How to Repair a Credit Score Whether it’s buying a car, finding a place to…
How to Avoid Mortgage Insurance
Buying a home with less of a down payment may be an attractive option, especially for those who want to buy a home right away instead of waiting to save up for a larger down payment. However, it is important to realize that putting down less than 20% of a home’s appraised value may require the addition of mortgage insurance (MI). Usually, this is paid as part of your monthly mortgage payments and the size of the fee depends on the down payment amount and your credit score. Private Mortgage Insurance (PMI) only applies to conventional loans, since VA loans typically do not have mortgage insurance requirements despite their low down payment and FHA loans have their own type of mortgage insurance (more on that later).
The easiest way to avoid mortgage insurance is to save up for a down payment of 20% or more, but there are other ways to avoid a mortgage insurance cost requirement.
Refinance Your Mortgage
Home values and interest rates are far from constant. You may be able to take full advantage of interest rate changes and home value increases to lower your monthly mortgage payment and possibly remove your mortgage insurance. A higher home value can help you reduce or eliminate mortgage insurance because lenders use what is called the loan-to-value ratio (LTV) to determine how much equity a homeowner has. Also, if you have owned your home for over a year, you are actively paying down the current loan which will also help increase the loan-to-value ratio.
The LTV is calculated by dividing the current loan balance by the original appraised value and presented as a percentage, so a higher home value will bring down your LTV. If the new LTV calculation comes out to 80% or lower, you will not be required to pay mortgage insurance on your refinanced loan.
Don’t think you have enough value in your home to eliminate your mortgage insurance? While you may not be able to entirely get rid of PMI, you may be able to reduce the monthly Mortgage Insurance payment through this same refinance method. Let’s say you originally put 5% down on your home. Since this would give you an LTV of 95%, it would requires a high level of mortgage insurance. In this scenario, if you own your home for over 2 years with a value increase of 4% – 5% each year as you pay down your loan, your new loan-to-value (LTV) would likely be around 85% (15% home equity). In this scenario, your mortgage insurance would not be eliminated, but could be reduced by 50% – 60% per month.
Many of the factors related to home value are out of your control. However, if you don’t want to wait around for new developments, rise in demand, or changes in local economy, you can try to raise the value of your home by remodeling it. Adding a pool, upgrading the kitchen, and improving the bathroom space are a few of the remodeling options that can increase your home’s value.
When going this route, keep in mind that it is the appraiser’s sole discretion to add value for these property enhancements and the amount may vary. For example, an appraiser can value a new pool as $20,000 of added value even if you spent $50,000 to install it.
Get a Second Appraisal
Since LTV is based on the original appraisal, you can lower that ratio by getting a second appraisal demonstrating that the value of your home has risen since you became the homeowner. An appraisal with a higher home value than the original appraisal for your loan will lower your LTV and increase your chances of PMI exemption. Consult with your current mortgage servicer and mortgage insurance provider to see if they will allow for this option. You should also be prepared to pay an appraisal fee if you plan on going this route.
Wait It Out
The Homeowners’ Protection Act requires private mortgage insurance companies to stop charging PMI once borrowers have paid the mortgage down to an LTV of 78% as long as the borrower is current on all of their mortgage payments. Some loan options such as those with interest-only periods or principal forbearance can make the loan take a very long time to reach 78% LTV, so lenders are also required to drop the PMI once borrowers reach the halfway point of their amortization schedule even if they haven’t hit an LTV of 78% yet. The amortization schedule is the timeline of your mortgage payments over the lifetime of your loan. Your lender will also tell you the dates of when you reach these milestones in the form of a PMI disclosure form that they will provide for you.
Prepay on Your Mortgage
Making extra payments on your loan is not only a good way to pay off your home more quickly, but it can also lower the overall cost of the loan by reducing the amount of interest that you’ll be charged on. The more you prepay your loan, the faster you can reach the LTV threshold for mortgage insurance elimination. Check with your lender and mortgage servicer to make sure there is no penalty for paying extra per month.
Request PMI Cancellation
The last option for getting rid of your PMI is through a request. According to the Consumer Financial Protection Bureau, once your LTV gets down to 80%, you can request PMI cancellation from your lender or mortgage servicer in the form of a written letter. To do this, you must be current on your payments, have good payment history, have zero (0) junior liens (such as a second mortgage), and possibly prove the stability or rise in your home’s value in the form of an appraisal (as was discussed earlier).
Getting a Second Mortgage
While there are many ways to remove your private mortgage insurance after you have been paying your loan for a while, you can put forward a down payment of less than 20% without a PMI requirement by financing your home using two mortgages at the time of purchase. The first mortgage will be worth 80% of your home’s value, which is the same amount you would receive if you had made a 20% down payment. The second mortgage can be worth up to 10% of the home’s value, and is meant to be combined with your down payment for the remaining amount of the home’s value. Utilizing this financing option with a conventional first mortgage will allow you to have no mortgage insurance.
However, there are some caveats to this option as it is only available to home buyers with very good credit scores and can require at least a 10% down payment. Second mortgages also typically have higher rates than first mortgages and are susceptible to increasing over time. If you choose this option, you must also be ready for the possibility of interest-only payment periods and a payment that may increase. Many borrowers pay both loans until they have 20% equity on their home, at which point they finance their two mortgages into one.
FHA Mortgage Insurance (MIP)
Up until now we have talked about private mortgage insurance (PMI), which only applies to conventional loans. The FHA loan programs also require mortgage insurance in the form of an upfront payment due at closing (UFMIP), which can be as high as 1.75%, and monthly mortgage insurance (MIP). This is different from PMI because MIP is provided by the FHA with different guidelines and requirements.
Whether or not you qualify for FHA MIP cancellation depends on the time of your loan closing, your down payment, and the loan term. Since FHA changed their rules in 2013, loans opened prior to June 3, 2013 have different requirements compared to loans opened after that date. See the charts below to find out when a loan’s FHA MIP is up for review.
For FHA loans opened after June 3, 2013
For FHA loans opened before June 3, 2013
As you can see, if you were to put down less than 10% for your down payment today, you would be stuck with FHA MIP for the whole loan term. Remember this when structuring your loan, since good planning is the best way to avoid mortgage insurance. For newer loans with a down payment of more than 10%, MIP goes into review 11 years after the loan closes. Older loans generally have the MIP lifted once they reach 78% LTV. If you are stuck with MIP because of a low down payment, there is only one option to get rid of it: refinancing your mortgage into a new loan without PMI. Of course, you have to meet the eligibility requirements discussed earlier in order to benefit from that option
Avoiding Mortgage Insurance
It is important to look at each loan option available and analyze what your goals and financial abilities may be. A great lender and professional loan officer will be able to help you avoid additional fees and mortgage insurance if possible. To avoid mortgage insurance, the wisest approach is to put 20% down or obtain a second loan if eligible. When you cannot avoid mortgage insurance, you can explore the other options such as refinancing, getting a second appraisal, making your home more valuable through remodeling, writing a request, prepaying on your mortgage, and waiting out the length of the mortgage insurance requirement.
Financing details are for educational purposes only. Rates, program terms, fees, and conditions referenced are subject to change without notice. Not all products are available in all states for all amounts. All mortgage applications are subject to underwriting guidelines and approval. This is not an offer of credit or a commitment to lend. Residential Wholesale Mortgage, Inc. dba RWM Home Loans is an equal housing lender licensed by the CA Department of Real Estate #01174642 and CA Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act. NMLS# 79445