With the housing market up meaningfully since its peak in 2006, we have amazing wealth in equity. However, new homeowners have been required to meet strict guidelines to qualify for a mortgage.
Private Mortgage Insurance
One such guideline is home purchasers need to have at least a 20% down payment when buying a home, creating a gap between what the homeowner owes and what the home is worth. If home buyers are unable to put 20% down, they can still qualify for a mortgage, but they need to purchase private mortgage insurance (PMI). PMI insures the loan in case the homeowner defaults and the sale of the home would not recoup what was owed. While this protects the lender and the homeowner both, the homeowner must pay the monthly PMI payment until they accrue 20% equity in the home.
PMI can cost homeowners anywhere from .25-2.25% of the loan amount annually, which is paid monthly through mortgage payments. This range is based on the value of the loan being insured, credit score, and the overall risk that the homeowner will default. This can cost a few hundred dollars a month and can make it expensive to afford a mortgage. Homeowners often overlook this extra expense in the details of the principal, interest, property taxes, and home insurance. If the value of your home has increased and you are paying mortgage insurance, it might be time to petition your bank to remove the PMI coverage altogether.
Andy and Melissa bought their first home in 2010. They have paid their mortgage consistently and haven’t refinanced. They bought their home for $120,000 and made a down payment of 3%. They took out a 30-year loan for $116,400 with an interest rate of 4.69%. Their neighborhood has experienced a major increase in market value over the last 12 years, and their home value has increased 50% since they bought it. Their home is now worth $180,000 and the principal on the outstanding mortgage balance has been reduced to $85,000. Can they petition the bank to have PMI removed at this point? The formula for calculating the equity in your home is the outstanding mortgage balance divided by the current home value. That means they have 47% equity in their home ($85,000 divided by $180,000). Remember, PMI can be removed once the equity in your home is over 20%, so PMI isn’t required for Andy and Melissa’s mortgage anymore.
Andy recently reviewed their mortgage statement and realized that they were still paying for PMI. The amount they were paying had been reduced because their equity had increased, but, because they had so much equity, it did not seem necessary to continue to pay at all.
Andy called his lender and petitioned to have the insurance removed. This saved his family $50/month going forward. Had they reviewed their financial situation with a financial advisor sooner, they could have taken the PMI off long before and saved even more money. $50/month may not seem like a lot, but it could be redirected towards things like saving for a child’s college education or paying off high interest debt. This is a great example of why every household should have a financial advisor. An advisor who does comprehensive financial planning will evaluate all the moving parts of your financial life and bring these details to your attention to strengthen your financial situation. We recommend reviewing these decisions with a financial planner, like us.