Mortgage lenders typically require you to pay private mortgage insurance, or PMI, if you put down less than a 20 percent down payment on your home. PMI gives the lender extra protection in case you end up not being able to pay off your loan. Federal regulations require cancellation of PMI once you reach 22 percent equity in your home, and you may request cancellation a bit sooner -- when you have 20 percent equity -- if your payments are current. Lenders determine equity by dividing your outstanding loan balance against the property's original value when you bought it.
Closing Price Vs. Appraisal Price
The closing price is the agreed-upon cost between you and the seller. It is the original purchase price stated in your mortgage documents. A closing price is not necessarily the same as the home's list price, which is what the seller first asks a potential buyer to pay for the home. A professional real estate appraiser determines the appraisal price, or the home's current market value. The appraisal price may differ from the closing price, depending on contract negotiations. Property values change over time, and you may obtain a new appraisal price after you live in the home for a while -- for example, if you intend to refinance.
The Federal Trade Commission states that PMI must be automatically cancelled once the loan balance reaches 22 percent equity. This rule applies to all mortgage loans signed on or after July 29, 1999. The home's original purchase price determines when your loan balance reaches 22 percent equity. This means that once your loan balance is at 78 percent loan to value, your lender can no longer add PMI charges on your monthly statement, provided your payments are not past due. You do not need to order an appraisal for automatic cancellation to take place, because it's based on the original purchase price of the home.
Typically, your lender will not automatically cancel your PMI at 20 percent equity. You must request that your lender cancel the coverage. Similar to automatic cancellation, the loan-to-value percentage is based on the home's original closing price and you must be current with your payments. Unlike automatic cancellation, however, the lender may require that you order a current appraisal under certain circumstances. One of these circumstances might be a drastic change in average home values since the original purchase: the lender might require proof, based on an appraisal, that you have sufficient equity on the home based on its current worth.
Home improvements that raise your home's equity may shorten the time that you have to pay PMI. If you make significant improvements to your property, such as an in-ground pool or solar panels, you might consider ordering an appraisal. The appraisal price could turn out to be high enough to increase your equity to 20 percent. You will need to request that your lender cancel the PMI and show proof of the equity increase. With this type of request, the lender does not use the closing price to determine loan-to-value.
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