Q: I have a question for you about mortgage loans, private mortgage insurance (PMI) and smart money moves. Somehow my lender managed to stick me with eight years of PMI. In a few months, I’ll be hitting seven years on the origination date of my loan. I want to take out a separate loan (at 5 percent interest) to prepay my mortgage payments (including real estate taxes and insurance for the next 12 months in advance) and terminate the PMI immediately.
This would save me thousands of dollars since the PMI is $337 per month. My thinking is that I will redirect my mortgage payments to the newly issued short-term loan while avoiding mortgage payments for the next 12 months.
Could the mortgage lender reject this idea? What about the PMI that they’re expecting to collect for the next 12 months? Would they refund that to me?
A: You say that your lender stuck you with mortgage insurance payments, but you should know that just about every loan taken out that exceeds 80 percent of the home’s value will carry mortgage insurance. (Of course, without PMI, you would have been unable to buy your home unless you came up with a full 20 percent of the purchase price in cash, so there’s that.)
To make the math easy, if your home has a value of $100,000 and you take out a loan for $81,000 or more, your loan will have some form of mortgage insurance attached to it.
Private mortgage insurance insures the difference between the 20 percent a conventional lender would have required you to put down on the home and what you’re putting down. So if you put down 18 percent, you’ll pay less in PMI than if you put down 3 percent (because the lender’s risk is lower). Also, your lender is the primary beneficiary of the mortgage insurance. If you fail to make your monthly mortgage payments and your loan goes into default, the lender will collect; not you.
Here’s how that part of PMI works: If you default on your loan and the lender takes over the property, the lender will then sell off the home to pay off the debt you owe. In the course of that sale, the insurance company will pay the lender money in case the lender does not get repaid the full amount owed under the loan. In very simplistic terms, the insurance company is there to cover the lender’s potential loss on the amount of the loan that exceeds 80 percent of the original value of the home. In your example, if the loan goes into default and the lender recovers $80,000, the insurance company would pay the lender $10,000.
Once you have a loan with conventional private mortgage insurance, the premium ends when the loan gets to 78 percent of the original value of the home or midpoint in the amortization schedule. For most people with 30-year loans, the 78 percent comes around the seventh or eighth year of the loan term, just as you mentioned.
Unfortunately, you can’t just get rid of mortgage insurance unless you take certain steps to do so. The first option is to simply refinance the loan. Given where interest rates are now, you might be able to get a lower rate and save even more than what you had in mind by refinancing. Furthermore, given you are about eight years into a 30-year loan, you might consider refinancing into a 15-year loan. A 15-year loan, even at this point, will save you thousands of dollars compared with what you would pay over the 22 years left of your original loan, and you’d likely eliminate the PMI payments since property values in most of the country have risen so much over the past eight years.
If you are unable to or (for some reason) don't want to refinance, you can apply to get rid of your PMI by paying down the mortgage balance; but you may have to pay for an appraisal of the home so the bank can confirm that the current value is at least where it was when you took out the loan eight years ago. You must also be current in your payments for the prior two years. If you were late in making a payment, you may have trouble ending the PMI payments.
These are some of the basic rules, and there are others that you might have to comply with. For example, you generally can’t get rid of mortgage insurance during the first two years of a loan. In other situations, the appraisal rule may be a little more restrictive than the 78 percent that is used to automatically get rid of mortgage insurance.
Given these issues, it's sometimes easier to refinance a loan than to apply for the PMI termination. Furthermore, if you can refinance your loan in 30 days, you might get the refinance done faster than having to apply for the elimination of the mortgage insurance through the lender.
Your lender can give you a list of what you must do to eliminate PMI from your loan. You should also talk with a few other lenders to see what your options are. If you’re looking for your best money move, it’s this: Shop around and then compare what kind of loan you qualify for (including payments and fees) with what you’ll have to pay to get rid of PMI. We’re betting a 15-year refinance is where you’ll end up.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.