Say Good-Bye To PMI?

In the last "Neusletter" we talked about saving you thousands of dollars with a systematic approach to paying down your principle, while avoiding some of the "fee programs" that offer you a bi-weekly option. In this issue of the "Neus", I'll be talking to you about Private Mortgage Insurance, otherwise known as PMI.

What is PMI? If you financed your home purchase, and paid less than 20% as a down payment, then you most likely pay a PMI premium. This is an insurance policy paid by the homeowner to protect the Lender if they default on the loan. It insures that the lender will get their money back in case they have to take the property back in foreclosure. That's right! The Lender is the beneficiary, not the property owner who pays the premium.

PMI premiums can be very costly, too. $40 to $80 or more per month can really add up over the course of 15 to 30 years, so putting an end to paying this premium as soon as you can will really save you money over the course of your loan. One thing to point out here is that in most circumstances, you cannot cancel PMI on FHA loans. However, what you learn in this article may help you decide whether or not this is the right time to refinance out of the FHA loan into a conventional loan with no PMI, and possibly a lower interest rate. Be very cautious when you are refinancing for any reason other than improving your equity position. My suggestion would be to Call On Us to weigh the pros and cons of refinancing.

For a number of reasons PMI has received a black eye over recent years. One reason is that no one really believes that they are going to default on their mortgage, so PMI can be seen as an unnecessary monthly expense and adds to the cost of home ownership. Another reason is that lenders, in recent years, have made it difficult to drop PMI coverage which meant that borrowers were paying for insurance that was no longer necessary. There have even been rare occasions where the lender has been caught canceling PMI coverage without telling borrowers and pocketing the premiums under the guise of self-insurance.

Here is why PMI is a good thing. It has been statistically proven that the less cash a borrower has in the transaction, the more likely they are to default on the loan. Therefore, lenders view making loans with less than a 20% down-payment as too risky. Because of the protection the PMI provides the lenders, they are willing to make loans with lower down payments at market interest rates. Without PMI average homebuyers would have to wait until they saved up a 20% down-payment plus closing costs before they were able to purchase a home.

Although PMI is good for the consumer, it does not mean that a borrower should keep paying it past the point where it is no longer required. In July of 1998, The Homeowner's Protection Act came into effect that set guidelines for both lenders and borrowers for removing PMI from their loan requirements. The law basically says that a Buyer has to pay down the balance of the mortgage to reach "80% of the original value of the property" before they can ask if PMI can be dropped. The law also defines the original value as the lesser of the purchase price, or the appraised value at the time of the purchase. The law also required lenders to remove PMI when the loan reaches 78% of the original value of the property whether the borrower requests it or not. Bottom line is that this law is just a stop gap for Buyers who are not paying attention to their loan, and who don't understand what PMI is.

You might be thinking that paying your mortgage down to 80% will take forever. In fact in most cases it will take 10-15 years. The Homeowner's Protection Act is nice, but it nearly disregards the other way that equity in real estate is built. Appreciation cannot be forgotten when you are figuring equity. For example: someone with a home originally worth $150,000 who experienced 4% appreciation per year would have a home worth more than $180,000 in just five years. In this example, appreciation alone is enough to give that homeowner 20% equity even if it was bought with no down payment. This is illustrated in the graph below:

So what should you do as a sensible homeowner? First, contact your lender to ask about their policies toward PMI. Many lenders will offer to drop PMI when asked. However, they might ask you to pay for an appraisal to show you have reached 20% equity. If you are confident that your appreciation and loan balance reduction have totaled 20% equity, then go for it. It's money well spent. If you have had your current mortgage for 5 years or more, it might well be time to remove PMI from your mortgage payment.

Suggestion:

First, begin the Equity Building System pointed out in last months "Neusletter". Next, monitor your progress on your loan principle reduction each year, along with the appreciation of your home. When you feel you are getting close to 20% equity, Contact Us and we will give you some counseling on your next step. Once you have successfully removed PMI from your payment, add that to the extra amount you are already paying in the Equity Building System, and you are on your way to growing your net-worth and paying off your mortgage well before your neighbors do!