How to cancel PMI (mortgage insurance)
One questions I often get from clients buying a home or refinancing with less than 20% down or 20% equity is “how do I cancel PMI on my mortgage?”. PMI is a benefit to both the lender and, though harder to recognize, the borrower. Without mortgage insurance companies, borrowers would be required to put down a much greater down payment or have much more equity in their homes to refinance to draw on equity or reduce interest owed. Currently mortgage insurance is tax deductible for most people too, so though it’s an inconvenience to see that large payment on a mortgage statement each month, the benefits shouldn’t be ignored.
What is PMI?
Mortgage insurance, or PMI (Private mortgage insurance), is an insurance policy paid for by those borrowing money for a mortgage with less than a 20% down payment or 20% equity in their home. This insurance policy covers a lender from catastrophic losses should a borrower default. Think of it this way: If a lender were forced to foreclose on someone that had put down 20%, equity would likely cover the lender’s losses, at least mostly. But if a borrower put 5% or less down? Between legal fees, taxes, insurance, and other carrying costs, a lender is likely to lose a lot. In a depreciating market, they could lose a huge portion of their money. Mortgage insurance “bridges the gap” by insuring the lender for a portion of the loan amount, so if a borrower were to default, the lender may still have losses, but the insurance policy at least mitigates them.
How to cancel PMI
Logic says that if a PMI policy needs to be in place to cover lenders against catastrophic losses on low down payment/low equity financing, then once equity accrues and there is a lot of space between what a borrower owes and what a house is worth, the PMI should no longer be necessary. In fact, this depends on the type of loan. Currently, FHA mortgages carry PMI that cannot be removed by a borrower without paying off a mortgage in its entirety (usually via a refinance), but on conventional loans, PMI can be removed from a loan without the costs associated with a refinance (although, sometimes a refinance makes more sense – it’s always a good idea to check with your loan officer). How & when PMI can be removed is determined by a few things.
Cancelling based on original home value
Borrowers can cancel their PMI based on the original value of a home at the time they purchased or refinanced IF
- they make enough payments to get to 80% of the original value on schedule
- they make additional payments to get 20% equity based on the original appraised value/purchase price
Typically, with this type of cancellation a borrower should reach out to their lender in writing, and they shouldn’t expect much cooperation if there are any 2nd mortgages/liens against the property. A lender wants to see plenty of equity before they give up the security blanket of a PMI policy, the the Homeowners Protection Act of 1998 requires lenders to remove PMI if these requirements are met.
Cancelling based on appreciation/improvements/current value
Borrowers can cancel PMI based on an updated home value/equity that’s increased after their most recent mortgage transaction. This can occur naturally due to area appreciation, home renovations/improvements, extra payments being made, or a combination of the three. Most lenders have different requirements for cancelling PMI under these circumstances (the Homeowners Protection Act does not cover this type of cancellation), but generally, requirements to cancel PMI are:
- accumulation of 25% equity any time after a mortgage is 2 years old
- accumulation of 20% equity if the mortgage is 5+ years old
- payments on the mortgage are current and have been timely
- if there’s not adequate data to support equity requirements, a new appraisal could be required
The Homeowners Protection Act has a provision that actually requires PMI to be removed from your mortgage under the following circumstances:
- You’ve paid down your principal to leave yourself with 22% equity based on the original property value
- Your payments are current and have been made timely
While PMI is protection for the lender, it can be a burdensome cost for a borrower, so the smart move is to work with a loan officer and real estate agent to try to get rid of PMI as early as possible. More often than not borrowers with PMI can ditch the payment much earlier than the “wait” option will remove it automatically. Renovations, natural appreciation, and making extra payments toward a mortgage principal are all great ways to get rid of PMI sooner than later, and can save a borrower a ton of money both short and long term.