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What Is Exactly PMI And When Should You Get Rid Of It?
Home mortgage lenders are an interesting group within the real estate industry. It seems they are happy to lend anybody money. Assuming a half-way decent credit rating, any potential home buyer can secure a loan for a house. Why? Because these transactions are secured by a very valuable asset: the home itself. If a borrower defaults on a loan, the risk for the lender is often only the difference between the value of the home and the amount outstanding on the loan, less the amount it costs them to foreclose and resell the property.
For this reason, home mortgage lenders are very wary of lending more than a certain percentage of a home's value. Traditionally, this has been 80 percent. The cushion this provides the lender helps ensure that their losses from loan defaults are kept to a minimum.
However, in recent years, it has become increasingly more common for home buyers to use down payments of 10, 5 or even 0 percent. Naturally, loaning this much presents the lenders with a lot more risk. To offset this risk, these transactions often require "Private Mortgage Insurance" or "PMI." This supplemental policy protects the lender in case a borrower defaults on the loan, and the value of the house is lower than the loan balance.
PMI has been a large money-maker for the home mortgage lenders. The amount of the insurance - often $40-$50 per month for a $100,000 house - is commonly rolled into the mortgage payment. Given the size of the overall payment, this additional fee is often overlooked by homeowners. They continue paying the PMI even after their loan balance has dropped below the original 80 percent threshold. This occurs naturally, of course, as the homeowner pays down the principal on the loan. On a typical 30-year loan, however, it can take many years to reach that point.
Until recently, mortgage lenders were under no obligation to tell homeowners when they had reached a point where the PMI can be dropped. That all changed in 1999, when the "Homeowners Protection Act" took effect. In most cases, this law now obligates lenders to terminate the PMI when the principal balance of the loan reaches 78 percent of the original loan amount. Savvy homeowners can get off the hook a little earlier. The law stipulates that, upon request of the homeowner, the PMI must be dropped when the principal amount reaches only 80 percent!
It is important to note that this law only applies to home loans - whether first time or refinances - that closed after July, 1999. Also certain other conditions must be met, such as being current on the loan payments. Buyers that purchased before July 1999 can also have their PMI removed, but they must initiate the process and though the lender is under no obligation to do so, most will.
Of course, there is another way that homeowner's equity can reach beyond the 80/20 percent ratio. Many areas of the United States have seen significant gains in the value of real estate over the past decade. In fact, certain areas have seen appreciation levels of 100 percent or more. Even those people living in areas with more modest gains may find that the value of their property has quickly grown to the point where the amount of principal they owe on their loan is less than 80 percent of the home's current value. Again, in these cases, the mortgage lenders are under no legal obligation to remove the PMI. In most cases, however, as long as the homeowner has been prompt on their loan payments and does not represent an exceptional risk, the mortgage lenders will agree to remove the extra fees.
The hardest thing for most homeowners to know is just when does their home equity rise above this magical 20 percent point? Well, a certified residential real property appraiser, such as, Albert Marshall Cheney, Cheney Appraisal Services, can certainly assist you in determining if your current mortgage loan will qualify for PMI removal. It is the appraiser's expertise in understanding the market dynamics of their local or metro area. They know when real property values have risen, or declined, within their particular market area of expertise. Many appraisers offer specific services to help customers find the value of their homes and remove PMI payments. Faced with this data, the mortgage company will most often eliminate the PMI with little trouble. The savings from dropping the PMI pays for the appraisal report in a matter of months. At which time, the homeowner can enjoy the savings from that point on.
Cheney Appraisal Services is always very interested in assisting the homeowner with as much information as possible. Therefore, please consider these additional online informational pages on "PMI" and the "Homeowners Protection Act" by clicking on the below links:
Cancellation of Private Mortgage Insurance: Federal Law May Save You Hundreds of Dollars Each Year
Private Mortgage Insurance (PMI): Law Requires Lenders to Cancel PMI
Also, here is another article explaining PMI:
The Basics of Private Mortgage Insurance (PMI)
By Bankrate.com
If your down payment on a home is less than 20 percent of the appraised value or sale price, you must obtain private mortgage insurance, known as PMI, with your lender. This will enable you to obtain a mortgage with a lower down payment because your lender is now protected against any default on the loan.
PMI charges vary depending on the size of the down payment and the loan, but they typically amount to about one-half of 1 percent of the loan, according to the Mortgage Bankers Association of America. Mortgage insurance premiums are not tax deductible.
Example
Let's say you put down 10 percent or $10,000 on a $100,000 house. The lender multiplies the 90 percent loan, or $90,000, by .005. The result is an annual PMI of $450, which is divided into monthly payments of $37.50.
Most home buyers need PMI because 20 percent of the sale price on a home is a lot of money; for instance, that's $20,000 on a $100,000 home. Home buyers must maintain the PMI premiums until they cross that one-fifth-of-principal threshold, a process that can take years in longer-term mortgages.
Tip
Keep track of your payments on the principal of the mortgage. When you reach the point where the loan-to-value ratio hits 80 percent, notify the lender that it is time to discontinue the PMI premiums. The Homeowners Protection Act of 1998, which took effect in 1999, requires lenders to tell the buyer at closing how many years and months it will take for them to reach that 80 percent level and cancel PMI. Lenders must automatically cancel PMI when the balance hits 78 percent.
Note: The law does allow lenders to continue requiring PMI all the way down to 50 percent equity for so-called high-risk borrowers. Traditionally, those loans that are considered riskier include reduced documentation loans, in which customers provide less proof of income and other information during the approval process. Loans for people with spotty credit histories and higher debt-to-income ratios also fall into this category. Additionally, some FHA loans require payment of PMI throughout the entire life of the loan.
Ways to avoid PMI
In today's market, there are some new ways to avoid mortgage insurance even when you don't have the standard 20 percent down payment.
Pay more interest: Some lenders will waive the mortgage insurance requirement if the buyer accepts a higher interest rate on the mortgage loan. The rate increases generally range from .75 percent to 1 percent, depending on the down payment. The advantage is that mortgage interest is tax deductible.
Using an "80-10-10" loan: This program involves two loans and a 10 percent down payment. The 90 percent loan is financed with a first mortgage equal to 80 percent of the sale price, and a second mortgage for the remaining 10 percent of the sale price. The second mortgage has a higher interest rate but since it applies to only 10 percent of the total loan, the monthly payments on the two mortgages are still lower than paying one mortgage with mortgage insurance. Plus, again, there is the advantage of mortgage interest being tax deductible.
Example: If we compare the purchase of a $100,000 home under the "80-10-10" plan with a standard fixed mortgage including PMI, we find that the former is $17.45 cheaper each month.
Here's how it works. Under the "80-10-10" plan, the 10 percent down payment on a $100,000 house is $10,000. The first mortgage is $80,000 at 7.50 percent, which comes to a monthly payment of $559. The second mortgage for $10,000 has a 9.50 percent interest rate, making a monthly payment of $84. Total monthly payments of the two loans: $643.
With a $10,000 down payment, one mortgage of $90,000 at 7.50 percent has a monthly payment of $629, plus PMI of $31.45, making a total payment of $660.45.
This page was provided by Albert Marshall Cheney with Cheney Appraisal Services in the Mobile Bay Metro Area, Baldwin and Mobile Counties of Alabama. You may contact Al Cheney with your additional questions at 251 533-2424 or email at Albert@CheneyAppraisalServices.com.
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