Canceling PMI can save you thousands. If you own a home and you put less than 20% down, it’s likely you have Private Mortgage Insurance, or PMI. This is insurance that you, the borrower, pays to protect your lender if you default on your mortgage. Stated another way, the loan-to-value ratio (LTV) is too high and there isn’t enough home equity.
Depending on how you look at it, PMI is a little insulting. The lender seems to be saying that they don’t trust you to pay them back so you need to pay extra. The amount you pay for mortgage insurance can vary depending on the amount you put down, but let’s assume the following scenario.
You find a home for $277,777 and put 10% down. Your loan amount is $250,000. The mortgage insurer charges 0.49% of the mortgage amount for a total annual premium of $1,225. This amount is divided by 12 which comes to $102.08 and is added to your monthly payment. This amount does NOT go toward principal reduction. It simply vanishes into thin air and could otherwise be used for debt reduction or savings and investment.
The good news is that this PMI payment won’t be around forever. According to the Consumer Financial Protection Bureau (CFPB), borrowers can request removal of PMI when their loan balance reaches 80% of the value of the home at the time of purchase. Furthermore, lenders are required to automatically drop PMI when the loan balance reaches 78% of the original home value.
Mortgage Insurance: Canceling PMI Can Save You Thousands
Let’s take the example above and assume a 30 year fixed rate mortgage at 4.5% with no additional payments toward principal:
- Borrower takes the initiative and requests cancelation at 80% loan-to-value (LTV): The borrower would have paid $7,350 in PMI over 6 years.
- Borrower waits for automatic removal at 78% LTV: The borrower would have paid $8,779 in PMI over 7 years and 2 months.
However, what the CFPB website doesn’t mention is that lenders may be willing to cancel PMI even earlier under certain situations. One lender I contacted has the following policy for canceling PMI:
- The loan must have a minimum two year payment history with no late payments.
- The borrower pays for a new appraisal.
- The loan balance to current value based on the new appraisal must be at least 75% LTV.
Why is this important?
If you have purchased within the last two to four years, it is likely that values in your neighborhood have risen. If so, you may be eligible to have PMI removed from your loan much earlier and put that money back into your pocket.
According to Zillow, a real estate website, the median home price in Sacramento has risen from $213,000 in January of 2013 to $292,000 in March of 2017. That is a 37% increase. Granted, not all areas have experienced the same price increases and real estate markets vary widely across the country.
However, consider our example above. If you bought a house for $277,777 two years ago and your loan amount was $250,000, your current loan balance would be about $239,000 due to monthly payments toward principal. For the borrower to be at 75% LTV, the new appraised value must come in at $318,000 which is a 14.7% increase.
Canceling your PMI at year two of your mortgage under this scenario could save you between $4,900 and $6,300 for the price of a $500 appraisal. That may not seem like much when we’re talking about loan balances in excess of $250,000, but consider the future values if invested for 20 years:
Be proactive. If you’ve purchased a home within the past two to four years and are paying PMI, contact your lender. Get familiar with their policy on canceling PMI and take the steps to determine if you’re eligible. Doing so could put thousands of dollars right back into your pocket.
Proceed with caution when paying off debt:
If you start looking for ways to reduce debt, odds are you will find more and more ways to do it. It can almost become an addition. Cancelling PMI can be a great way to save money and pay off your mortgage sooner. Don’t let the desire to be debt free cloud your judgment.
As a financial advisor, my clients often express a desire to finally rid themselves of a mortgage. They are within 10 to 15 years of paying it off and they almost become obsessed with bringing the balance to zero. For them, the final pay off on their mortgage will bring greater peace of mind. I completely understand those sentiments and agree that paying off debt, in general, is a good thing.
Unfortunately, this desire to reduce debt to zero can cause some folks to go from the frying pan into the fire. One example of this is withdrawing from tax deferred retirement accounts to pay off mortgages. This situation can often occur when someone leaves a job and is considering a rollover of their 401k. When you leave an employer you are given options as to what to do with your 401k. One of those options is a lump sum withdrawal.
Withdrawing from a 401k:
Proceed with caution when it comes to withdrawing from a 401k via lump sum. I can appreciate the desire to pay off debt. However, the rush to do so can result in paying significant taxes and not getting as much bang for your buck. This is compounded by the loss of potential future earnings on those funds.
Paying the 10% penalty for early withdrawal from the 401k is on top of ordinary income taxes that would be due. Look at whatever you withdraw from a 401k (assuming all dollars are pre-tax) as regular income. The 10% penalty adds insult to injury.
If you leave an employer, don’t be tempted to take and early withdrawal from your 401k and consider a rollover. If you roll it over, you maintain the status quo. There will be no tax or early withdraw penalty and the funds should continue to grow tax deferred. When you retire, you’ll have a source of funds to make periodic withdrawals to supplement your income in retirement.
It is important to note that much of this depends on what portion of your 401k is pre-tax or after-tax if any. I wrote an article called Tax-Deferred vs. Tax-Free Retirement Accounts that goes into a little more detail.
Do you have questions about canceling PMI or paying off debt?
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