Homeowners who cannot put down at least 20 percent of the total cost of a home mortgage are typically required to purchase private mortgage insurance (PMI). At closing, the homeowner may be required to make a PMI payment of 1.75 percent of the total loan, with 0.85 percent of the total charged in the monthly mortgage payment. The rationale behind PMI is that it protects lenders against default on an FHA loan. But in practicality, it can add a $100-$200 per month on payments.
The Homeowner's Protection Act (HPA) of 1998 requires the lender to cancel PMI when the owner has paid down the balance to 78 percent. However, owners have the right to request cancelation of PMI when they reach 20 percent equity in the home. In other words, it's up to the consumer to take action to cancel mortgage insurance and save on payments as soon as possible. But they must meet certain conditions.
Qualifying to Cancel Mortgage Insurance
For homeowners with FHA mortgages closed on June 3, 2013 or later, PMI is cancelled when they attain 78 percent loan-to-value (LTV) ratio based on the "last known value" – most likely the original value at closing. This can take at 10 years or more for an owner with a 30-year mortgage and several years for those with 15-year terms unless they prepay on the loan to retire it more quickly. Under law, the lender must tell the consumer the length of time or number of payments required before qualifying for PMI cancellation.
To get an idea of how close they are to qualifying, consumers should divide their current loan balance by the appraised value on the mortgage. For example:
Current balance: $225,000
Original appraised value: $280,000
Current LTV: 80%
There ways to reach the cancellation levels more quickly. Borrowers can make improvements and ask for a new appraisal. Depending on the lender, if the consumer has made timely payments consistently (no more than 30 days late) since the mortgage was approved, the current appraisal may be used in lieu of the original sales price. When considering a cancellation, owners should contact the lender, Fannie Mae, or Freddie Mac to see if they qualify. It's also crucial to contact the consumer protection agency in their state to determine if there are any requirements or penalties for cancelling PMI early.
Other Options to Cancel PMI
Another way to eliminate the requirement for PMI is to refinance the mortgage. If the value has increased sufficiently, the new or same lender may approve refinancing without requiring PMI. But it's incumbent to determine whether new financing costs outstrip any potential savings of eliminating PMI. Estimate new payments using LendingTree's Refinance Payment Calculator.
Many homeowners benefit from refinancing from an FHA mortgage to a conventional loan. Not only can they reduce or eliminate PMI entirely, they may get better rates. VA loans are government insured and FHA loans ae backed by insurance over the lifetime of the mortgage. With Fannie Mae and Freddie Mac loans, regulations permit PMI at lower rates than in FHA mortgages, and mortgage insurance cancels automatically when the equity reaches 20 percent. Another boon is that the PMI on conventional loans adjusts downward as the equity rises for owners with at least 5 percent equity. Again, it's up to the consumer to request cancellation of PMI with these Fannie Mae and Freddie Mac products.
Those looking at refinancing options can compare mortgage offers to determine potential savings.