Dear Dr. Don,
I recently bought a house and got married. We only had 10% (or $55,000) to put down on the house and are currently paying a private mortgage insurance, or PMI, premium of $300 per month. When we got married, our joint income level put us over the threshold to contribute to an individual retirement account. Since my current IRA investments have been doing poorly and I cannot contribute any more, my husband wants me to pull out the $14,500 I have in the account and put it toward paying down the mortgage so we can cancel the PMI policy. Does this make financial sense?
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-- Kathy Cancel
I don't think it makes sense, at least not at this time.
Everyone hates paying private mortgage insurance because it's there to protect the lender, but the homeowner has to pay the premium. The good thing about PMI in your situation is that it allowed you to buy a $550,000 house with only 10% down.
For the lender to be required to cancel the PMI policy, the home's loan-to-value ratio has to be at 78%, based on the lesser of the original purchase price or its appraised value at purchase. The homeowner can, however, petition the lender to cancel the policy once the measure of loan-to-value falls to 80%. That means you'd need to reduce the loan balance by another $55,000.
You can ask your lender to consider improvements you made to the property or any price appreciation the home has experienced to get to the point where a current home appraisal shows a loan-to-value that would allow PMI to be canceled. However, for loans held by Fannie Mae or Freddie Mac, there's also typically a seasoning issue, where the loan has to be outstanding for a period of time -- typically two to five years -- before you can petition to have the PMI policy canceled. You also need to have a clean payment history.
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Before you cash in that IRA, you should know these limitations. Talk to your lender or loan servicer about these restrictions on canceling PMI.
Cashing in your IRA will net you less than $10,000. How much less depends on your marginal federal and state income tax brackets and whether the distribution is subject to the 10% penalty tax. Whether you would qualify for the first-time homebuyer's exemption from the penalty tax is complicated enough that you should take it up with your tax professional.
If you don't like the performance of your IRA, then change how you have the money invested. You can move the account, if needed, to have different investment options available to you. If yours is a traditional IRA, you can always contribute, but the question is in whether these contributions generate a tax deduction.
It's a common scenario. People put money aside for retirement and then find a reason to raid the account to meet a current financial goal. Sometimes it can make financial sense, but I'd rather see you make additional mortgage principal payments over time to chip away at the loan balance than raid your IRA, especially since it's likely that you're two to five years away from being eligible to cancel your PMI policy.
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