A lot of people will advise you to not buy a house unless you have 20% to put down. That's probably good advice if you live in an area with reasonable rents and moderate housing prices.
But when you live somewhere like Los Angeles or New York City, where rental prices are a few thousand dollars a month and home prices start at half a million dollars, it might make sense to put down what you can and make a mortgage payment for close to the same price you would pay in rent.
Not many of us can afford to pay $2,500 a month in rent while trying to save up a $100,000 down payment, which is where private mortgage insurance (PMI) comes in.
What is PMI?
PMI is insurance that you have to buy if you put less than 20% down when you buy your home. It's a monthly fee that's paid into your escrow account.
How much does PMI cost?
The amount of the fee depends on several factors including your credit and the amount you're financing compared to the value of the house. It could be a couple hundred a month or three times that.
This PMI calculator can give you a rough estimate, but your mortgage broker can give you a more accurate idea.
Why is PMI a thing?
You are considered less of a liability to mortgage companies if you have 20% equity in your home. Another way to say that is that you have an 80% or less loan to value (LTV) ratio in your home.
Why is PMI a good thing?
PMI guarantees that a mortgage company will recoup some of their costs if you default on your loan. Otherwise, mortgage companies wouldn't lend you money if you didn't have 20% down.
Think about it like this, your friend's friend wants you to buy her a $200 concert ticket. You don't know this friend. You've heard good things, but you can't be sure she'll pay you back.
She offers to send you $10 (5%) as a down payment . That probably doesn't instill a lot of confidence in you. This friend's friend could easily walk away from $10 and you'd be burdened with finding someone else to buy the ticket for $200. You'd stand to make $10 for a lot of extra effort and the risk wouldn't be worth it.
But your mutual friend says, "I guarantee you will get paid at least $40 (20%), even if I have to cover it myself." Then, worst case scenario, you'd have to find someone else to buy the ticket for $200 and you'd make a $40 profit. This is a much more appealing risk.
Why is PMI a bad thing?
Because your monthly mortgage payments are a lot of interest, taxes and fees and a little principal balance, it could take you many years until you PAY 20% equity into your house. If you are paying $300 a month in PMI over five years, that's an extra $18,000 dollars.
How can I get rid of my PMI in the slowest and most painful way possible?
Your bank will eventually remove your PMI when you have dutifully paid your principal balance for many years and have at least 20% equity in your home. Banks are required to automatically drop the PMI when the LTV is 78%.
How can I get rid of my PMI in a shorter and less painful way?
The much better option (which can save you thousands of dollars), is to get rid of your PMI when the value of your house PLUS what you have paid toward your principal brings your loan to value ratio to 80% (in other words you have 20% equity).
So if the value of your house has increased enough, your PMI can be forgiven.
How do I figure this out?
Here's what to do, thanks to my CPA father. You need the loan to value* to be 80% or .80 (hello again, math skills, it's been awhile). So take the current amount you owe on your loan, let's say that's $90. Divide that amount by .80, which gives you $112.50. So you would need the value of your house to be $112.50 in order to drop the PMI.
*Some banks will require 25% equity. See below.
Ok, great, my home's LTV is 80%. Now how do I drop the PMI?
There are two options.
1. Contact the bank that has your home loan.
Inform them that you think you have an 80% LTV based on current home prices in your neighborhood and you want to drop your PMI. All banks will have a different process, but all banks will require an appraisal that goes through a company of their choosing at your cost. Our bank required a two year minimum ownership and a 75% LTV if the loan was under five years.
This means you're going to have to shell out a few hundred bucks for an appraisal now for a shot at saving a few hundred bucks every month for the next few years. Obviously, you want to have a very reasonable assumption that your house will appraise for what you need it to appraise for. Otherwise, you're wasting a lot of money on an appraisal.
2. Look into refinancing.
Refinancing costs a lot more. You have to pay the closing costs and fees just like buying a house (and, if you are rolling those costs into the loan, then you need your house to appraise for even more because you are increasing the amount of the loan). And you still have to pay for an appraisal. But, if current rates are less than what you are paying now, you could save a lot of money by eliminating your PMI and lowering your monthly interest payment.
How can I increase my chances of getting a great appraisal so I can eliminate the PMI?
Make your home look spectacular for the appraisal. Fix it up like you would if you were selling the house. It matters.
Find out what recourse you have if the appraisal falls just short of what you need. Can you pay the closing costs in cash if you are refinancing? Can you make up the difference in cash if you are a just trying to eliminate the PMI?
A lot of us couldn't own a home if private mortgage insurance wasn't an option. It's a necessary evil but not one you need to hold onto for long.