If you’ve been paying PMI or have been offered a loan contingent on you buying PMI, it’s time to take a look under the hood to understand what it is and what you get.
What is PMI?
PMI stands for private mortgage insurance. This is insurance you pay for but actually benefits the financial institution you borrowed money from.
If for some reason (ANY REASON) you stop making your payments on your property, the insurance company you paid the PMI premiums to makes the payments for you while the bank is happily foreclosing on your property.
That’s right. Even though you paid for this insurance, it doesn’t stop the bank from kicking you out on the street if you can’t pay your mortgage.
Why Do You Have to Buy PMI?
People don’t buy PMI voluntarily. They buy it because sometimes, the bank won’t give you a loan if they don’t buy it.
Why does the bank sometimes insist on you having this coverage?
Well, if you look risky to them, they need to cover their bets.
Think about it. If you take a mortgage and put down less than 20%, the bank’s risk goes up because you have less skin in the game.
Remember, they are putting up hundreds of thousands of dollars and hoping that you pay it back. Statistically, the less you put down the greater the default risk.
And if you default on the loan, that means that the lender is responsible for the costs associated with the lost mortgage income, the cost of foreclosure and then managing the real estate and its upkeep.
This is where PMI comes in. If you default, the payout from the PMI can help the mortgage lender offset some of the costs associated with foreclosing on your home and trying to sell the property.
When You Can Stop Paying PMI?
PMI is a pain and it’s expensive. The good news is that you don’t have to pay it forever.
When you have enough equity in your home that you “own” 20% of it, you can cancel your PMI.
That means if your home has appreciated or if you’ve paid your loan down enough, you might not need the PMI.
For example, let’s say you buy a condo for $100,000 and put down 10% – or $10,000 and take an interest only loan for $90,000.
Your equity is only 10%.
But if a couple of years pass and the property is suddenly worth $150,000, your equity goes up to ($150,000 – $90,000) $60,000.
And $60k/$150k is 40%. Since you now have 40% equity the bank no longer can force you to keep buying PMI.
In reality, once you prove you have at least 22% equity, the lender is supposed to drop the PMI.
Because the premiums were added to your monthly payment in the first place, you’ll see your monthly payments drop (or your equity increase faster as you use the same payment to go more towards principal) once the PMI goes away.
Keep in mind that the Homeowner’s Protection Act (HPA) of 1998 requires lenders to offer automatic termination of PMI to their borrowers.
However, it is still a good idea to keep track and call your lender to task when it’s time to do the right thing.
How do you prove it’s time to stop paying PMI?
If your lender doesn’t drop the payment, ask them to do so when you have a good reason for thinking your equity is 22% or greater.
Remember,automatic termination doesn’t kick in until your loan value reaches 78% of the current value of your home, as long as you are current on your mortgage.
But you might differ on what the “current value of the home” is. And that means you might need to get it appraised.
(Keep in mind that if you are behind in mortgage payments, the lender doesn’t have to end the PMI until after you catch up.)
You will have to pay for the appraisal yourself so make sure you are spending the money wisely. Talk to your mortgage loan servicer (not the PMI insurer) about the PMI removal policy and then follow the procedure.
As long as the properly accredited appraiser can verify the value of your home and you follow the steps to have the PMI removed, there shouldn’t be a problem if you have the required equity in your home.
There are rules about late payments with your mortgage that can allow the lender to reject your request for PMI. If you’ve made late payments, find out what the bank’s policy is before you pay for the appraisal.