October 13th, 2014 7:09 AM by Jackie A. Graves, President
For those who’ve gotten a mortgage in the
past few years with little equity, most are all too familiar with private
mortgage insurance, the added premium built into the mortgage payment insuring
the lender against payment default.
Measured over time, it can cost you
thousands, so it’s worth a closer look—especially if you can eliminate it
There Are No Longer Tax Advantages
For years, mortgage borrowers got to enjoy
additional tax advantages by having the ability to write off their annual
mortgage insurance premiums—much like their property taxes and mortgage
interest. A dollar-for-dollar write-off, paying PMI wasn’t all that bad. From
2008 through 2013, it was simply the cost of doing business if you didn’t have the 20% down
Then the IRS changed the rules and disallowed
the mortgage insurance premium deduction for taxable years after Dec. 31, 2013.
As we enter Q4 2014, many homeowners are not privy to this change and will
learn that their PMI is now an after-tax expense (like fire insurance or a
consumer loan payment).
It Reduces Your Borrowing Ability
If your mortgage payment has PMI built in, by
definition you have more debt, requiring more income to offset it.
Without more income, the PMI erodes the
existing income normally used to offset the rest of the mortgage payment and
other obligations (like car payment, student loans, credit cards, etc).
The exact amount of the PMI is how much your
gross income is reduced by—without the tax advantage. For example, a $250 per
month PMI reduces your income by $250 per month.
Home Equity Needed
Here’s the thing: You don’t need to have 20%
equity anymore to get rid of PMI. If an appraisal of the property you’re going
to buy shows you have 10% equity, you could qualify for the lender to pick up
the monthly mortgage insurance payments, aptly called Lender Paid Mortgage
(This can also be done if you’ve already
purchased the home and want to eliminate PMI from your monthly payment.)
This is especially advantageous as PMI can be
anywhere from .75% of the loan amount to 1.3% of the loan amount, annually,
paid on a monthly basis. On a loan for $400,000, that could be as high as $430
per month—an immense net tangible benefit if the lender scoops up this premium
However, you need an appraisal to see if you
qualify for this. Most lenders’ appraisal fee is $400-$500, but it’s worth it
if you can get a substantially lower mortgage payment without the PMI.
On the flip side, the appraisal may also
determine you have insufficient equity to qualify, but it will help you
define exactly how much more value you would need to refinance in the future.
PMI Slows Your Mortgage Payoff Timeline
This is a big disadvantage of PMI.
Let’s say your mortgage payment is $2,800 per
month, and $300 of that is the PMI payment. You’re investing an extra $200
per month into your principal balance to reduce the interest you pay on the
mortgage over time—as a smart consumer, you’re making a $3,000 per month
If you didn’t have the PMI, you would be
paying an extra $500 per month directly to your principal, compounding your
timely prepay efforts and reducing your interest expense exponentially.
If you’re overpaying on your mortgage and you
have PMI, you’re only realizing half the potential you would be if you were
able to get rid of the PMI or shift the cost of the PMI to the lender via
lender paid mortgage insurance.
How to Cut PMI If You’re Refinancing
Some homeowners have a mortgage they took out
when 30-year mortgage rates were below 3.75%. In this case, why refinance a
mortgage if you have a 3.25% 30-year fixed with PMI and a new 30-year fixed
rate mortgage is just over 4%? Well, petitioning out with PMI is daunting task,
indeed, especially depending the type of loan you have.
If you have an FHA mortgage you took out
pre-June 2014: The requirement then was after 60 months of mortgage insurance
premiums paid to HUD and 20% equity,
you had the ability to petition out of PMI—and it is up to the lender’s sole
discretion to grant the homeowner’s request, not a guarantee.
Alternatively, the PMI would be removed at
78% loan-to-value and 22% equity based on an amortization schedule from the
original loan inception, calculating out at 120 months (that’s 10 years).
However, PMI for FHA loans originated after
June 2014 with 3.5% down contains permanent mortgage insurance, and the only
way out is to refinance or with 10% down. You can petition out of the mortgage
insurance after 10 years. However, refinancing may be a more worthwhile choice
in either situation.
loans, you can petition to remove it after a minimum of 24 months of
mortgage payments. The key here is this: If refinancing into a conventional
loan with lender paid mortgage insurance is less costly than how much more you
would pay in PMI between now and when 24 months is up, moving out of the PMI
would make sense as long as the rate is the same—or lower.
*Mortgage Tip: If the interest rate
on a new refinance is .125 %to .25% higher than the current rate with PMI, the
rate differential could make financial sense if prepaying the mortgage.
Borrowers might just have more equity than
they think. In many markets, home prices have not only stabilized but have
risen, creating more equity for homeowners who otherwise were thinly financed
in years past.
This additional equity can easily pave the
path to reducing the PMI payment, if not completely removing it.
The Bottom Line
You can avoid PMI if you have as little as
10% down payment or home equity. Work closely with your loan officer; they
are incentivized to help you.
If you can’t avoid mortgage insurance,
depending on your financial situation, ask your lender what other adjustments
can be made to reduce your mortgage costs: credit score, loan program and of
course equity all play important roles in your loan structure. You can
check your credit scores for free every month on Credit.com.
This story was written by Scott
Sheldon and originally appeared on Credit.com.
To view the original article click here