For homebuyers paying less than 20% down on their home purchase, mortgage insurance is a necessary evil. In many ways this insurance is beneficial because it allows homebuyers to purchase a mortgage with less than 20% down. This insurance protects the lender if the borrower defaults on the mortgage loan buy guaranteeing the lender will receive the amount of the loan that is in default. There are two types mortgage insurance, government loan mortgage insurance (MI) and conventional loan private mortgage insurance (PMI).
Your monthly rate for PMI insurance is based on your credit worthiness just as your mortgage interest rate. The lower your credit score, the higher your PMI payment. The good news for homebuyers is that once your loan to value ratio drops to 80% you are able to cancel the insurance which results in a lower monthly mortgage payment. To calculate the loan to value ratio (LTV), simply divide your mortgage balance by the market value of your home.
Although according to the Homeowner’s Protection Act, your PMI should automatically cancel when the LTV is 78% or less, the borrower will need to request cancellation when the LTV is at 80%. You, as a borrower, should assume the responsibility for requesting this insurance cancellation by sending a written request to the lender once you have proof that your LTV is 80% or lower. If the lender does not respond in a timely manner, re-send your request (always by certified mail), and if the lender does not approve your request,
you may bring an action against them in court.
Most lenders will have specific guidelines about cancellation requests in the PMI policy, so be sure and review the document before attempting the cancellation.
For borrowers with FHA loans the rules are different. Originally the PMI on FHA loans had to be carried for the life of the loan but then the Federal Housing Administration changed that requirement in 2000 since their Mutual Mortgage Insurance Fund had completed a financial turnaround. With this announcement the FHA began allowing borrowers who achieved a 78% LTV to cancel the PMI just like on conventional
Unfortunately in June of 2013, the HUD began instructing lenders that the automatic cancellation of PMI premiums would cease and that any mortgage that was at 90% LTV or greater at origination (most FHA
loans) would be required to maintain the PMI for the life of the loan. For loans that were originated with an LTV less than 90%, the PMI must be maintained for at least 11 years.
Knowing that PMI will be required if the down payment is less than 20%, the borrower should take the cost into consideration when contemplating the home purchase. For example, the cost of the PMI will amount to approximately $45 per month per $100,000 borrowed which translates to an additional $90 per month for a $200,000 mortgage. Since the PMI insurance premiums will be paid over several years of the mortgage, this amount can add to thousands of additional dollars to the loan.
A borrower can avoid paying for PMI by taking out a second loan for the additional amount needed for the down payment. For example, the borrower may elect to pay a cash down payment of 10% and then taking a second for 10% which creates an 80/10/10 loan. The costs of the 1st and 2nd should be considered against the cost of the PMI to determine whether this would be financially beneficial or not. In many cases the PMI is more beneficial to the borrower than detrimental and usually only paid for about two years.