What is PMI and how to get rid of it

Real estate lenders are a funny lot. It seems they're happy to lend anybody money. Assuming a half-way decent credit rating, any potential home buyer can secure a loan for a house. Why? Because these transactions are secured by a very valuable asset: the home itself. If a borrower defaults on a loan, the risk for the lender is often only the difference between the value of the home and the amount outstanding on the loan, less the amount it costs them to foreclose and resell the property.

For this reason, lenders are very wary of lending more than a certain percentage of a home's value. Traditionally, this has been 80 percent. The cushion this provides the lender helps ensure that their losses from loan defaults are kept to a minimum.

In recent years, however, it has become increasingly common to see home buyers using down payments of 10, 5 or even 0 percent. Naturally, loaning this much presents the lenders with a lot more risk. To offset this risk, these transactions often require Private Mortgage Insurance or PMI. This supplemental policy protects the lender in case a borrower defaults on the loan, and the value of the house is lower than the loan balance. This idea of "insuring the lender" originated with the Federal Housing Administration back in the 1930s, and until recently applied only to loans which fell under the very restrictive loan limits imposed by FHA.

Private lenders realized about fifteen years ago that they were missing out on a good thing. PMI has been a large money-maker for the mortgage lenders. The amount of the insurance - often $40-$50 per month for a $100,000 house - is commonly rolled into the mortgage payment. Given the size of the overall payment, this additional fee is often overlooked. Homeowners continue to pay the PMI even after their loan balance has dropped below the original 80 percent threshold. This occurs naturally, of course, as the home owner pays down the principal on the loan. On a typical 30-year loan, however, it can take many years to reach that point.

Now, don't get me wrong: PMI is a wonderful financial device. It has enabled hundreds of thousands of people to overcome the greatest obstacle to home-ownership, the accumulation of a large downpayment. But paying for PMI when you don't need to is like insuring a car you don't own!

Until recently lenders were under no obligation to tell home owners when they had reached a point where the PMI can be dropped. That all changed in 1999, when the Homeowners Protection Act took effect. In most cases, this law now obligates lenders to terminate the PMI when the principal balance of the loan reaches 78 percent of the original loan amount. Savvy homeowners can get off the hook a little earlier. The law stipulates that, upon request of the home owner, the PMI must be dropped when the principal amount reaches only 80 percent!

It is important to note that this law only applies to home loans - whether first time or refinances - that closed after July, 1999. Also certain other conditions must be met: the most critical is being current on your loan payments. In addition, most lenders require that you maintain Private Mortgage Insurance for a specified minimum period. Buyers who purchased before July 1999 can also have their PMI removed, but they must initiate the process; though the lender is under no obligation to do so, most will.

Of course, there is another way that a home owner's equity can reach the 20% level. The Central Florida area has seen significant gains in the value of real estate over the past decade, in almost every neighborhood and price range. In fact, certain areas have seen appreciation levels of 100 percent or more. Even those living in areas with more modest gains may find that their loans qualify for PMI relief. Again, in these cases, the lender may be under no legal obligation to remove the PMI. In most cases, however, as long as the home owners have been prompt on their loan payments and don't represent an exceptional risk for some other reason, the lender will agree to remove the PMI burden. In a sense, this actually improves the lender's risk profile - if you owe less money each month, it is obviously easier for you to meet your obligations!

The hardest thing for most home owners to know is just when their home equity rises above this magical 20 percent point. This is where we can help.

Contact your lender, and ask what the requirements would be for eliminating your PMI requirement. Typically, the lender will verify that you have a good payment history, and ask you to provide an appraisal from a certified appraiser in good standing which verifies the present value of the property.

Then ask for your loan balance. If you know your balance, divide that by 0.8. This will give you a figure for the value required to establish that you have the all-importantant 20% equity in your home. If you think your property is worth this much, you should give us a call. We will research the market and let you know if you should proceed with an appraisal.

 
For more information on PMI and the Homeowners Protection Act, try one of these links:

Cancellation of Private Mortgage Insurance: Federal Law May Save You Hundreds of Dollars Each Year

Private Mortgage Insurance (PMI): Law Requires Lenders to Cancel PMI