The ROI Of Eliminating PMI With Principal Prepayments

So, while lender-paid PMI may be something to think about for some taxpayers, what most homebuyers think of when they pay PMI is either a monthly or lump-sum PMI payment. For ongoing PMI payments, annual payment amounts might range from 0.3% to 1.2% of the mortgage amount depending on many factors including the property location, size of the down payment, and how the property will be used.

Terminology note: Mortgage insurance premium (MIP) and private mortgage insurance (PMI) are effectively the same from a borrower’s perspective, but MIP is used in reference to FHA and other governmental loans (including reverse mortgages), whereas PMI (private mortgage insurance) is used for conventional loans. However, despite serving effectively the same function, the rules for eliminating MIP can be substantially different than the rules for eliminating PMI.

Ongoing PMI Payments

With ongoing PMI, the premiums are paid until the loan-to-value (LTV) ratio reaches a certain threshold. This threshold can vary depending on a specific loan, but PMI can be eliminated on most conventional loans when the LTV ratio falls below 80% (FHA and VA loans typically must reach an LTV ratio of 75% subject to certain time limitations).

However, it is important to note that PMI is not automatically eliminated until the LTV ratio reaches 78%. While the LTV ratio is between 80% and 78%, it is the borrower’s responsibility to request that PMI is ended.

In addition, merely reaching the 80% LTV threshold based on the original value of the home does not guarantee elimination of PMI either, as the lender will likely require the borrower to obtain an appraisal, and the property may or may not then appraise at a value needed to actually eliminate PMI (i.e., if a house subsequently appraises at a lower valuation).

Further, whether appreciation can count towards improving a borrower’s LTV depends on their situation as well. In most cases, short-term appreciation (e.g., less than two years) will not be allowed to count towards eliminating PMI, and the borrower will need to reach a less-than-80% LTV ratio based on the lesser of the appraised value or original purchase price.

Note: For simplicity, several illustrations are shown in this post with 0% down. However, in practice, most conventional loans require at least 3% down, such as the 3% down (97% LTV ratio) programs now offered by both Fannie Mae and Freddie Mac).

Example 1. Jim takes out a $200,000 mortgage and on a $200,000 home. Given his credit score and other factors, he will pay an annual mortgage insurance premium of 0.6%, which amounts to an additional monthly payment of $100 ($200,000 * 0.006 / 12 = $100). Jim will pay this same $1,200/year premium amount until his LTV ratio is less than 80% (a mortgage balance of $160,000 based on the original purchase price of the home), despite the fact that his outstanding loan balance is declining from year-to-year.

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