My husband and I bought a house 18 months ago. We went in with less than 20% down, and so are stuck paying mortgage insurance to the tune of over $80 per month. What exactly is mortgage insurance for, and is it possible for us to "cancel" our mortgage insurance by showing a good history of paying on time?? We have never been late nor missed a mortgage payment, we make more money now than we did when we bought the house (proof that we are able to pay), and we have excellent credit rating. It seems to me that we've proven ourselves and shouldn't have to pay for this insurance anymore. What steps would I take to investigate further with my bank?

~ Diane, Idaho

Diane is one of about 1.5 million homeowners who needed Private Mortgage Insurance (PMI) to get a mortgage last year. About 10% of those who have mortgages have PMI.

And for many home buyers, it's a good thing that PMI exists. In recent years personal income has not kept pace with increases in home prices. And it's been more difficult for young families to save a sizeable down payment. Having PMI makes the lenders more willing to give mortgages to people who haven't saved a 20% down payment.

What makes 20% the magic number? Mortgage companies have found that those with less than 20% equity are more likely to default on the mortgage. So the good news is that PMI allows you to get into a house sooner. The bad news is that PMI can be expensive. For instance, if you're only putting 5% down, your PMI could amount to 0.7% of the money you borrow. On a $100,000 mortgage that works out to $58 per month or $700 a year.

The purpose of PMI is to pay the mortgage company if you default on your mortgage. There are only eight companies that issue PMI. Unfortunately, you don't get to shop around to find the lowest rate. The mortgage company gets to choose who gets your business.

Over time your home equity should increase. Perhaps you've paid the mortgage for a number of years. Or maybe home values in your neighborhood have increased. In either case, your equity has risen to more than 20% of the home's value. If you've made your mortgage payments on a timely basis, you should be able to drop the PMI.

But, many homeowners didn't know that. Until recently, no one was required to notify you when PMI was no longer needed. Some mortgage companies will require that you keep PMI regardless of your equity for a number of years. One such company is Federal Home Loan Mortgage Corp (Freddie Mac). They buy up many mortgages and typically require that you keep PMI for at least five years.

Let's get to the heart of Diane's question. Can she cancel her PMI? The answer will depend on her mortgage company and the mortgage agreement. The fact that they've never been late and make more money now will be helpful. But much will depend on the equity that Diane has in the home. And she doesn't mention how much of their home they actually own. But even if her equity is less than 20%, it can't hurt to ask.

The best way to do that is to contact the bank or mortgage company and ask who is responsible for requiring PMI. Get their name and job title. Write that person a letter stating your case. Stick to the facts. Remember, the loan officer isn't supposed to be swayed by sentiment or your desire for savings. Their job is to make sure that the bank protected if you default. So provide facts that will demonstrate that you're a good risk.

A new law doesn't directly affect homeowners like Diane, but could still be helpful. The Private Mortgage Insurance Act takes effect July 29, 1999. The new law gives home buyers a number of rights. First, you must be given a written statement explaining that you have PMI and when you'll be allowed to cancel it. The law also states that the lender must allow you to cancel PMI when your equity is 22% or more. And you can ask for permission once you've reached the 20% equity level. Of course, in reality, the form will be one of the dozens that you receive at closing and many people still won't realize that they can cancel PMI in a few years.

The law also only affects new mortgages. But, if you're like Diane and have a mortgage written before the law takes effect, you may still benefit. Both Freddie Mac and Fannie Mae (who hold over 1/3 of all mortgages) will be applying the new rules to old mortgages. FHA loans are an exception to the new law. Check with your lender, but you can expect to continue to pay PMI if you have an FHA loan.

A final tip for Diane. When she does get to cancel the PMI she might want to take that $80 each month and apply it to prepaying her mortgage. She's used to getting along without the money, so it's like getting a free savings plan. This strategy could help her pay off a 30 year mortgage in 15 years! Not bad for money that she'll never even miss.

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