The Money-Wasting Mortgage Mistake You’re Likely to Make
Property taxes, homeowners insurance, interest, HOA fees—when it comes to your monthly mortgage payment, your loan’s principal doesn’t lack company. Still, few of these additional costs and expenses draw as much ire from a homeowner than private mortgage insurance (PMI.)
If you’re begrudgingly shelling out extra cash for a PMI premium, then private mortgage insurance needs no introduction. But for the uninitiated, here’s a quick rundown: PMI is required by a lender if a borrower is unable (or unwilling) to make a 20% down payment when using a conventional mortgage to pay for a home (the same is true for financing through the Federal Housing Administration, but the rules and stipulations differ). In the mortgage world, lenders prefer borrowers have as much money (or equity) invested in a home, so they’re less likely to default. However, when this isn’t possible and the lender has a majority stake in the home, the lender will require the borrower to purchase private mortgage insurance to protect the lender in case of default and foreclosure.
In short, the PMI safeguards the lender—at the expense of the borrower—and it remains on the loan until the borrower’s equity in the home reaches 20%. The cost isn’t exactly chump change, either: Premiums typically range from $30-70 per month for every $100,000 borrowed, depending on the borrower’s down payment amount and credit score. What’s more, homeowners have no say in choosing the mortgage company and they can’t negotiate the rate. Adding insult to injury, there’s no guarantee that mortgage insurance premiums paid in 2018 and beyond will remain tax deductible.
There’s a flip side, though: PMI allows homebuyers with a modest bankroll to take advantage of today’s low mortgage rates (now hovering in the low 4% range compared to the 10%-plus rates of the 80s). Also, PMI can be eliminated entirely from a mortgage payment, if its been “seasoned” for at least 12 months, and the loan-to-value (LTV) ratio is no higher than 80% (read: The borrower has at least 20 percent equity in the home). This is all on the condition that the loan is in good standing.
That brings us to the mistake first-time homebuyers are likely to make: not keeping tabs on their LTV ratio (you can calculate this by dividing the loan balance by the home’s appraised value). Get this: Lenders aren’t required by law (or more precisely, the Homeowners Protection Act) to automatically terminate PMI on a conventional loan until the borrower’s LTV reaches 78% (that’s based on the original appraised value or sales price, whichever is lower). However, according to the same act, you can request, in writing, for the PMI to be removed once the LTV reaches 80%.
So what’s the big deal? Let’s crunch some numbers. Say you purchase a home tomorrow for $215,600 (the current median home value in the United States, according to Zillow). You put 5% down (or $10,780), which leaves you with a loan amount of $204,820. To petition to drop your PMI at 20 percent equity, you’ll need to pay down your principal to $163,856 (the loan amount multiplied by 0.8). A peek at an amortization schedule for a 30-year loan with 4% interest shows that you’ll reach an LTV of 80 percent in December 2027. But the lender isn’t required to cancel the policy until September 2028, when you reach an LTV of 78 percent ($159,759.60). That means you could be making unnecessary PMI payments for close to a year—wasting upwards of $1,300—if you don’t request the PMI be removed.
Even if you set an alarm for December 2027, nine years is a long time to wait—and a longer time to pay. For homeowners in search of a shortcut, Amin Taghavi, a mortgage planner at Rock Hill Financial in Narberth, Pennsylvania, has some advice. “Do your homework,” he says. “After paying the PMI for a full year, see what comparable properties are selling for in your area, and if you think your home’s value has increased enough to get you to 20 percent equity, ask for a reappraisal.” This entails having an appraiser (chosen by the lender) visit your home to determine its current market value; the service costs between $450 and $600, depending on your location. Reappraisals can also benefit homeowners who’ve made significant improvements to their home since the initial purchase date. Though you do have to fork up hundreds of dollars for the service, it might be worth saving the what-would-be thousands of dollars in PMI over the additional eight years of payments that would bring you to 20% equity.
Another way to fast-forward to your final PMI payment is through refinancing (getting a different mortgage with a lower interest rate once you have more equity in the home), but with closing costs to consider and mortgage rates slowly on the rise, this is becoming a less viable option. Instead, Jeremy Durkin, a senior mortgage consultant with Trident Mortgage in Philadelphia, Pennsylvania, suggests that homeowners simply tack on an extra $200 or $300 to their mortgage payment every month that goes towards paying down the principal. A strategy that’s both foolproof and effective? Sold.