Whether it’s auto, home, or life, insurance provides protection and compensation in the case of loss, damage, or illness. Many homeowners purchase mortgage insurance (MI), which is a cost for borrowers who have a conventional mortgage and do not provide a 20 percent down payment of a home’s purchase price.
Although many homeowners find MI beneficial because of its protection, there are drawbacks, especially when it comes to costs and the challenges in canceling the policy. Luckily, this blog post provides several ways to get rid of MI. But first, let’s fully detail MI and go over some pros and cons.
What Is Mortgage Insurance?
MI is an insurance policy that compensates lenders if the mortgage holder defaults on a mortgage loan. It serves two primary purposes:
- For the lender, it provides a level of protection if the buyer defaults on their mortgage or their home goes into foreclosure.
- For the homeowner, it ensures qualification for a loan that they might not otherwise be able to get.
MI is required in two scenarios:
- The down payment is less than 20 percent of the property purchase price. Anything below this price is considered a risky investment.
- The mortgage is a Federal Housing Administration (FHA) loan or a U.S. Department of Agriculture (USDA) loan. Both typically require MI.
Although many homeowners hold MI because of the loan terms, others will opt-in if they do not want to pay for a high down payment. In fact, if the homeowner’s investments create wealth, they will choose to pay for MI and make more money in the long run.
MI can either be paid up-front or monthly. MI is usually canceled when the borrower has at least 20 percent equity in the house.
The Pros and Cons of Mortgage Insurance
MI is not a one-size-fits-all approach. Every homeowner has a specific financial situation that determines whether or not MI is a sound financial investment. With that said, here are several pros and cons that apply to most homeowners.
The Pros of MI
- It can be a smart financial investment. Even if a homebuyer can afford a 20 percent down payment on a mortgage, they may choose to pay a lower down payment and opt-in for MI if their investments are working well.
- It can allow you to lock in lower interest rates. Rather than waiting until they have 20 percent for a down payment, a homebuyer can take advantage of lower interest rates. Missing this opportunity and purchasing with a higher interest rate could result in you paying more for the house over time.
- It can allow you to purchase a home as prices increase. Similar to the previous point, if the homebuyer waits until they have 20% for a down payment, it could be a missed opportunity to purchase a home at a lower price.
- It can indirectly help you pay off high-interest debt. By paying a lower down payment, the borrower can apply savings to high-interest debt, such as credit card debt, student loans, and auto loans.
- MI can be costly. According to an article from Investopedia, the average annual cost of MI ranges between 0.4 and 2.25 percent of the total loan amount. That means a $300,000 mortgage can result in an additional $3,000 per year.
- MI can be difficult to cancel. After falling below the 80 percent loan-to-value ratio, the borrower still needs to submit a request for MI cancellation by sending an official letter. In many cases, the MI provider will likely require an official appraisal of the property. If home values have lowered, they might still require the homeowner to keep their MI.
- Some MI policies require a contract for a designated period. This means that even if the borrower pays 20 percent of their purchase price point, they might still need to pay MI until the contract is completed.
Getting Rid of Mortgage Insurance
If you currently have MI and have decided that you would like to get rid of it, here are four options commonly used by homeowners:
1. Pay down mortgage for automatic termination of MI.
The Homeowners Protection Act gives the homeowner the right to remove MI at specific home equity milestones or when they reach 20 percent home equity.
When the homeowner’s loan-to-value ratio drops to 78 percent, the lender or servicer must terminate the MI. This is only applicable to homeowners who are in good standing and haven’t missed any mortgage payments.
They must also stop MI at the halfway point of the amortization schedule. For example, MI would be dropped after 15 years on a 30-year loan.
2. Request MI cancellation when the mortgage balance reaches 80 percent.
Rather than waiting for automatic cancellation, homeowners can request that MI is canceled once the loan balance reaches 80 percent of the home’s original balance. As long as the homeowner makes payments on schedule, they can find the date they will hit 80 percent on the MI disclosure form.
Pro tip: If you have the cash to spare, you can reach 80 percent faster by making extra payments.
3. Refinance your mortgage.
Refinancing your mortgage can provide savings from two different angles:
- While rates are low, you can consider refinancing your mortgage to save on interest costs or reduce monthly payments.
- Refinancing can eliminate MI if your new mortgage balance falls below 80 percent of the home’s original value.
As with any refinancing, weigh the closing costs against the potential savings from the new loan terms and MI elimination.
4. Reappraise your home.
There are a lot of buyers and low inventory in the current market, so your home equity could reach 20 percent earlier than expected. In this market, paying for a new appraisal might be worth it. If you have owned your home for at least five years and your loan balance is no more than 80 percent of the new value, you can request that your MI is canceled. You might also be able to get your MI canceled if you have owned the home for at least two years and the remaining balance is no greater than 75 percent.
Consult a Loan Officer About Your Mortgage Insurance
As you can see, there are many moving parts when it comes to mortgage insurance. If you currently have mortgage insurance and would like to get rid of it, talk to one of our Loan Officers to determine which route would best suit your situation.
If you would like to learn more about the home-buying process, check out these essential home-buying tips directly from our Loan Officers.