Published February 06, 2013
If you put down less than 20% when you purchased a home, you probably pay for mortgage insurance every month. But with planning and patience, you can get rid of mortgage insurance to reduce your house payments.
Mortgage insurance is designed to protect the lender in case the borrower defaults. The premium is included in the borrower's monthly mortgage bill and varies depending on the type and size of the loan, the down payment amount and the credit of the borrower.
For instance, a buyer with a credit score of 700, who makes a 5% down payment and takes out a $200,000 conventional mortgage, should expect to pay about $156 per month in mortgage insurance, says Matt Hackett, operations manager at Equity Now, a mortgage bank in New York City.
Many borrowers don't realize that eventually they will get rid of mortgage insurance premiums. They can choose to do it sooner or later.
If you pay your mortgage according to the payment schedule you were given when you first took out the loan, your mortgage insurance will eventually go away on its own. The lender is required by law to terminate your mortgage insurance when the loan balance is scheduled to reach 78% of the original value of the home. When the time comes, the homeowner must be current on the loan.
This option may take years, and paying down your mortgage faster won't speed the process.
"Automatic termination at the 78% threshold is not based on the actual payments made, but is based on the date that the loan is first scheduled to reach 78%, according to the initial amortization schedule," says Sara Millard, senior vice president and deputy general counsel at United Guaranty Corp.
The law, under the Homeowner's Protection Act of 1998, only applies to home loans on primary residences. Some states, such as New York, have their own laws that require termination of insurance for primary and vacation homes.
Federal Housing Administration loans are not governed by the same law. But the FHA has a similar rule that terminates the insurance premium on most loans once the loan reaches 78% of the original value of the house or after five years, whichever comes later.
If you pay down your mortgage to 80% of the home's original value, you can ask the lender to cancel your mortgage insurance. There is no guarantee the lender will say yes.
This is different from simply having 20% equity in your home, based on the current market value.
"Everybody thinks they can get rid of their mortgage insurance when they have 20% equity, but that's not really the case," says Ed Conarchy, a mortgage adviser at Cherry Creek Mortgage in Gurnee, Ill.
Technically, borrowers can request the servicer to cancel mortgage insurance based on the current value of the home. But, generally, the borrower has to wait two to five years after taking out the loan to make the request, and the lender can reject it for a number of reasons, depending on which investors own your loan.
Lenders are more likely to approve requests that are based on what the home was worth at the time the loan closed. You must have a good payment history to be approved for this request, says Millard. That includes no 30-day or more late payments in the past year or a 60-day late payment in the past two years.
Even if you meet all these requirements, there may be other obstacles.
"The lender can simply say, 'Your home has gone down in value,' so this is still a risky loan," Conarchy says.
Having a second mortgage on the home can also be an impediment, Millard says.
Borrowers with FHA loans may not request mortgage insurance cancellation, says Stacey Sprain, assistant vice president of credit policy at Fairway Independent Mortgage Corp. in Sun Prairie, Wis.
"With FHA, you would have to refinance to drop the mortgage insurance," Sprain says.
With an FHA or a conventional loan, the easiest way to dump your mortgage insurance is a refinance, says Conarchy.
"The ultimate trump card is a refinance because you are going to do a new appraisal, and if you establish you have 20% equity, then you don't need mortgage insurance," he says.
If you don't have 20% equity but have some cash to pay down the mortgage, refinancing may still be a better option than simply paying down the existing loan and hoping the lender will approve your request to remove the mortgage insurance, he says.
"With a refinance you are in control," Conarchy says. "You kill two birds with one stone: You get rid of your mortgage insurance and you get a lower interest rate."
Copyright 2013, Bankrate Inc.