Private mortgage insurance (PMI) sounds like something that's of benefit to you as a homeowner. It's not, and once you have to pay it, you'll almost immediately begin asking how to stop paying PMI. There's an easy answer. All you have to do is get to where you only owe 80% of the loan value, and you can ask for it to be removed.
Whether you pay PMI has nothing to do with your credit score (though you may pay a higher rate if yours isn't up to snuff). It's not even tied to whether you have a good payment history. Instead, it's all about your loan-to-value ratio. If you owe more than 80% of your home's value, you will be paying PMI. Once you get down to owing 80%, you may be able to get rid of PMI, and when your balance drops to 78% of your home's purchase price, assuming you have a conventional loan, your lender is legally obligated to remove PMI.
Insurance seems like something you can't have enough of when you buy a home, but this type of insurance doesn't help you, the person who owns the home. Instead, the PMI payments you make are something you pay for that benefits your bank or mortgage lender.
This isn't insurance that pays your mortgage if for some reason you can't. It's insurance that protects your lender's investment if you fail to make your payments. Basically, PMI is you paying for something that you get no benefit from -- and who would willingly do that if they had a choice?
How can you get out of paying PMI?
In most cases, when you buy a home with a down payment of less than 20% of the purchase price, you have to pay PMI. If your down payment gives you more than 20% equity, then congratulations -- PMI probably won't be something you have to worry about.
Many homebuyers, however, can't afford to make that large of a down payment at the time of purchase. It's possible, though, to make extra payments to the principle to reach that threshold. Over time, if the value of your home rises, that may also help you reach 20% equity more quickly even if you don't make extra payments.
The problem is that your lender won't simply remove PMI when you hit the 20% equity mark. You have to ask, and the lender can say no -- for a while. A lender has to drop PMI when you reach 22% equity based on the original purchase price of the home.
There are, however, two other ways to get rid of PMI. Both generally require the value of your home to have risen:
- Refinance your mortgage: A new lender may be willing to negotiate on PMI or a new, higher valuation may make it no longer relevant if it gives you the required equity.
- Get a new appraisal: If your home goes up in value, then you have more equity. Your lender won't take your word on that, so you will need to pay for a new appraisal to establish that you have reached 20%.
Don't forget to ask
“PMI can cost anywhere from 0.41% to 2.25% and is largely determined by your credit score, loan-to-value (LTV) ratio, and debt-to-income (DTI) ratio,” according to Millionacres writer Liz Brumer-Smith.
That's not a small sum of money. In fact, if you borrow $225,000 and pay 1% in PMI (a pretty reasonable rate), you will pay $187.50 per month for PMI (or $2,250 a year). In exchange for that cash, you get exactly nothing. Most homeowners would consider that a bad deal and would work to be able to stop paying as soon as possible.
Make extra payments to get to 20% equity as fast as you can, and monitor whether home values go up in your area (you can get a rough view by looking at what similar homes sell for). Stay on top of these things, and you should be able to get out from under paying PMI sooner rather than later.
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