To put it mildly, refinancing activity has exploded in the past year or so. As you might expect, the main reason is that interest rates are at historic lows. Many borrowers can dramatically reduce their monthly mortgage payments by obtaining a new loan with a lower refinancing interest rate.
However, what if you already have a relatively low mortgage interest rate, but you're paying private mortgage insurance, or PMI, because you put less than 20% down when buying your home? Can you refinance to get rid of this expense? Here's what homeowners with PMI need to know.
Can I refinance to get rid of PMI?
Yes. You can refinance your loan to get rid of PMI. In order to do this, your new mortgage balance must be 80% of your home's appraised value or lower.
If you take out a conventional mortgage and put less than 20% down, your mortgage lender will normally add PMI to your monthly payment. That PMI payment does not protect you, the borrower. It protects the mortgage company in case you fall behind on your mortgage.
In a nutshell, there are two cases where it might be possible to refinance to get rid of PMI. First, if your original mortgage balance was greater than 80% of the home's purchase price, and you've since paid down quite a bit. Or second, if your home's value has increased significantly since you purchased it, and refinancing would result in a loan-to-value (LTV) ratio less than 80%.
For example: Let's say your home was worth $300,000 when you bought it. You took out a mortgage for 95% of the value: $285,000 (and had to pay PMI). But now your house's value has gone up -- it's worth $375,000. You still owe the same amount. But now what you owe is now 76% of the home value, so you don't need to pay PMI.
It's important to mention that refinancing is not the only way to get rid of PMI. Here are some others:
- With a conventional loan, your lender is required to cancel your PMI at the halfway point of your amortization schedule, or when your mortgage balance has reached 78% of the home's purchase price -- whichever comes first.
- You can request PMI cancellation when your mortgage balance reaches 80% of the home's purchase price.
- If you've owned your home for five years or more, you may be able to reappraise the home (which costs around $500) to demonstrate that your loan balance is less than 80% of your home's current value.
All three of these apply to conventional mortgages only. If you have an FHA mortgage loan, different rules apply. It can be very difficult to get rid of FHA mortgage insurance without refinancing.
Is getting rid of PMI enough reason to refinance?
Yes -- in many cases, it's worth refinancing your home loan to get rid of PMI.
But refinancing isn't free. You'll likely have to pay:
- Origination fees
- Appraisal fees
- Other closing costs
Costs can vary dramatically among mortgage refinance lenders, but expect to pay a few thousand dollars to refinance. The question to ask yourself is, "Will savings from refinancing will outweigh the costs?"
Let's say you're paying $200 per month for PMI. You refinance with the exact same interest rate -- but without PMI -- for $6,000 in closing costs. You'll save $200 per month this way. In 30 months, you'll have saved $6,000, the same amount you paid to refinance. It's only after that you'll start seeing the benefits of getting rid of PMI. So, as long as you're planning to stay in your home for longer than that, it could make sense.
Of course, a real-world situation will likely be a bit more complex. The refinancing rates you're offered may not be exactly the same as your current interest rate. And if you replace a mortgage you've been paying down for years with a fresh 30-year loan, you should consider the difference in payoff length.
Is refinancing to end PMI a smart choice for homeowners?
Generally, yes. But like most major financial decisions, refinancing to get rid of PMI depends on your situation.
If you're able to get rid of PMI by refinancing (and it will save you enough money to justify the cost), refinancing can certainly be a smart choice.
Be sure to consider how long you plan to stay in the home, the fees and other costs of refinancing, and other relevant factors before making your decision.
Still have questions?
Here are some other questions we've answered:
The Ascent's best mortgage refinance lenders
Refinancing your mortgage could save you hundreds of dollars for your monthly mortgage payment and secure you tens of thousands of dollars in long-term savings. Our experts have reviewed the most popular mortgage refinance companies to find the best options. Some of our experts have even used these lenders themselves to cut their costs.
FAQs
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If you could save enough money to justify refinancing, it can be a smart idea. For example, if you're paying $200/month in PMI, and the closing costs of a refinance are $2,000, it will take you 10 months to pay for your refinance with the savings from removing PMI.
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Yes -- if the costs of refinancing are outweighed by the savings, it can certainly be a good idea to refinance to remove PMI. If you think you'll move soon, or refinancing your mortgage won't save you money in the long-term, it may not be the right decision for you.
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Yes, getting rid of PMI alone can be enough of a reason to refinance. But you'll get the biggest benefit from refinancing if you can also lower your interest rate.
About the Author
Matt is a Certified Financial Planner® and investment advisor based in Columbia, South Carolina. He writes personal finance and investment advice for The Ascent and its parent company The Motley Fool, with more than 4,500 published articles and a 2017 SABEW Best in Business award. Matt writes a weekly investment column ("Ask a Fool") that is syndicated in USA Today, and his work has been regularly featured on CNBC, Fox Business, MSN Money, and many other major outlets. He’s a graduate of the University of South Carolina and Nova Southeastern University, and holds a graduate certificate in financial planning from Florida State University.
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