How to get rid of PMI

Private mortgage insurance, or PMI, is an added expense that some homebuyers are required to pay. As the name implies, PMI is a separate insurance policy that covers mortgage payments.

The purpose of PMI is to protect lenders in the event that a homebuyer defaults on a mortgage. To learn how to stop paying PMI, check out what you need to know about shelling out for mortgage insurance.

What is PMI?

If you take out a conventional home mortgage and put down less than 20 percent of the purchase price, you most likely will be required to purchase private mortgage insurance. The same is true if you’re refinancing and your home equity is less than 20 percent.

PMI is calculated based on a combination of factors. Usually, the more money you put down, and the shorter your loan period, the smaller your PMI payments will be. Your credit score also will play a role. Lenders often show their PMI rates on their websites. Typically, you will pay a PMI premium of $30 to $70 per month for every $100,000 you borrow.

How to get rid of PMI

Options for getting rid of PMI include the following:

■ Paying a higher down payment.

■ Getting a higher-rate loan.

■ Getting a Federal Housing Administration loan.

■ Having a loan-to-value ratio of less than 80 percent.

■ Getting to the halfway point of a mortgage.

Understanding how PMI works, and how to avoid this added expense, might save you money. Here are more details on your options for eliminating PMI:

■ Avoid PMI from the start.

The best way to get rid of PMI is to avoid it in the first place. If you can save enough money for a down payment of 20 percent, you won’t have to deal with the hassle of PMI.

■ Find a lender who will work with you

Another option for PMI removal is to work with a lender who can structure a loan for you that doesn’t require PMI, even if you put less than 20 percent down. Not all lenders will do this, but if you find one that does, be prepared to pay a higher interest rate on your mortgage. If you opt for this route, calculate the total amount you would be paying under both scenarios — PMI plus a lower-rate loan versus no PMI plus a higher-rate loan — to determine which is more financially prudent.

■ Get an FHA loan

FHA loans are another option if you’re making a low down payment, as they don’t require PMI. FHA loans do require mortgage insurance, however, which is essentially the same type of insurance that PMI provides. Rates can be lower or higher than what you would face if you took out a conventional loan and paid PMI.

Once the amount of your outstanding mortgage falls to 78 percent of the value of your home, your lender must automatically terminate your PMI payments. You can request termination in writing when your loan-to-value reaches 80 percent. If your home value has risen significantly and you can refinance with a loan that is less than 80 percent of the value of your home, you are no longer required to pay PMI. Making additional payments toward the principal of the mortgage is another option, thereby reducing the amount you owe relative to the value of your house.

A final way to remove your PMI is with time. Lenders must automatically remove PMI once you reach the midpoint of your loan period. For example, if you have a 30-year mortgage, once you reach the 15-year mark, your PMI must automatically end, even if you haven’t reached the 78 percent LTV threshold.

How much is mortgage insurance?

To calculate how much PMI you will owe, take the amount of your outstanding loan and multiply it by the PMI rate. The resulting figure is your annual mortgage insurance payment. For example, if a lender has a PMI rate of 0.50 percent and you owe $250,000 on your loan — after your down payment — multiply $250,000 times 0.50 percent to get your annual payment amount of $1,250.

How is PMI paid?

Traditionally, there are three ways to pay PMI:

■ Monthly.

■ Upfront.

■ Combination of upfront and monthly.

The most common way to pay PMI is simply to have it added to your regular, monthly mortgage installment. With an upfront payment, you pay the entire amount of your PMI at the time you take out your loan. A combination payment is somewhat akin to your mortgage loan: You will pay part of the PMI upfront as a down payment, then you will pay the balance off with your monthly installments.