LTV, your lender divides your loan balance by your home's value. The LTV is represented as a percentage, rather than a decimal figure. In general, you must put 20 percent down on a purchase, which results in an 80 percent LTV, or you must refinance with at least 20 percent equity, to avoid PMI. Likewise, your lender requires 20 percent equity or more, plus a good repayment history of at least two years, to cancel PMI coverage.
Closing Price Cancellation
A federal law known as the Homeowners' Protection Act stipulates that your lender must automatically cancel PMI coverage when you pay the loan down to 78 percent of its original loan balance. The lender determines that you have met the 78-percent benchmark based on your loan amount at origination, rather than the home's closing price. Lenders typically state when you can expect to reach this point in a PMI cancellation disclosure document that you sign at closing. The law applies to PMI borrowers who obtained loans after July 29, 1999.
To convince your lender to cancel your PMI based on an increase in your home's value, you'll often need an LTV of 80 percent of the appraised value. An appraisal report compares your home to nearby homes with similar characteristics which have recently sold. It gives the lender a good idea of what is can sell your home for if you end up in foreclosure. The cancellation process, which is not guaranteed and has rules which vary by lender and PMI companies, involves paying for an appraisal out-of-pocket. Depending on the type of appraisal required by your lender and your property type, appraisals can cost between $200 and $600.
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