Real estate lenders are a funny lot. It seems they're happy to lend anybody money. Assuming a half-way decent credit rating, any potential home buyer can secure a loan for a house. Why? Because these transactions are secured by a very valuable asset: the home itself. If a borrower defaults on a loan, the risk for the lender is often only the difference between the value of the home and the amount outstanding on the loan, less the amount it costs them to foreclose and resell the property.
For this reason, lenders are very wary of lending more than a certain percentage of a home's value. Traditionally, this has been 80 percent. The cushion this provides the lender helps ensure that their losses from loan defaults are kept to a minimum.
In recent years, however, it has become increasingly more common to see home buyers using down payments of 10, 5 or even 0 percent. Naturally, loaning this much presents the lenders with a lot more risk. To offset this risk, these transactions often require Private Mortgage Insurance or PMI. This supplemental policy protects the lender in case a borrower defaults on the loan, and the value of the house is lower than the loan balance.
PMI has been a large money-maker for the mortgage lenders. The amount of the insurance - often $40-$50 per month for a $100,000 house - is commonly rolled into the mortgage payment. Given the size of the overall payment, this additional fee is often overlooked. Homeowners continue to pay the PMI even after their loan balance has dropped below the original 80 percent threshold. This occurs naturally, of course, as the home owner pays down the principal on the loan. On a typical 30-year loan, however, it can take many years to reach that point.
Until recently lenders were under no obligation to tell home owners when they had reached a point where the PMI can be dropped. That all changed in 1999, when the Homeowners Protection Act took effect. In most cases, this law now obligates lenders to terminate the PMI when the principal balance of the loan reaches 78 percent of the original loan amount. Savvy homeowners can get off the hook a little earlier. The law stipulates that, upon request of the home owner, the PMI must be dropped when the principal amount reaches only 80 percent!
It is important to note that this law only applies to home loans - whether first time or refinances - that closed after July, 1999. Also certain other conditions must be met, such as being current on the loan payments. Buyers that purchased before July 1999 can also have their PMI removed, but they must initiate the process and though the lender is under no obligation to do so, most will.
Of course, there is another way that home owner's equity can reach beyond the 80/20 percent ratio. Many areas of the United States have seen significant gains in the value of real estate over the past decade. In fact, certain areas have seen appreciation levels of 100 percent or more. Even those people living in areas with more modest gains may find that the value of their property has quickly grown to the point where the amount of principal they owe on their loan is less than 80 percent of the home's current value. Again, in these cases, the lenders are under no legal obligation to remove the PMI. In most cases, however, as long as the home owner has been prompt on their loan payments and don't represent an exceptional risk, the lenders will agree to remove the extra fees.
The hardest thing for most home owners to know is just when does their home equity rise above this magical 20 percent point? A certified, licensed real estate appraiser can certainly help. It is an appraiser's job to know the market dynamics of their area. They know when property values have risen - or declined. Many appraisers offer specific services to help customers find the value of their homes and remove PMI payments. Faced with this data, the mortgage company will most often eliminate the PMI with little trouble. The savings from dropping the PMI pays for the appraisal in a matter of months. At which time, the home owner can enjoy the savings from that point on.
For more information on PMI and the Homeowners Protection Act, try one of these links:
Cancellation of Private Mortgage Insurance: Federal Law May Save You Hundreds of Dollars Each Year
Private Mortgage Insurance (PMI): Law Requires Lenders to Cancel PMI