The banking world is full of confusing acronyms and mind-boggling terms. When I signed my original mortgage, one of the strangest things to me was “PMI”, or Private Mortage Insurance.
What was this so-called “insurance”? Who did it benefit? And why did I have to pay for it?
I lots of time researching this concept and I want to share what I’ve learned with you. I’m not a real estate or banking professional – just someone like you, trying to navigate the confusing world of homeownership. I’m hoping this article will help you to better understand PMI and feel more confident about the mortgage process.
What the heck is PMI?
PMI is Private Mortage Insurance. It’s an extra cost that you have to pay to banks if they think you’re a risky borrower. Banks are worried that risky borrowers will stop paying their mortgage and the home will go into foreclosure. Banks often lose money in foreclosure.
The idea behind PMI is that the bank already has some extra money from you (the PMI) to help cover any money they would lose in a foreclosure.
Who has to pay PMI?
If your downpayment is less than 20% of your home’s cost, the bank considers you a risky borrower. And you’ll be required to pay PMI.
I don’t think I’m a risky borrower, but continue.
The amount of PMI you have to pay depends on your lender, the cost of your home, and the size of your downpayment. Your lender can help you calculate how much PMI you’d have to pay each month.
For reference, I paid $100 per month in PMI for a $274,900 home and a 3.5% downpayment.
PMI is typically added to your mortgage payment each month, so you’re paying one lump sum to the bank.
PMI doesn’t sound fun. Do I have to pay it forever?
To avoid paying PMI in the first place, you can put 20% down when you buy your home. But if that’s not possible (it wasn’t for me), you don’t have to pay it forever.
You can get rid of PMI once you have 20% equity in your home.
Wait, back-up. What’s “equity”?
Equity is how much of the home you truly own. Say your home is valued at $100,000 and you made a downpayment of $5,000. That means you have 5% equity in your home.
As you pay off your mortgage, your equity in the home increases. Let’s say you’ve paid off $15,000 of your mortgage. Add that to your $5,000 downpayment, and you’ve paid $20,000 towards your home. On a $100,000 home, that means you now have 20% equity.
Um, okay. How does this “equity” help me get rid of PMI?
After you have 20% equity in your home, you’re no longer considered a risky borrower.
Awesome. So PMI is automatically removed when I reach 20% equity?
Strangely, no. Banks aren’t required to automatically remove PMI until you reach 22% equity.
You’re kidding me. What can I do about that?
If you don’t want to wait for automatically cancellation, you can write to your bank after you have 20% equity and request that they remove PMI from your loan. If you meet the 20% equity requirement, banks are required to remove PMI with your written request.
What if I want to get rid of PMI sooner?
You’re in luck – you can get rid of PMI sooner through two different ways.
The first is by paying extra on your loan. The faster your pay off your loan, the sooner you’ll reach 20% equity. Pay a little bit extra every month or pay extra when you can. Every little bit will help you reach 20% equity sooner.
TIP: Make sure the bank knows that your extra payment should be applied against your principle (mortgage), not the interest).
The second way to get rid of PMI sooner is to monitor your home’s value. If you think your home value has increased, you can ask for a new appraisal. That new appraisal then determines if you have 20% equity in your home.
Let’s back to our example of the $100,000 home. You put down a $5,000 downpayment, giving you 5% equity. You ask for a new appraisal and your home appraises at $130,000. Even if you haven’t paid any more than the $5,000, the new appraisal means you suddenly have more than 20% equity in your home.
For both of these methods, you’ll need to work with your bank to confirm that you have 20% equity in your home and request that they remove PMI.
Any caveats I should be aware of?
Veterans Affairs (VA) home loans don’t have PMI, so you don’t need to worry about PMI at all.
To remove PMI from Federal Housing Authority (FHA) and United States Department of Agriculture (USDA) home loans, you have to refinance and switch to a non-USDA/non-FHA loan to get rid of PMI.
In my case, I started with an FHA loan. Once I had 20% equity, I had to refinance and switch to a non-FHA loan to get rid of PMI. The bad news is that refinancing adds more closing costs to your mortgage balance. (Boo.) The good news is that you may be able to negotiate better terms. (Yay!)
Although re-financing meant that I had to add more closing costs to my mortgage balance, it also gave me an opportunity to lower my interest rate. The combo of eliminating PMI and reducing my interest rate saved me $400 a month.
I understand PMI now! What are my next steps?
For me, the key steps were monitoring my decreasing loan balance and my increasing home value. Once the two combined to the magical 20% equity number, I contacted my bank to start the process of eliminating PMI.
You can track your decreasing loan balance on your bank’s website. To track your home value, you can use your tax assessment and online real estate websites like Zillow and Redfin. You can also reach out to your bank to get their estimate. Their estimate isn’t a guaranteed appraisal amount, but it’s probably closer to what it’ll end up being than any other source.
I hope this article gave you some insight into this crazy world of mortgages. You’ve got this!