Private Mortgage Insurance (PMI)
What is PMI? How to cancel PMI.
[an error occurred while processing this directive]When your down payment is less
than 20% you usually have to pay for Private Mortgage Insurance (PMI).
This protects the lender in case you don't make your house payments.
This doesn't mean you can blow off making your house payments -- if you
fail to pay, the bank will still repossess your house. The insurance
company will pay the bank the difference between 20% and the amount you
actually put down. If you put down 5% and default, the insurance
company pays the bank the other 15% that you didn't pay.
So the bank gets protected and you get to pay for their
protection. What's in it for you? What's in it for you is that you
get to buy a home for less than 20% down! Used to be that banks
wouldn't give you a loan under any circumstances unless you made a
large down payment because they felt it was too risky. But now with
PMI,
banks will take loans with very low down payments, sometimes even 0%
down. That makes it much easier for you to get into a home.
There's no PMI on VA (veterans) loans, which is a nice
bonus if you qualify for one of these.
You don't shop for PMI. If your lender requires
it, they'll choose it and add it automatically.
The PMI premium is paid monthly as part of your mortgage
payment. The smaller your down payment, the more expensive
the PMI is. My PMI Calculator will give you a good
estimate.
Another way to do it is to divide the loan amount by 1300,
1500, 2300,
or 3700 for loans with down payments of 3%, 5%, 10%, or 15%
respectively. For example, let's say you buy a $200,000 home and put 5%
down. Your down payment is $10,000 and the morgtage is $190,000. Divide
the $190,000 mortgage by 1500 and you get your monthly PMI cost, $127.
Canceling PMI
PMI is usually (but not always) canceled automatically
once you own 22% of
your home. It used to be that the insurance company would keep
happily charging you the premium forever, since many homeowners didn't
know they could cancel. This was obviously taking advantage of the
uninformed homeowner, so now insurance companies are required by law to
automatically cancel your PMI as soon as you own at least 22% of your
home, based on the original purchase price, although in some cases
they're not required to automatically cancel (which we'll cover in a
minute). Assuming you qualify for automatic cancellation, here's how
long it will take to reach 22% equity, depending on the length of the
loan and the interest rate, ignoring any possible appreciation:
Time it takes to own 22% of your home
(for 5% / 10% and 15% down payments)
|
|
Interest Rate
|
15-year Mortgage
|
30-year Mortgage
|
|
6%
|
4 / 3 / 2 years
|
10.5 / 8.5 / 5.5 years
|
|
7%
|
4 / 3.5 / 2 years
|
11.5 / 9.0 / 6.5 years
|
|
8%
|
4.5 / 3.5 / 2.5 years
|
12.0 / 10.0 / 7.0 years
|
|
9%
|
4.5 / 3.5 / 2.5 years
|
13.5 / 11.0 / 8.0 years
|
|
10%
|
5 / 3.5 / 2.5 years
|
14.5 / 12.0 / 9.0 years
|
From this table you might think "Wait a minute -- on
a
30-year loan I should own about half of my house after about 15 years,
but with a 10% interest rate and a 5% down payment you're saying I'd
own only 22%?! What gives?"
The answer is that because of how
mortgage interest works, most of your payments in the early
years goes to interest, not paying down your loan. On a 30-year
loan of $100k at 7%, the payment is $665/mo., but when you make the
first payment, a whopping $583 goes to interest, and a mere $82 goes
towards owning the home. On 15-year loans a much higher percentage goes
towards the home itself, which is why 15-year mortgages are a better
deal if you can get them -- and why you should try to pay off your loan
in 15 years anyway if you can't. There's more on this in our section
about paying off a loan early.
But let's get back to PMI and canceling it. Of
course,
you don't have to wait for the automatic cancellation at 22%. You can
write to the insurance company and ask them to cancel your PMI coverage
as soon as you hit 20% equity.
And here's one more thing you can do: If your house has
increased in value then you suddenly own a lot more of it, and you can
cancel your PMI even earlier. For example, let's say you put $5,000
down on a $100,000 home, and in a couple of years the value shoots up
to $119,000 because it's a hot real estate market. You own the $5000
you put into the house, plus the $19,000 it increased, for a total of
$24,000. (You also own the equity you built from making mortgage
payments, but because of how mortgage interest works, most of your
payments for the first few years goes to interest and not principal, so
we'll ignore paid equity for our example.) So the $24,000 you own
divided
by the $119,000 value of the home means you own over 20% of your home.
So you don't need PMI any more. But to cancel the PMI you'll need to
convince the lender that your home is really worth $119,000 now, so
you'll have to pay for an appraisal which might run $400 or so. You'll
have to weigh the cost of
the appraisal against the amount you'll save by canceling PMI early to
see if it's a good deal for you.
When PMI is canceled automatically
and when it isn't
Don't assume your PMI will be canceled automatically. Check
this table.
|
Canceled Automatically
if ALL are true
|
Not Canceled Automatically
if ANY are true
|
|
Conventional loans
|
FHA loans
|
|
Loan signed on or after July 29, 1999
|
Loan signed earlier than that
|
|
All mortgage payments have been made on time in the year
prior to PMI cancellation
|
Any mortgage payments have been late
|
|
Buyer is not considered high risk
|
Buyer is considered high risk
|
References
- Article
examining the overall advantage of PMI to homeowners, Auburn
University, 1997
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