Let’s talk about the PMI. You will learn what is it, and also how you can ask your lender to drop it, saving you money! And I show you a small trap nobody talks about, or at least it is not clear enough.
You can also watch my video “Private Mortgage Insurance (PMI): How to get rid of it? Save hundreds of dollars!” on my YouTube’s channel. Check it out!
What is a Private Mortgage Insurance, a.k.a. PMI?
First, what is a PMI? PMI stands for private mortgage insurance. Its purpose is to protect the lender, in case you do no pay your loan.
You can have a private mortgage insurance only in the case of a conventional loan. If you have an FHA or VA mortgage, there is no PMI. In the FHA case, you have a MIP, mortgage insurance premium, which is an upfront charge of 1.75% of the loan amount for a 30-year mortgage, plus you can have an additional mortgage insurance premium, up to 1.55% a year. I will talk about FHA loans in another video.
So in a conventional loan, the lender prefers not to finance more than 80% of the value of the property. Why? Because in case a borrower does not pay the mortgage, the lender may have to foreclose and sell the property. By lending only 80% of the value, the lender has some room in case the market declines to sell the property and still not lose money. A lender hates losing money.
How does the lender estimate your loan-to-value ratio?
Do you know how the value of a property is estimated? It is not merely the price you pay. The lender will want to have an appraised value; then he takes the lower of the sale price and the appraised value to have the value on which he will compute the loan-to-value ratio or LTV.
And to avoid a PMI, you have to have a loan-to-value ratio of 80% or lower. If you don’t, you may still get a conventional loan with a LTV as high as 95%, but you have to pay a PMI. Please check with your lender.
Let’s take an example: You negotiated the price of a house to $400,000. You have a down-payment of $40,000, so you want to borrow $360,000. The appraiser comes and says the value of the property is $500,000. You make a terrific deal! Congratulation, at the closing you have $140,000 equity! So are you off the hook for the PMI? $360,000 divided by $500,000 is a loan to value of 72%? No! The lender will take $400,000 as original value to calculate the LTV, so you get 90%, and you have a PMI.
Another example: the same property, but the appraisal comes back at $379,000. You have a loan to value of 95% and a PMI. Remember, you take the minimum between the appraised value and the price you pay.
What are the payment options for a PMI?
Now how does the PMI work? Usually, you pay each month an insurance premium with your mortgage payment. The PMI costs depend on numerous factors: your credit score, the loan amount, the terms of the loan, the loan-to-value ratio, and the type of loan.
You may choose three other payment options for the PMI: You can prepay the private mortgage insurance at the origination by paying a lump sum, you can have the lender to pay for the PMI in exchange for a higher interest rate, and you can have a split premium: you pay a portion of the PMI as a lump sum at the origination plus small monthly payments. The last one is not very common.
How can you stop paying a PMI?
1. When your loan-to-value hits 80%
You do not pay the PMI for all the life of your mortgage. You can ask your lender, in writing, to drop it as soon as your loan-to-value goes down to 80% and you are both current on your payments and have a good payment history. Your lender will ask for an appraisal of your property and may ask you to certify that you have no junior liens on your property, such as a second mortgage, or a HELOC.
If everything is okay, no more PMI for you!
There are many ways to get to the 80% loan-to-value ratio quickly. You can improve your property, raising its value, and at the same time, mathematically decreasing the LTV ratio. Or you can prepay your mortgage. And the last one, without any action from your part, the market goes up. As tide lifts all boats, so the value of your property is going up. And the loan-to-value ratio goes down.
2. When your loan-to-value reaches 78%
2.1 You are current on your mortgage payments
When the LTV of your property goes below 78%, and you are current on payments, your lender is required by law to drop the PMI. Pay attention! Here is the trap I talked about in the introduction! The lender as to terminate the PMI at the date your loan-to-value goes to 78% as defined in the original mortgage payment schedule. It is not the actual date your loan-to-value goes to 78%.
Let me explain! You prepay your mortgage every month by a small amount, let’s say $50. The actual date you PMI is hitting the 78% loan-to-value ratio occurs 6 months earlier than initially planned. Will your lender drop the PMI 6 months earlier? No! He will ask for proof that the property has not declined in value, so a new appraisal you have to pay.
So factoring in the cost of the appraisal, it may not be financially advantageous to ask for the cancelation of the PMI. So, in that case, you may want to pay 6 more months of PMI if it is cheaper.
Though, you may ask your lender if he accepts a BPO instead of an appraisal. A BPO is a Broker’s Price Opinion and is generally less expensive than an official appraisal because it is not an official appraised value. So if your lender accepts it, you may try to get a BPO.
2.2 You are NOT current on your mortgage payments
What happens when you are not current on your payments on the date the LTV reaches 78% on the initial amortization schedule?
In that case, your real LTV is over 78% on that date, since you missed some payments. You have to bring your payments up to date, and then your lender will cancel the PMI.
3. When you refinance
Another way to remove a PMI is to refinance your mortgage. With the interest rates going down recently, it may be an advantageous option. You both get rid of your PMI and lower your monthly payments.
4. When you reach the midpoint of the term of your loan
The other case of termination is when you reach the midpoint of the term of your loan (15 years on a 30-year mortgage), if you are current on your payments, the lender has to terminate the PMI, this last case is chiefly for loans that are not fully amortized.
To summarize you have to pay a PMI if your loan-to-value on a conventional loan is higher than 80%. You can request, in writing, to cancel your PMI as soon as your loan-to-value goes down to 80%. The value, in that case, being an appraised value of your property at the current market condition. However, you have to have a good payment history and be current on your payments. Your lender may ask you to pay for an appraisal, or in some case accept a BPO. He may also require that you have no junior liens. If you are current on payments, your lender is required to drop the PMI at the date your LTV reaches 78% on the initial amortization schedule, not the date it reaches 78%, if it is earlier.
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