Many homeowners with mortgages are saddled with an extra monthly expense for which they get nothing in return.
I'm talking about private mortgage insurance, which most borrowers have to pay for if they purchase a home with less than a 20 percent downpayment. The insurance protects the lender in case of default, not the homeowner.
It's not a small expense. For a median-priced home in the Charleston area, annual PMI charges easily could be higher than annual property taxes. The good news is, in most cases, PMI charges eventually go away as home equity rises.
But here's the thing - many homeowners don't know the rules, and as a result could end up wasting money by paying for PMI longer than they need to.
Those with a mortgage signed prior to July 29, 1999 typically have to ask their lender to drop the PMI when they attain enough home equity, because there's no requirement that it end automatically. The magic number is 20 percent equity, which is the same as 80 percent loan-to-value.
Those who signed a mortgage after mid-1999 have more protection from unnecessary PMI charges thanks to the Homeowners Protection Act of 1998, which requires lenders to terminate PMI the month after the borrower's loan-to-value ratio hits 78 percent of the original home value (the value at the time of the loan). However, if the borrower asks, the lender must drop PMI when the borrower's loan balance reaches 80 percent of the original home value.
That seemingly small difference can be worth some real money, because PMI can tack more than $100 every month onto the payment for a median-priced home, or considerably more depending on credit scores and downpayments made.
With a 30-year mortgage, it can take nearly a year of monthly payments to get from 80 percent equity down to 78 percent, when the lender must automatically end PMI, and that's a year of PMI payments borrowers can avoid if they just ask.
For example, let's say someone buys a $180,000 house, with a 10 percent downpayment. They borrow the rest, $162,000, with a 30-year loan carrying a 4.5 percent interest rate. So, they start out borrowing 90 percent of the property's value.
It would take that person 62 months of payments to bring the loan balance down to 80 percent of the property's original value, when they can request PMI cancellation, and an additional year to reach 78 percent, when the lender must terminate PMI. So, knowing when the loan will reach 80 percent and requesting cancellation of PMI coverage would save the borrower a year of PMI payments, easily more than $1,200.
If you don't know when your loan will reach that magic 80 percent loan-to-value ratio, ask your lender, review your mortgage and escrow paperwork, or run your loan numbers through an online amortization calculator. Bankrate.com has a good, free calculator that can figure out the principal remaining in each month of a 30-year mortgage.
The loan-to-value percentages used to figure out when PMI should be canceled are based upon the value of the home at the time of the loan, so borrowers aren't stuck with extra years of PMI payments if the property value decreases. But if the property value increases, that boosts the borrower's equity in the property and can lead to an earlier end to PMI payments.
For homeowners in a time of rising home values and falling interest rates - what we've been experiencing recently - refinancing also can be an opportunity to shed PMI payments. Someone refinancing a loan will have a fresh appraisal, and if the loan's 80 percent or less of the property value, no PMI would be required.
Home equity also can be boosted by making extra principal payments on the mortgage, which essentially shifts savings into home equity while increasing cash flow by ending PMI payments.
Borrowers need to be up to date on mortgage payments in order to drop PMI, and the rules don't apply to certain types of loans, including Federal Housing Administration loans.
For would-be homeowners, it's important to know that mortgage loan options can range from those where the PMI payments never end, to PMI-free mortgages, to a range of PMI costs in between.
VA loans don't require PMI, for example, while FHA loans come with PMI payments that cannot be terminated. One choice for people with low to moderate incomes is a new mortgage option from the S.C. State Housing Finance Authority, which requires PMI but at lower rates than typical lending institutions would charge (because the authority requires less insurance protection).
That's a lot to think about, but you can't have too much information (TMI) about PMI.