If you put less than 20% down on your home when you bought it, you probably pay Private Mortgage Insurance as a part of your mortgage payment. If you took an FHA loan, no matter how much money you put down, you must pay mortgage insurance each month.
You may wonder if it makes sense to refinance your loan to get out of the PMI if you have the chance. In some cases, it may make sense, but certain factors have to fall into place. Keep reading to learn if it’s right for you.
What Will it Cost?
Your first consideration should be the cost. You can’t refinance for free. So what will it cost? Do you have the money available to pay the closing costs or will you wrap the costs into your loan? This will make a difference in what you should do.
If you have the money to pay upfront, you can keep your mortgage payment down and enjoy the PMI free loan, assuming you have at least 20% equity in the home. If you wrap the costs into your loan, you increase the principal balance of your loan. This makes your payment higher. While you still might avoid PMI, you just made your loan balance higher, which means it will take longer to own the home free and clear.
What’s Your Break-Even Point?
Putting the cost aside for a second, it’s time to figure out your break-even point. It’s not enough to assume that you’ll save because you won’t pay PMI anymore. You need to know when you will start realizing those savings. This goes back to the closing costs. How long will it take you to pay back the closing costs based on the savings you’ll earn?
Here’s a quick formula that you can use:
Total closing costs/Monthly savings on new loan = Months to break even
Just how long is a ‘good amount of time’ depends on your circumstances. Typically, a break-even point of three years or less is feasible. But, that’s only if you are going to stay in it longer than three years. Let’s say that your break-even point is 3 years and you are going to move in 4 years. Does it make sense to fork over the money for closing costs just to save a little money over the course of one year? It probably doesn’t make sense.
On the other hand, if you plan to stay in the home for the foreseeable future and it will only take 3 years to pay off the closing costs, then it may make sense to do so. You have to know that break-even point as well as your plans to figure out what’s right for you.
Can You Get the PMI AutomaticallyRemoved?
If you have a conventional loan, you should know about a little rule that conventional loans have. You are able to request that the lender remove your PMI once you owe less than 80% of the home’s value. This could be the home’s original value or the current value, if it increased. You may have to pay for an appraisal to prove the higher value of your home, but that costs peanuts compared to a full-blown refinance.
If you know that you owe less than 80% of the home’s value, you can request removal of the PMI in writing. The lender will then evaluate the situation to determine if you do in fact ow less than 80% of the home’s value.
Here’s another fun fact, though. If you don’t request that the lender remove the PMI when you owe less than 80% of the home’s value, the lender has to remove it once you owe 78% of the home’s value. It’s an automatic removal. You don’t have to request the removal in writing or prove anything. The lender must remove it on their own.
If you are close to this point, it may not make sense to pay to refinance since you can get the PMI removed free of charge. If you are happy with your current loan’s term and interest rate, it may be better to just leave the loan alone and let the PMI fall off on its own.
As you can see, every borrower has a different situation. It’s up to you to figure out which option works the best. Weigh the pros and cons of each situation to help you decide which option will leave you with the best results.