If you finance a home with a conventional loan and less than a 20 percent down payment, the lender will require you to purchase private mortgage insurance. The cost of PMI adds significantly to your mortgage payment, and dropping the insurance can save you hundreds of dollars a month. You can start trying to get PMI off your loan when the loan-to-value ratio hits 80 percent.
Federal Law Requires PMI Removal
As noted on the federal Consumer Financial Protection Bureau website, the Homeowners Protection Act provides for the removal of PMI when certain conditions are met. Under the law, a homeowner can request cancellation of PMI when the loan balance falls to 80 percent of the home's value at the time the loan was originated. The request to cancel must be made in writing and the lender can require that the homeowner provide proof of the home's current value and that there is not a second mortgage. When the loan-to-value ratio reaches 78 percent, the law requires the lender to terminate PMI coverage and the cost to the homeowner.
Two Ways to Determine Loan to Value
The PMI cancellation or termination rules percentages are based on the loan balance compared to the home's value when the loan was originated. For example, if you purchased a $200,000 home with 5 percent down and a $190,000 mortgage with PMI, the LTV ratio hits 80 percent when the loan is paid down to $160,000 and 78 percent when it is paid down to $156,000. If your home has increased in value, you may hit the 80 percent LTV quicker. You can request PMI cancellation with proof of home value -- a paid-for appraisal -- and the lender may accept your cancellation request.
The 2 Percent Difference
The difference between the point at which you can request cancellation and the point at which cancellation is mandatory may not seem like much. However, with a 30-year mortgage, it takes quite a few payments to pay off 2 percent of the value. For example, with a 5 percent mortgage rate, it will take about 12 payments to move your LTV needle from 80 to 78 percent. Multiply the amount you pay for PMI insurance each month times 12 and then decide whether it makes sense to request cancellation of the insurance at 80 percent.
Borrower and Lender PMI Requirements
As part of your original mortgage paperwork, the lender should include a disclosure form that states when -- with according to the payment schedule -- you will pay your loan down to 80 percent of the home's value. If you make extra principal payments you will pay off the loan quicker and need to make your own calculation to determine when you hit 80 percent. PMI will not be canceled or terminated if your mortgage payments are not current.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.