With mortgage rates low, consider canceling PMI

As mortgage rates stall near record lows, it’s a fine time to refinance to grab a lower interest rate. But there are other reasons to refinance. One of them is to cancel mortgage insurance.

Mortgage insurance is a policy that reimburses the lender if you default on your home loan. Most lenders require mortgage insurance when you make a down payment of less than 20 percent. The borrower pays the premiums. It’s often known as private mortgage insurance, or PMI. The Federal Housing Administration sells mortgage insurance, too, in what’s called an FHA loan.

Sometime after you buy the house, the combination of mortgage payments and value appreciation will mean that you owe 80 percent or less of the home’s value, which is another way of saying that your equity is 20 percent or more. Ask your private mortgage insurer at that point to cancel PMI. You will have to pay for an appraisal and fill out paperwork.

How this might work

Let’s say you bought a house three years ago for $100,000. You made a 10 percent down payment and borrowed $90,000 with a 30-year, fixed-rate mortgage with an interest rate of 4.5 percent. The average 30-year fixed rate on Aug. 14, 2013, was 4.57 percent. Your monthly principal, interest and mortgage insurance payment totals $487.

Three years later, you have made all your payments, and now you owe $85,000. The house has gained in value and now it’s worth $108,000. You owe 79 percent of the home’s value: the $85,000 you owe divided by the $108,000 appraised value.

You could petition the bank to drop the mortgage insurance or wait a few months for mortgage insurance to be dropped automatically, once the loan-to-value ratio, or LTV, drops to 78 percent.

You would save even more by refinancing: You drop the PMI, and you get a lower interest rate. It’s a combo that can make your monthly payment a lot lower.

In this example, your monthly principal, interest and monthly mortgage insurance payment would go from $487 to $382, if you refinance with a 30-year loan at 3.5 percent. An even smarter move would be to pay the loan off in 25 years (tell your lender you want to amortize it for 25 years) so you’re not starting all over with another 30-year loan commitment. Paying it off in 25 years would make the monthly principal and interest $426, which still saves $60 a month over the higher-rate loan with PMI.

That 3.5 percent rate is possible for borrowers with good credit.

Mortgage rates this week

The benchmark 30-year fixed-rate mortgage remained unchanged this week, at 3.56 percent, according to Bankrate’s weekly survey of large lenders. A year ago, it was 4.06 percent. Four weeks ago, the rate was 3.6 percent.

The mortgages in this week’s survey had an average total of 0.25 discount and origination points. Over the past 52 weeks, the 30-year fixed has averaged 3.87 percent. This week’s rate is 0.31 percentage points lower than the 52-week average.

— The benchmark 15-year fixed-rate mortgage was unchanged at 2.84 percent.

— The benchmark 5/1 adjustable-rate mortgage rose to 3.05 percent from 3.04 percent.

• The benchmark 30-year fixed-rate jumbo mortgage rose to 3.61 percent from 3.58 percent.