For anyone who got a mortgage in the last few years with little equity, most are all-too-familiar with mortgage insurance, the added premium built into the mortgage payment insuring the lender against payment default. Measured over time, it can cost you thousands. The facts you must know…
Zero Tax Advantages
For years mortgage borrowers got to enjoy additional tax advantages by having the ability to write off their annual mortgage insurance premiums much like their property taxes and mortgage interest. A dollar for dollar write-off, paying PMI didn’t used to be all that bad. Between the years 2008 through 2013, it was simply the cost of doing business if you didn’t have the holy grail 20% equity. Enter Q4 2013- IRS changes the ruling disallowing mortgage insurance premiums deduction for taxable years post December 31, 2013. Currently, as we enter Q4 2014, many homeowners not privy to this change, will come to learn their PMI they continue to carry is now as after-tax expense akin fire insurance or a consumer loan payment.
Mortgage Insurance Reduces Your Real Income
That’s right you heard it correctly. Think about it for a second, if your mortgage payment has PMI built in, you by definition have more debt, requiring more income to offset it. Without more income, the PMI errodes the existing income normally used to offset the rest of the mortgage payment + other obligations ( i.e. car payment, student loans, credit cards, etc). The exact amount of the PMI is how much your gross income is reduced by -without the tax advantage. For example if the amount of your PMI is $250 per month, your income is reduced by $250 per month, the only way the $250 per month would not adversely affect your gross income would be if it was not there (refinanced), equivalent to an income raise, allowing you to “see” of your after tax dollars.
Home Equity Needed
You need not have 20% equity any more to get rid of PMI. 10% home equity is the magic number, which is the difference between the loan amount and the value of the house supported with an appraisal. Lenders offer an alternative to the standard 20% threshold, Lender Paid Mortgage Insurance where the lender actually pays the monthly mortgage insurance the consumer would otherwise incur. This is especially advantageous as PMI can be anywhere from .75% of the loan amount to 1.3% of the loan amount on a monthly basis. On a loan for $400,000 that could be as high as $430 per month, immense net tangible benefit if the lender scoops up this premium each month right? * Without an appraisal, you’re only speculating. Contact a lender, get an appraisal. Why speculate, when you otherwise could be realizing the benefits of a substantially lower mortgage payment without the PMI? Most lenders appraisal fee is between $400-$500. The reality is the appraisal may determines insufficient equity, but, it does define exactly how much more value you would need need to refinance in the future.
Limits Your Ability To Pay House Off Faster
This is a big disadvantage of PMI. Let’s say you are investing an extra $200 per month on to your principal balance in effort to reduce the interest you pay on the mortgage over time. Using this example lets say your mortgage payment is $2800 per month, $300 of which is the payment PMI payment . As a smart consumer you’re making $3,000 per month mortgage payment instead. If the PMI was not there, an extra $500 per month would be going directly to your principal compounding your timely prepay efforts, reducing interest expense exponentially. If you’re overpaying on your mortgage and you have PMI, you’re only realizing half the potential you could be if you were able to get rid of the PMI or shift the cost of the PMI to the lender via lender paid mortgage insurance.
Petitioning Out Of Mortgage Insurance Without Refinancing
Some homeowners have mortgage they took out when 30 year mortgage rates were sub 3.75%. The case, why refinance my mortgage when I have a 3.25% 30 year fixed with PMI and a new 30 year fixed rate mortgage is just over 4%? Well, petitioning out with PMI is daunting task indeed, especially depending the type of loan you have.
If you have an FHA Mortgage you took out pre-June 2014. The requirement then was after 60 months of mortgage insurance premiums paid to HUD and 20% equity, you had the ability to petition out of PMI and it is up to the lender’s sole discretion grant the homeowner’s request, not a guarantee. Alternatively, the PMI would be removed at 78% loan-to-value 22% equity based on an amortization schedule from original loan inception calculating out at 120 months (that’s 10 years).
Not all that easy, remember? PMI for FHA Mortgage Loans originated after June 2014 with 3.5% down contains permanent mortgage insurance, wherein the only way out is to refinance or with 10% down you can petition out of the mortgage insurance after 10 years, still, refinancing may be a more worthwhile choice in either situation.
For conventional loans the PMI can be petitioned to be removed after a minimum of 24 months of mortgage payments. The key here is- if refinancing into a conventional loan with lender paid mortgage insurance is less costly than how much more you would pay in PMI between now and when 24 months is up, moving out of the PMI would make sense as long as the rate is the same, or lower.
*Mortgage Tip: if the interest rate on a new refinance is an .125 to .25% higher than the current rate with PMI, the rate differential could make additional financial sense if prepaying the mortgage
The critical masses of borrowers very well might have more equity than they otherwise might think. In Santa Rosa, and the surrouding Sonoma County, area homes prices have have risen sharply creating more equity for homeowners who otherwise were thinly financed in years past. This additional equity accumulation can easily pave the path to subsequently reducing the unnecessary PMI payment, if not completely removing it.
The Bottom Line
PMI can be avoided if you have the cash or the home equity needed to do so as little as 10%. If you cannot qualify for financing focus on the financial factors you can control. Work closely with your loan officer, they are incentivized to help you. If mortgage insurance is an absolute depending on your financial situation, ask your lender what other adjustments can be made to reduce your mortgage costs, i.e. credit score, loan program, and of course equity all play important roles in your loan structure.
Need to get out of your higher cost PM mortgage? Start by letting a 10 year experienced mortgage professional give you a free mortgage rate quote!