Does PMI Go Away After 20 Percent Equity?

Private Mortgage Insurance (PMI) is common in many mortgage agreements, particularly for those who make a down payment of less than 20% of the home’s purchase price. This insurance primarily protects the mortgage lender, not the homeowner, against financial losses if the borrower defaults on the loan. While PMI adds to the monthly housing expense, it enables individuals to purchase a home sooner without a substantial initial down payment. Understanding how PMI works and the conditions under which it can be removed is important for homeowners to manage their mortgage costs effectively.

Understanding Equity and Loan-to-Value

Home equity represents the portion of your home that you truly own outright. It is calculated by subtracting your outstanding mortgage balance from your home’s current market value. For example, if a home is valued at $400,000 and the mortgage balance is $140,000, the equity is $260,000.

The loan-to-value (LTV) ratio is a metric that compares the amount of your mortgage loan to the appraised value of your home. To calculate LTV, divide the current loan balance by the home’s appraised value and then multiply by 100 to get a percentage. For instance, a $140,000 loan on a $200,000 home results in a 70% LTV.

A lower LTV ratio signifies less risk for lenders, often leading to more favorable loan terms and avoiding additional costs like PMI. The 80% LTV threshold, which corresponds to 20% equity, is a significant benchmark because it triggers considerations for PMI removal. As principal payments are made over time, the outstanding loan balance decreases, which in turn reduces the LTV ratio and increases home equity.

Automatic PMI Termination

Federal law, the Homeowners Protection Act (HPA) of 1998, mandates the automatic termination of PMI for certain conventional loans. Under this act, lenders are required to cease collecting PMI premiums when the loan’s principal balance is scheduled to reach 78% of the home’s original value. This original value is defined as the lesser of the property’s sales price or its appraised value at the time the mortgage was created.

This automatic termination is based on the original amortization schedule of the loan, regardless of whether the property’s value has appreciated or depreciated. For this termination to occur, the borrower must be current on their mortgage payments. The HPA also stipulates that PMI must be terminated when the loan reaches the midpoint of its amortization period, even if the 78% LTV threshold has not yet been met, provided the borrower is current on payments.

Borrower-Initiated PMI Cancellation

Homeowners have the right to request the cancellation of PMI once their loan balance reaches 80% of the home’s original value. This can occur earlier than automatic termination if additional principal payments are made or if the home’s value has increased. To initiate this process, borrowers need to submit a written request to their loan servicer.

Several conditions must be met for a borrower-initiated cancellation. The borrower must have a good payment history. Lenders may also require certification that there are no junior liens, like a second mortgage, on the property.

If the request is based on increased property value, the lender may require a new appraisal to confirm the current market value of the home. This appraisal, paid for by the homeowner, helps to verify that the 80% LTV threshold has been reached. If all conditions are satisfied, the servicer is obligated to cancel the PMI.

Alternative Approaches to PMI Removal

Beyond the standard automatic or borrower-initiated cancellation processes, homeowners can explore other strategies to eliminate PMI. One method involves making extra payments toward the mortgage principal. By accelerating principal reduction, the loan balance decreases faster, allowing the homeowner to reach the 80% LTV (or 20% equity) threshold sooner than scheduled.

Refinancing the mortgage can also be an effective way to remove PMI. If a homeowner refinances into a new loan and the new loan’s LTV is 80% or less, the new loan would not require PMI. This strategy is appealing if current interest rates are lower than the original loan’s rate, offering additional financial benefits. However, refinancing involves closing costs, which should be weighed against the savings from eliminating PMI.

Another approach involves obtaining a new appraisal if the home’s market value has increased due to market appreciation or home improvements. If a new appraisal demonstrates that the LTV based on the current value is 80% or less, the homeowner may request PMI cancellation from their lender. This method is advantageous in strong housing markets.