Home buyers frequently come across home and mortgage terminology they've never heard of before - and PMI may be one of those terms. Why do only some homeowners have to deal with this additional fee, and how can you get rid of it? Here's what you need to know.
PMI Meaning
Homeowners who put down less than 20% of their home’s purchase price at closing will likely be required by their lender to pay for Private Mortgage Insurance, or PMI. PMI protects the lender against foreclosure - if you were to default early on your loan, they would be able to collect from the insurer.
Typically homeowners pay for their PMI in the form of a monthly payment that is paid along with their mortgage payments.
PMI typically costs .25% to 2% of your loan balance, depending on a wide range of factors - the riskier you are to the lender, the more you’re likely to pay until you can get rid of PMI. And like with mortgage rates, rates vary depending on the lenders themselves.
"[The cost of] mortgage insurance is not the same for every lender," explains mortgage advisor Robert Wagner. "The lenders we use may have slightly lower charges for the PMI than another lender, because there’s a bunch of PMI companies out there.”
There’s several reasons to avoid having PMI - if you can. It can quickly become an expensive, additional fee to keep up with. Consider the average cost of a home (nationwide) is now about $285,000. Even at a 1% rate - which is fairly average for PMI - that amounts to $2,850 per year. And unlike your mortgage, it doesn’t count toward equity in your home.
How to Avoid PMI
No one likes an extra fee! The easiest way to avoid PMI is lowering your debt ratio. If you put down 20% of your home’s purchase price at closing, you won’t need to pay PMI. You can also get rid of your PMI by continuing to pay off your mortgage.
How to Get Rid of PMI
When does PMI go away? Once you have 20% equity in your home, you can ask your lender to drop the PMI. “PMI will be immediately cancelled by your lender once you reach 78% equity. You can request PMI removal at 80% equity,” says Houwzer mortgage advisor Lisa Hunter.
PMI Cancellation Letter
To request PMI cancellation, you’re required to send your lender a written request. This is important to do, because until you’ve reached the 22% equity threshold, they’re not actually required to release you from it. Generally, the lender will grant your request if you’ve been on time with payments and your home’s value hasn’t declined. Make sure your letter includes your address, account number, request, the date, and your signature. Here is a sample letter provided by the Federal Reserve you can use as a guide.
If your payment history has been spottier than what a lender would desire, you can potentially get rid of PMI through refinancing. Refinancing can have the added bonus of reducing your interest rate, if the current rate is lower than the one you were locked in for. According to our mortgage team, the average cost to refinance a home is $3,000 to $4,000 - so you’ll need to evaluate the potential costs and decide which path forward ultimately saves you the most.
FHA-Backed Loans
If you’re a first-time home owner, you may have a loan backed by the U.S. Federal Housing Administration (FHA) - this allows homebuyers to put down as little as 3.5% down, and the FHA loan comes with its own version of PMI, known as a mortgage insurance premium (MIP). However, the downside of having an FHA-backed loan is that FHA loans opened after 2013 come with MIPs that last, essentially, the lifetime of the loan - which can add up to thousands of dollars in payments over the years. They do not go away when you achieve 22% equity.
Since you can’t request a cancellation based on home appreciation or increased equity, in most cases the only way to eliminate the MIP is to refinance your home.
Can I Cancel PMI if My Home Value Increases?
This is the most common way to cancel your PMI, but you can also do so through a re-appraisal of your home, or through adding value to your home. Adding a pool to your home, for example, would raise the value of your home even though your debt would remain the same. If you owe $200,000 on a home plus pool valued at $250,000, rather than $200,000 on a home by itself valued at $225,000, then you are now at the 20% threshold.
“In the event you believe your value has appreciated and you now have 20% equity you can pay to have an appraisal done to prove the appreciated value,” explains Hunter. “Some lenders do require you to keep PMI for a period of time from the loan consummation (typically no more than two years) so we would need to make sure that this period, if it exists, has expired.”
Is PMI Tax Deductible?
For most people, the PMI will not be considered tax deductible. This is because a PMI tax deduction is only possible if you itemize your deductions - and only about 10% of Americans itemize. If you take the standardized deduction, it is considered part of it. If you take the itemized deduction you can deduct your PMI, but keep in mind that once your gross income rises above $100,000 this deduction starts to be phased out.
“This changes from year to year. Your best bet is to consult your tax professional,” advises Hunter.
What is a Lender Paid PMI?
A “lender paid” PMI is confusing in terminology because it’s not really the lender who pays for it - it’s still you, the homeowner. Instead of having a separate mortgage insurance, your lender will raise your rates, meaning you pay more in interest each month. The disadvantage here is that, while you might have an overall lower monthly payment than if you were paying PMI and your mortgage at the same time, the lender paid PMI won’t disappear when you hit 22% equity - you’ll remain locked into your rate for the lifetime of the loan.
