How To Remove PMI: 3 Options To Consider

One of the main barriers to buying a home is coming up with a 20% down payment needed to secure a conventional mortgage. If a buyer doesn’t have the 20% down payment that mortgage lenders want to see, then he or she will have to make PMI (Private Mortgage Insurance) payments until they reach a certain mortgage balance. Here is how PMI works and some to remove it from mortgage payments.

What is PMI and how does it work?

Private mortgage insurance is required by mortgage lenders when the borrower’s down payment is not large enough (usually 20 percent). Sometimes, PMI is also required when a person tries to refinance a home with less than 20 percent equity built up. Additionally, government-backed loans also charge mortgage insurance.

Lenders’ reasoning for charging PMI is simple; they want to protect their investment when a borrower’s down payment isn’t big enough in case the borrower can’t make payments. It’s basically an insurance policy for the lender if the borrower defaults on their mortgage. There are no real benefits to borrowers other than it allows them to qualify for a mortgage when they normally wouldn’t meet approval standards.

In the lenders eyes, the lower a down payment then the riskier the loan because the borrower needs to take a larger loan to cover the value of the home, which results in a higher payment. Factor in less equity available in the property, then it’s easy to see why a lender could end up taking a loss if a borrower ends up defaulting.

How much does PMI cost?

PMI is usually applied to a mortgage payment when the loan to value is under 20 percent. For example, if a home was purchased for $400,000 and you only put down 10 percent, or $40,000, that would mean there is a loan to value of 90 percent, requiring a borrower to pay PMI. As discussed below, PMI would be in effect on this particular loan until there have been enough mortgage payments made to reach a loan balance of $320,000

Conventional mortgage loans factor a PMI payment based on a percentage of the original loan amount; generally ranging from 0.3 to 1.5 percent, depending on your credit score and down payment. For example, on a $400,000 mortgage, a 1 percent PMI fee would cost you $4,000 per year, or $333 per month.

Ways to get rid of PMI

Pay down the mortgage

Since PMI is designed to protect the lender from the risk associated with a borrower putting less than 20% down on their loan, simply paying your mortgage over time will result in PMI being removed from your loan.

• Pay down the mortgage to 80 percent of the purchase price: Simply take the price paid for the home and multiply it by 80%. If the mortgage is paid down to that amount, PMI can be removed. According to the Consumer Financial Protection Bureau (CFPB), you must also meet the following criteria to have the PMI removed:
  • Your request must be in writing.
  • You must have a good payment history and be current on your payments.
  • Provide evidence that the value of your property has not decreased to the value of the home when you first bought it. Because of this requirement, values in the area of the property should be checked before asking to remove PMI
• Pay down the mortgage to 78 percent of the purchase price: Once the mortgage reaches a 78 percent loan to value ratio, then the mortgage company is required to automatically drop PMI from a borrower’s loan. The only stipulation is that a borrower must be current on their loan payments. This is because of the Homeowners Protection Act which legally requires lenders to remove PMI from conventional loans.
• Wait until the midpoint of the mortgage term: Paying the mortgage on time for half the time period of the loan is also another way to automatically eliminate PMI. For example, if a borrower took out a 30 year mortgage, with PMI attached to it, then the PMI would automatically be removed once the borrower has been making timely payments for the last 15 years. Additionally, it’s beneficial to note that the PMI will be removed after 15 years regardless if the loan has reached 78 percent loan to value.

Refinance the mortgage

Now that mortgage rates are low, borrowers might consider refinancing to lower their interest rates in an effort to save money on their monthly payments. Additionally, if a borrower is paying PMI, then refinancing might be a way to remove it from the mortgage payment, assuming the new mortgage balance is lower than 80% of the purchase price. This can be a way to double down on savings! Refinancing works really well if a home has gained substantial value since a borrower made the initial purchase. 

For example, if a home was purchased 5 years ago with only 10 percent down, and the home’s value has risen 20% since then, the borrower now owes less than 80 percent of what the home was purchased for. Under this scenario, the borrower could refinance into a lower interest rate and at the same time, remove PMI from the loan. 

Refinancing also works well if the borrower is weighing the closing costs associated with the transaction against the savings or a lower interest rate and eliminating PMI.

Prove the value of the home has risen

The last option for removing PMI from a loan is by proving the outstanding balance on the mortgage is 80% or less of the current value of the property. This can happen because the borrower followed the above steps and paid down the loan or because property values have been increasing in the area.

It’s a good idea to do a little research before attempting to prove this to the mortgage company. The best route would be to get a feel for property values by talking to a local real estate agent or looking online at various websites that give an estimated value.

The next step is to contact the mortgage company that is carrying the loan to get appropriate paperwork necessary to remove PMI. There will be a checklist of requirements that will need to be followed for it to be successful, including ordering an appraisal.

The appraisal will prove that the property is now worth more than its original purchase price. However, it’s going to cost anywhere from $300 – $1000 for a professional appraiser to look at the property so it’s important to factor that in. 

Additionally, it’s important to check with a lender to ensure there aren’t any terms or conditions around removing PMI too early. Some lenders require a borrower to have paid on the mortgage for two years and also on-time payments before PMI can be considered for removal. It’s important to not pay for an appraisal until there is clarity around what can and can’t be done.