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Is buying a home becoming more affordable? See the new "Salary you need to buy a median-priced home in the top 50 metro areas"

Is buying a home becoming more affordable? See the new "Salary you need to buy a median-priced home in the top 50 metro areas"

How to get rid of mortgage insurance?

home-with-additionMortgage insurance is a useful tool that helps people buy homes sooner. But when it's outlived its usefulness, you'll want to get rid of mortgage insurance as soon as possible. Here are three ways to accomplish this.

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Cancel mortgage insurance 3 ways

There are three ways to cancel mortgage insurance.

  • Wait for automatic termination.
  • Request early cancellation.
  • Refinance to a loan with no premiums or at least lower premiums.

Note that these methods won't work for every loan, so read carefully for important details.

How not to get rid of mortgage insurance

Before you try to get rid of mortgage insurance, you need to understand some limitations. First, FHA home loans and USDA-guaranteed mortgages come with two types of mortgage insurance - an upfront premium and a monthly premium. The monthly premiums cannot be automatically canceled; nor can you get an early termination. They go on for the life of the loan. Your only option for termination is to refinance.

The next thing you need to understand is that lenders set your automatic termination date when they draw your loan documents. They use your amortization schedule to determine when your loan amount will drop to a 78% loan-to-value (LTV). That is the automatic termination date. Note that this date does not change if you prepay your mortgage, so don't just pay it down and assume that your PMI is cancelled. It won't be. You can only request early termination of mortgage insurance.

Related: Estimate PMI at Your Credit Grade (PMI Calculator)

How automatic PMI termination works

The Homeowners Protection Act of 1998 (HPA) governs your right to get rid of PMI. PMI is private mortgage insurance, not government-guaranteed Mortgage Insurance Premiums (MIP).

Under HPA, your mortgage lender or servicer must terminate your PMI premiums automatically when:

  • Your loan amortization schedule indicates that your balance will drop to 78% LTV. Irrespective of the outstanding loan balance. That won't help you if you prepaid your mortgage.
  • If you're not current on your mortgage, you must bring your loan current for automatic termination under the 78% rule to kick in.
  • Alternatively, PMI must terminate at the midpoint of the mortgage (180 months for a 30-year loan) if you are current on the payments. This may apply when you have a mortgage modification in force.

What is a 78% loan-to-value or LTV? It's the original property value (either the sale price or appraised value, whichever is lower) times .78. If you purchase a $200,000 home and put 10% down, your loan amount would be $180,000. And 78% of $200,000 is $156,000. Your lender must stop collecting PMI within 30 days of the termination date, or the first day in which your loan becomes current following that date.

How early PMI cancellation works

HPA sets out the conditions under which you can cancel your PMI before the automatic termination date.

  • You can request cancellation once your mortgage reaches 80% LTV or on the day that it is set to reach an 80% LTV based on the original amortization schedule.
  • You must have a good payment history with your mortgage lender or servicer.
  • You may have to prove that the property value has not declined. This may involve paying for an appraisal.
  • The lender will verify that there are no additional liens against the home (a new home equity loan or liens resulting from delinquent taxes, judgments, or unpaid contractors, for instance). You might have to pay for a title search.
  • The law states that you must make your request in writing. However, Fannie Mae and Freddie Mac both state that they do not require requests to be written.

Is it worth paying for a home appraisal to stop paying PMI at 80% rather than 78%? That depend on your loan amount and the cost of an appraisal. Home appraisals can cost thousands for full examination of a unique or extensive property. Or they can be less than $100 for an online valuation or "desk" appraisal.

If you start with a $180,000 4.25% mortgage, you'd be set for an automatic termination at Month 84. You can request early cancellation at Month 72. That's a full year earlier. If your PMI is $75 per month, that extra years would cost you $900. Assuming that you can drop PMI for less than this, you should absolutely make the request. And the total cost might be just a phone call.

Early cancellation due to property value increase

Mortgage lenders are not obligated to cancel your PMI because property values have risen. However, your mortgage lender or servicer might be willing to allow it. Contact it and get its policy in writing before paying for an expensive appraisal. If you can drop PMI early with a higher appraisal, it may absolutely be worth doing so.

For instance, the average home appreciation rate in the US runs between 3.5% and 5% depending on who you ask. So if the $200,000 property in our example appreciates at 4% per year, you could be eligible to drop PMI at Month 27. And if your premium is $75 per month, you'd save over $4,200 by dropping PMI early.

Lenders must disclose your rights to cancel PMI

When you close on a home loan, your mortgage lender must supply these disclosures:

  • A written initial amortization schedule indicating the date at which your PMI would drop off automatically and the date at which you can request early cancellation
  • A written notice setting forth your PMI cancellation and termination rights
  • Exemptions to the general cancellation and termination provisions for "high-risk" loans and whether an exemption applies to your loan

Every year, the loan servicer or mortgage lender must disclose:

  • Your right to cancellation or termination of MI
  • An address and telephone number to contact the servicer/lender to determine whether the you may cancel MI

Every year when you receive that disclosure, check your property value and see if cancellation is possible.

Related: When Does it Make Sense to Refinance?

How to cancel mortgage insurance with a refinance

If your lender won't allow you to get rid of mortgage insurance early due to a property value increase, or if your mortgage is backed by the FHA or USDA, you'll have to refinance to drop your MI. You can avoid MI with a non-government mortgage and an LTV at 80% or lower.

You can estimate your property value with the many online sites and tools available. Note that they only provide estimates, while a refinance lender is likely to require a full appraisal.

Weigh the cost of refinancing against the benefits. Costs include lender fees and third party charges like appraisals and title insurance. You should be able to get a discounted rate for your title insurance. The HSH Tri-Refi Calculator can show you if you'll save enough to make refinancing a good idea.

Even if your new loan-to-value is over 80%, it might be worth refinancing. If your LTV is lower than that of your original loan, your PMI costs should be lower. If your credit score has improved, you should get a lower rate. And if you replace a government-backed loan with a conventional mortgage, your MI will drop off eventually. That benefit may tip the balance in favor of refinancing.

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