Mortgage insurance – it’s the dreaded part of any new mortgage. The only way around it is to put down more than 20% of the purchase price of a home. Not many people have this option. Even government-backed loan requires some type of insurance. So how can you get rid of it on a conventional loan? The good news is there are many ways!
Pay the Balance Down
Paying the loan’s balance down is the most natural way to eliminate mortgage insurance. If you have a conventional loan, you pay PMI because you owe more than 80% of the home’s value. Once you owe less, you don’t pay for the insurance. It’s that simple. But, if you borrowed say 95% of the home’s value, it could be a long time before you can cancel the insurance. Luckily, there are other options if you can’t pay the balance down fast enough.
Pay for a New Appraisal
Waiting to pay the balance down can be nerve wracking. You have another option if your home’s value increased, though. It will cost you a little money, but it pays off in the end. A new appraisal can show the new value of your home. You must pay for the appraisal upfront, though. They cost anywhere from $300-$500. If the appraisal report shows a higher value, you may be in luck. As long as you owe less than 80% of your home’s increased value, you can request cancellation of the PMI.
You can usually recoup the cost of the appraisal rather quickly. Let’s say you pay $100 in PMI every month and the appraisal cost $300. It would take 3 months for you to make your money back. Then you reap the savings of a lower mortgage payment without PMI. Before you pay for an appraisal, make sure your loan servicer approves of the appraiser. If they don’t, the appraisal won’t count.
Refinance Your Loan
As a last resort, you can refinance your loan. This only works if your home increased in value, though. You still pay PMI if you borrow more than 80% of the home’s value. With a refinance, you’ll pay for a new appraisal. With a higher value and lower principal balance, you may be able to get rid of PMI.
If you only borrow the amount of your outstanding principal and your value increased, you may have a chance to eliminate PMI. You can refinance with any lender – you don’t have to stick with your current lender.
Government-Backed Loans and Mortgage Insurance
The above tricks only apply to conventional loans. If you have an FHA or USDA loan, the same rules don’t apply. These loans require mortgage insurance for the life of the loan. These loans don’t drop insurance because your value increases. Borrowers pay the insurance to help the government agencies guarantee the loans. Here’s how it works:
If a borrower defaults on an FHA or USDA loan, the FHA or USDA pays the bank back a portion of the loss. The representing agency then takes possession of the house. Because these agencies are self-funded, they require the funds from borrowers using the program. The insurance charged is an annual insurance for the life of the loan.
The amount of insurance you pay each year will drop accordingly based on your principal balance. The lower your principal, the less insurance you pay. But, it never drops off. Let’s say you took out an FHA loan for 30 years and you kept it for the whole term. You would pay insurance until the day you paid the principal off.
Getting Rid of Government Mortgage Insurance
There is one way you can eliminate government mortgage insurance. You can refinance the loan. You’ll have to refinance into a conventional loan, though. This is where it gets tricky. Government-backed loans are often more flexible than conventional loans. They allow lower credit scores and higher debt ratios. You had a reason for taking the government loan rather than a conventional loan in the first place. Refinancing into a conventional loan requires improved credit and a lower debt ratio in most cases.
You’ll also need to wait until you owe less than 80% of the value of the home. FHA loans only require a down payment of 3.5%. USDA loans don’t require any down payment. It could take a while for you to get your loan balance below 80% of the home’s value. Refinancing with an LTV higher than 80% would require Private Mortgage Insurance. If you did refinance before you hit 80%, you could use the above tips to eliminate PMI, though. Paying for another appraisal or waiting until you pay the balance down can help you get rid of it.
Making the Right Choice
You have many options at your disposal. Sit down and look at each payment. Don’t focus on the interest rate. Instead, focus on the total cost of the loan. You’ll want to compare:
- The cost of keeping your current loan
- The cost of paying for an appraisal and keeping your current loan
- The cost of refinancing and taking on a new loan
Look at the total cost and interest you’ll pay over the life of the loan. Also, consider how quickly you’ll pay the loan off. Refinancing often means restarting your term. If you already paid many years on your current term, do you want to start over?
Every borrower will have a different situation and answer that is right for them. Borrowers with homes with a lot of appreciation may benefit from paying for a new appraisal. A borrower whose home didn’t appreciate much probably wouldn’t benefit.
Weigh the pros and cons and talk to your lender before refinancing. There may be a simpler option. Unless you refinance out of a risky loan or you can lower your interest rate, you may be better off using a different option. Look closely at your Loan Estimate to see the true cost of each loan and option. This way you can make the financially smart decision for your home loan while eliminating mortgage insurance from your life.