It is perhaps the greatest boon to home buyers since the invention of the 30-year fixed-rate mortgage after World War II.
In the past 12 months, more than 1.2 million families purchased a home using private mortgage insurance (PMI), according to the Mortgage Insurance Companies of America (MICA), a non-profit trade association based in Washington, DC.
That’s as much as 10 years sooner than a home buyer would have been able to purchase a home if he or she had to scrape together a 20 percent down payment, notes Jeff Lubar, a spokesperson for MICA.
But while private mortgage insurance (PMI) has helped millions of first-time buyers purchase a home without having saved the requisite 20 percent in cash for a down payment, it is expensive.
On a home priced at $133,300, the average price of a home in 1999 according to the National Association of Realtors, PMI would cost $480 to $840, depending on the amount of the down payment. That’s four-tenths of a percent to 1 percent of the sales price of the home.
And, it never ceases to confuse, frustrate and even anger some consumers who feel that they’re overpaying for the service PMI provides.
In recent letters to this column, consumers have complained that lenders are making it even more difficult to cancel PMI, despite recent legislation that supposedly created a law to regulate the cancellation of this insurance policy.
The truth is that the law is confusing, perhaps even more so than before, says Vicki Vidal, director of loan administration for the Mortgage Bankers Association of America (MBAA).
“We (the mortgage bankers) wanted one cancellation period. We wanted all PMI to cancel at 20 percent,” Vidal says.
Instead, consumers are left with a complicated assortment of cancellation requirements. For example, if your lender resells your loan to Fannie Mae or Freddie Mac, as most loans are, the company that services your loan must follow Fannie Mae or Freddie Mac’s PMI cancellation guidelines.
According to Vidal, if you are paying down the principal loan balance, you’ll be able to cancel your PMI once you’ve reached the magic 20 percent equity in your home, and if you have an excellent payment history.
But you’ll have to pay for an appraisal (the lender chooses who will appraise your property) to make sure your property has not declined in value. You should expect that appraisal to cost $300 to $450, depending on where you live in the country.
If you are trying to cancel your loan based on price appreciation, you’ll have to jump through some additional hoops, in addition to paying for the appraisal.
For example, if you live in a single family home, condo, or townhome and want to cancel PMI but have only had your loan for five years or less, you’ll need to have at least 25 percent equity in your home. That’s equal to a 75 percent loan-to-value ratio (LTV) before the lender will permit you to drop PMI.
Why do you need more equity? The basic principal at work is: “What goes up may go down.” Lenders have to be sure that the dramatic rise in home value isn’t due to a speculative bubble that might burst. The extra 5 percent equity gives them security that even if your home’s value deflates a bit that you’ll still meet the 20 percent threshold.
Once you’ve hit the 5 year mark, you’ll only need an LTV of 80 percent to be able to cancel your PMI.
If you own a 2 to 4-family property that you live in, or a 1-4 family investment property, loans bought by Fannie Mae require that the property reach 70 percent LTV before you can drop PMI. If your loan was bought by Freddie Mac, Vidal says, you’ll need to reach 65 percent LTV before you can get rid of PMI.
“If your loan has been portfolioed by a bank, that is, the bank is holding onto it, you may face different requirements for dropping PMI,” explains Vidal.
In two situations, you can never drop your mortgage insurance, notes Vidal.
First, if you chose to have the lender pay your mortgage insurance in exchange for a slightly higher rate on your loan, you will never be able to get rid of the PMI. You’ll also have to refinance to get rid of it.
Second, borrowers with FHA loans can only get rid of mortgage insurance by refinancing the loan. As long as you have an FHA loan, you’ll have to pay mortgage insurance.
Some of the lender’s requirements for dropping PMI seem a bit onerous, considering that you could just refinance your loan. Vidal says that for some consumers, coming up with the cash to close on a refinance could be difficult. Also, the interest rate may be higher than you’re paying.
How should you know if it’s worth refinancing to get rid of PMI? Take out a pencil and add up the difference between how much you’ll save monthly on a new loan without PMI. If you can pay off your closing costs before you’d sell your home, it’s probably worth it.
For example, one reader wrote that he’s paying $1,800 per year for his PMI policy. If he can refinance his loan and get rid of PMI, and it will take less than two years to pay off the closing costs, it’s probably a great deal. On a 30-year amortization schedule, it could take 10 years or longer to reach the 80 percent LTV threshold.
Finally, the new law, with its automatic PMI cancellation policy, applies only to loans closed on or after July 29, 1999. For home loans closed before that date, lenders are not keeping track of where you are in your amortization schedule, which is key to canceling PMI when you reach 78 percent LTV.
Published: Jun 5, 2000