With the high cost of homes in the Bay Area market, private mortgage insurance (PMI) provides the protection lenders need to offer conventional housing loans to many buyers who would otherwise be priced out. If you put less than the traditional 20 percent down payment on a home, you were likely required to carry PMI to help reimburse your lender should you default on your loan. Fortunately, once you have acquired enough equity in your home, you can discontinue making PMI payments. Because it adds a substantial amount to your mortgage payment each month, it makes good financial sense to learn a few basic facts about PMI, and how and when you can cancel it:
How much does it run you? Although the cost of private mortgage insurance varies, it is typically about .5 to 1.5 percent of your loan principal on an annual basis, which is divided into 12 payments rolled into your mortgage payment each month. In many cases, this adds up to several hundred dollars per month – which you will see as “PMI” as a line item on your mortgage statement. Homebuyers with lower credit scores and larger loans will generally receive higher rates as they are perceived as higher-risk borrowers.
Is PMI tax deductible? In many cases, it is not. According to TurboTax, you qualify to write off your PMI premiums if you itemize your deductions and your adjusted gross income is $109,000 or less for a married couple filing jointly ($54,000 for married filing separately). Once your adjusted gross income exceeds $100,000 ($50,000 for married filing separately), the deduction phases out, and it is eliminated at more than $109,000 ($54,500 for married filing separately).
When can you drop your PMI premiums? You can request that PMI be cancelled when you have obtained 20-25 percent equity in your home. In most cases, you will need to wait at least two years before you can have PMI removed. Between two to five years of buying your home, you will usually need to have 25 percent equity in your home in order to cancel your PMI. Once you have been making mortgage payments for five plus years, you’ll need only 20 percent equity to ask that PMI be dropped. However, if your loan is considered high risk (e.g. you have below average credit), you may need to continue to make these payments until you have built up more equity.
Understand what your loan-to-value ratio is: Be aware that financial institutions often refer to your loan-to-value ratio (LTV) in regards to decisions about PMI. This is simply how much you still owe on your loan as it compares to the home’s current value. To obtain your LTV, you divide your current loan balance by your home’s current market value. To meet the minimum 20 percent equity threshold to request removal of PMI, you must accordingly have an LTV value no higher than 80 percent.
It may be automatically dropped: Provided that you have not taken out a high-risk loan, the Homeowner’s Protection Act mandates that your lender cancel your PMI when your outstanding balance is reduced to 78 percent of your home’s purchase price. This is the case even if your home has decreased in value since it was first appraised. By law, the lender must drop the policy at this point without your having to request cancellation. However, it’s a good idea to check that your policy has been cancelled once you’ve met the 78 percent threshold to ensure that your lender’s compliance with this law hasn’t fallen through the cracks.
How to get your PMI removed sooner: Depending on your property and your situation, there are several options available to help you eliminate your private mortgage insurance before your lender is required to do so. By having the lender remove your PMI early, you may be able to save several hundred dollars per month. Here are a few ways you might get your PMI removed earlier:
- Get a current appraisal: Are you fairly certain that the value of your home has increased significantly since you bought it? If your lender will consider this new appraisal when assessing your LTV ratio, it could be worth spending approximately $500 for a new appraisal to provide proof that you now have adequate equity in your home to cancel your PMI payments. However, keep in mind that it’s best to use an appraiser that your lender recommends.
- Invest in a home remodeling project: If there is a home improvement that will significantly increase your home’s value and allow you to recoup more than 100 percent of your costs, it can be worthwhile to have this completed before paying for a new appraisal. Examples of home enhancements that tend to pay off in the Bay Area market include basic home maintenance (e.g. a new roof), minor kitchen and bathroom remodels, exterior improvements (such as a new garage door) and adding a second bathroom. For more information on home improvements that provide the best returns, visit Remodeling Magazine’s 2017 Cost Versus Value Report.
- Refinance: Especially as interest rates are still historically low, you may be able to take out a new mortgage with more favorable rates and terms, including the possibility of eliminating your PMI payments if your home’s value has increased sufficiently. As realtor.com explains, you’ll have to determine if the amount you will save by stopping PMI payments is greater than the cost of refinancing.
Finally, before you make any financial decisions that impact when you can eliminate your PMI premiums, make sure to contact your lender to find out what you are required to do in order to have your policy cancelled early. In general, any correspondence on this matter should be done in writing.