Private Mortgage Insurance...What Should You Know?


If you purchased a home with less than the conventional 20% down, chances are that your lender required you to buy private mortgage insurance (PMI). For you, having PMI is another expense you can tack onto homeownership, but for the lender it's extra protection. PMI is designed to protect the lender in case the borrower defaults by using the money you paid into your PMI premiums each month to recoup some of their losses.

For example, on a loan of $250,000, PMI can cost you anywhere from $50 to $220 each month. It all depends on the size of the down payment you made and the length of the loan.

Why is PMI Necessary

For FHA insured home loans, PMI is required regardless of how much you put down as a down-payment. It can be 20% or even 90%, and FHA will still require PMI. In fact, with an FHA loan, you will be asked to provide upfront mortgage insurance in addition to annual mortgage insurance each month. And FHA requires premium payments to the government for the life of the loan. FHA was the loan of choice for a huge number of buyers over the course of the last four years since these loans were much more cost-effective and less restrictive than their conventional loan counterparts.

However, times have changed. FHA recently announced another increase in their annual premium and there are rumors of an increase in upfront premiums as well. Of course, this is all due to the losses FHA has had to take on in the past, but it also means that with the increasing cost of an FHA loan, conventional loans are now more cost-effective. With a conventional loan, borrowers have more options when it comes to paying PMI, and they can also “buy-it-out” to drop it from their monthly bills.
If you're wondering which is better, a conventional loan or an FHA loan, the answer is that there are benefits and challenges to both loan types. The general rule of thumb is that conventional home loans require good credit while FHA loans tend to be more flexible with those who have lower credit scores.

While having PMI is one way to get into a home without the burden of laying down that 20%, it's something you'll want to get rid of as soon as you can (unless you have an FHA loan, of course), so it's important you know your rights.

Dismissal of PMI

Once you've made enough payments to boost your equity up to 20% of the original purchase price, you can ask your lender to cancel your PMI. By law in fact, your lender must tell you at closing how long it will take for you to pay down your loan enough to get rid of your PMI. You can also expect an annual statement that outlines who to call for more information about canceling it. Generally, when your loan is near the 80% threshold, PMI will be automatically removed by the lender. But in practice, most lenders wait until 78%, and even then, it can still be difficult to get it removed. Some lenders request that the homeowner draft a letter requesting that the PMI be canceled with a formal appraisal prior to cancellation.

However, if you're a high risk borrower, your lender can require PMI until your loan shrinks to 50% of the home's value. If you have missed mortgage payments, you can slip into this category, so ensure your payments are up to date before asking your lender to discontinue your PMI. In addition, lenders may require a higher equity percentage if you choose to convert the home for rental use.

If you're set on removing yourself of PMI, you've got a good leg to stand on as long as you have 20% equity or greater. You can also opt to have your home refinanced. If your home has increased in value enough, the new loan won't require that you pay PMI. Sure, there are fees associated with refinancing, but you may find that in the long run, you save money.

Federal Income Tax Deductions

Many homeowners don't realize they can claim the PMI deduction on their federal income tax return. With the recent passage of the American Taxpayer Relief Act of 2012, Congress extended the ability to deduct PMI through 2013. If you have been paying PMI and you'd like to deduct them, here's what qualifies you:

Your loan was originated in 2007 or later.
Your mortgage is your primary residence or a second home that is not a rental property.
Your adjusted gross income is no more than $109,000. The deduction begins to phase out once your adjusted gross income exceeds $100,000 and at $50,000 for those who are married and filing separately.

Sources:

Realtor.com: Removing Private Mortgage Insurance

Wikipedia: Lenders Mortgage Insurance

Fox Business.com: How to Get Rid of Private Mortgage Insurance

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