What Happens to PMI If Property Value Drops?

Private mortgage insurance policies are designed to protect your lender in the event that you default on your loan. These policies are based around the size of your mortgage as a percentage of the value of your home. If your property value drops, you might have PMI issues if you decide to refinance your home. Falling values do not affect an existing PMI policy, however.

Purposes

Traditionally, lenders required homeowners to make 20 percent down payments. The 20 percent buffer meant that a lender had a good chance of selling a foreclosed home for a price that was sufficient to cover the mortgage debt and any legal fees. PMI was created as a tool to enable people who could not afford 20 percent down payments to buy homes. You pay monthly insurance premiums, and the insurer covers 20 percent of your lender's losses if you default on the mortgage.

Cancellation

you have the legal right to request cancellation of your PMI policy once you have built up 20 percent equity in your home. If you fail to make such a request, your lender must automatically cancel the policy once you have 22 percent equity in your home. You build equity as you pay down your mortgage balance. Crucially, equity calculations are based on the value of your home at the time you took out your mortgage rather than the current market value. Therefore, you can cancel your PMI even if housing market declines mean that you actually have little or no equity in your house.

Exceptions

Certain kinds of mortgages are classified as high-risk loans. These include jumbo mortgages that are high-dollar loans that exceed conforming loan limits. Government sponsored Freddie Mac and Fannie Mae set conforming loan limits at the county level, and these firms are also responsible for defining high-risk loans. If you have one of these loans, your lender must cancel your PMI policy once you have built up 23 percent equity in your home. If you have an adjustable rate loan, the equity calculation is based on the principal payment schedule in place at the outset of the loan term. Also, mortgage companies are not required to cancel PMI on loans of any size that were originated prior to July 1999.

Refinance

Falling property prices could prove expensive in terms of PMI if you decide to refinance your home. A refinance loan is an entirely new mortgage agreement, and your lender must appraise the home before approving the loan. You may have to replace a mortgage that does not include PMI with one that does if prices have fallen in your area. The cost of this insurance may offset any interest savings you would realize as a result of refinancing your loan.

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