Private mortgage insurance allows you to buy a home with less than 20 percent down. You pay for the PMI in your monthly mortgage payment at a cost of about half a percent of the total loan value. You may be surprised that you actually get no insurance coverage — the lender gets the insurance if you default on the mortgage loan. Even though the value of your home may drop, the cost of the insurance remains the same — until you try to refinance.
Private mortgage insurance isn’t required forever. The Homeowner’s Protection Act looks out for you. When you’ve paid 20 percent of the principal, federal law requires that your mortgage company notify you and review your qualifications to remove the PMI coverage. If you’ve paid diligently on the mortgage, you may be pleasantly surprised that your monthly payments decrease by $50 or so when you reach this point. This Act doesn’t apply to some Federal Housing Administration mortgages, known as FHA loans, even if you’ve been diligent and have a good payment record.
When you refinance your home, you and the lender will get a chance to revise the numbers. This includes a new appraisal that establishes whether your home has gone up or down in value. The lender uses the loan-to-value ratio to calculate if you’ll have to pay PMI insurance. If you need a $100,000 mortgage and the house value is $150,000, you’ll probably escape the PMI snare since you have 33 percent equity based on the loan-to-value ratio of $100,000 to $150,000, or 67 percent. If you’re upside down on your mortgage, your loan is greater than the appraised value of the house.
If your home decreases in value and you refinance, PMI may be required based on the new figures. For example, your house may have appraised at $150,000 originally and is now valued at $100,000. You may have paid $30,000, or 20 percent down, and financed $120,000 on the original mortgage. Now, your house is valued at $100,000 and you still owe say, $110,000. Applying loan-to-value ratio again, you'll have to finance $80,000 or less to avoid PMI.
Some lenders will skip the PMI for a higher interest rate on the loan. Bankrate suggests that the interest rate is 3/4 to 1 percent higher, depending on the down payment amount. This option appeals to young couples who want to take advantage of the tax benefit, as interest on the mortgage is tax deductible. PMI is not. You can request to recast your mortgage and pay down on the principal, with the same interest rate. Some lenders require a minimum of $5,000 for a recast, and you get a lower monthly payment with only about $250 in closing costs. This payment on the principal may be enough to get you below the 80 percent loan-to-value ratio and allow you to drop the PMI. Until lenders discontinued most second mortgages, an 80-10-10 mortgage was an acceptable way to avoid PMI coverage, even with decreasing home values. These “piggyback loans” have a first mortgage at 80 percent of the purchase price and the second mortgage for 10 percent of the loan, with the borrower paying 10 percent down. With the first loan at 80 percent of the value, the lender requires no PMI.
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