If you purchased your home with a down payment of less than 20%, odds are you also purchased-and continue to pay for-private mortgage insurance (PMI).
PMI protects lenders against default on loans with low down payments by providing coverage for the costs of foreclosure that cannot be matched by the borrower's investment in the house.
This protection is particularly important to lenders when a mortgage is taken for a low-down-payment purchase because of the statistical correlation between low borrower equity and default. There is also a common sense correlation: the more of your own money you have invested in a home, the less likely you are to allow it to go into foreclosure.
Here's how it works. Your mortgage lender chooses an insurer who sells the lender a policy covering 20% to 30% of the mortgage balance-more than enough to cover the lender's costs should they be forced to foreclose on your home. The lender then includes the cost of the premiums in your monthly mortgage bill.
PMI Helps You Get the Most for Your Money
Without the availability of private mortgage insurance many people would have to wait much longer before achieving the goal of homeownership, industry experts say. In the last 25 years, home prices have appreciated at a much faster rate than salaries have grown. This means that it is much harder for today's first-time homebuyers to save enough to make a down payment than it was for their parents or grandparents.
But PMI makes it possible for lenders to offer mortgages to buyers making down payments of as little as 5% to 10% of the home's total value. This can take years off prospective homeowners' wait for savings to accrue.
PMI also allows buyers-whether first-time or not-to significantly increase their purchasing power. Because it permits the down payment to be a much smaller percentage of the total purchase price, PMI can "convert" a prospective buyer's $10,000 from a 20% down payment on a $50,000 home to a 10% down payment on a $100,000 home-or even a 5% down on a $200,000 home.
Insurance Becomes Unnecessary Over Time
What many of the homeowners taking advantage of these policies don't know is that they do not have to go on paying PMI premiums indefinitely.
A recent law, The Homeowners' Protection Act of 1998, which went into effect on July 29, 1999 requires lenders to automatically cancel PMI once a homeowner's equity in a property has hit 22%. Homeowners, whose mortgages originated prior to the enactment of this law, will still be protected by the act's mandatory requirement that lenders notify all homeowners of their right to cancel PMI and how to go about doing this. Under this law homeowners have the right to initiate cancellation themselves once they have attained 20% equity in their home.
According to policies recently set by Fannie Mae and Freddie Mac (the organizations which purchase most mortgage loans from servicers on the secondary market), PMI must be dropped for homeowners who have held their mortgages for two years (Fannie Mae) or five years (Freddie Mac) and meet certain basic requirements.
The most basic of these requirements is the 20% equity stake (also referred to as 80% loan to value or LTV), but lenders will also consider the payment record and the current value of the house. In declining markets, the LTV may not be going down even though the homeowner's dollar investment in the house has risen.
Fannie Mae, which buys one in every five mortgages issued in the United States, is also requiring lenders to notify homeowners when they are eligible to have PMI canceled and how to go about doing it in disclosure statements made at closing and annually thereafter. This policy also requires lenders to cancel PMI automatically once loans reach the halfway point of the loan term (15 years for the typical 30-year mortgage) if borrowers have made their payments on time.
Fannie Mae also allows the lenders who sell its loans to automatically cancel PMI when borrowers reach an equity stake of 20% of the original value of the property.
Freddie Mac's policies, while not identical to Fannie Mae's, share many of these basic ideas, and also include the requirement that lenders "must" drop PMI if asked to do so by qualified borrowers.
How You Can Take Action to Drop Unnecessary PMI
In addition, Fannie Mae allows borrowers to request cancellation of their PMI with an 80% LTV based on the current value of their home. To do this, the borrower must pay for an appraisal to prove that some combination of increase in the value of the home and payments made toward the principal of the loan has caused the remaining mortgage amount to fall below 80% of the property's current value.
To request this kind of cancellation, send a written request to your lender-by certified, return-receipt mail-with a copy of your appraisal and of the applicable Fannie Mae policy so that the lender knows you are aware of your rights.
If neither Fannie Mae nor Freddie Mac has purchased your loan, and you wish to cancel PMI after attaining 20% equity, you can follow the same procedure. To make a request, send a letter-again, by certified, return-receipt mail-with a statement of your case and any supporting evidence you have. You can always consider (and let your lender know you are considering) refinancing with another company.
A FREE Home Sales Report from Homeradar.com can be invaluable in deciding whether or not it is time for you to pursue PMI cancellation by giving you up-to-date information on your home's current market value. With this knowledge, you can calculate your current LTV percentage and make an informed decision about whether or not it's time to drop your PMI.
If you are paying unnecessarily, canceling your PMI could save you hundreds of dollars each year. In addition, many PMI payment plans begin with the full first-year's premium payment placed in an escrow account by the lender, followed by 1/12 of the annual premium paid with each monthly mortgage payment. If your PMI payments were structured this way, you may also be entitled to a refund for any unused premium payments in the escrow account.
And if you think you might be qualified to cancel, but aren't quite sure, the information in a Homeradar.com Home Sales Report could save you the cost and frustration of trying to cancel too early. Because you must pay for an appraisal in many instances, which can cost several hundred dollars, and because some lenders will only allow you to request dropping PMI once a year, you need accurate information as to the value of your home in order to decide when it's time to pursue PMI cancellation.
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