I’ve heard many folks complain about their PMI and how it increases their monthly payments by $100 – $150. With some folks, it’s like the PMI has a bad rep. I think what they forget is that the PMI has given you the ability and flexibility to put down less than 20% for your home! For my wife and I, the PMI was literally a blessing! For instance, you can get an FHA loan with as little as 3.5% down. That’s pretty incredible if you ask me!
The extra $100 – $150 monthly is worth it, but don’t get comfortable with it either. Have the plan to get it removed once you’ve exceeded 20% equity on your home OR when you have reduced your loan to value (LTV – you’ll see this a lot in the mortgage world) below 80%.
PMI exists because it insures the lender in case you were to default on the payments. Lenders have found that homeowners with less than 20% equity in their homes are more likely to default and that is why this is the benchmark for mortgage lending. Believe it or not, there are different types of PMI. So as you’re working with your lender talk about this insurance and be aware of the following 3 types. Ask them which one will apply to you:
This means you pay a premium every month. For instance, $100/monthly.
Single Premium PMI
Single premium is almost implied in it’s own term. You make an upfront lump sum payment for the PMI. This would eliminate the monthly payments. I would just consider the impact on your cash flow if this is an option you’re considering. For instance, you might make a $1,200 payment upfront every year.
This is an interesting one because your lender could pay the PMI but that means they will incorporate the cost into your monthly payment and you may end up paying more interest in the long run. Also, with this type of deal, you would not be able to remove PMI because it is a permanent part of the loan for its lifetime. To be quite honest, this option sounds terrible.
Getting rid of the PMI
We all love the PMI because it can help us acquire a home with less money down! But the moment we’ve got the home and we’ve moved in, the next question is how do I get rid of this extra cost!? The magic number is 20%. Why? Well, as I mentioned above, 20% is the benchmark that lenders set to determine the risk of their borrowers. The sooner you get to 20% equity, the more options you’ve got. Making extra payments towards the principal will get you on a fast track to 20%. However, if the market is in your favor the appreciation of the home will get you on that express lane to 20% equity. As a personal example, my home value skyrocketed by 14% in less than 2 years and it got us over 20% equity! BOOYAH! We got lucky, but if you are relying on the appreciation, you’ll need to get an appraisal to verify the market value of your home. The appraisal makes the home value and the equity you have legit.
Here are the options once you’ve reached 20% equity:
- Notify your lender to discontinue/cancel the PMI
- If you think you’ve reached 20%, get an appraisal and present this to your lender
- Refinance your mortgage. This may help you in other ways as well, so check out this post that has 5 good reasons to refinance.
The bottom line is to love and hate the PMI. It can be love at first sight and there may be a honeymoon stage. But once you’ve realized that you’re spending an additional $1,000 – $2,000 a year for it, you’ll probably hate its guts and do everything possible to get rid of it. Just keep your perspective on its purpose and how it has helped you gain your home.