by Kristie from Utica, Michigan
Ask Kate if you should refinance your home for the sole purpose of getting rid of private mortgage insurance: Kristie, a novice at homeownership, asks if she should refinance at the same rate to remove private mortgage insurance (PMI). She also asks how rate-and-term vs cash-out mortgage refinancing works.
Additionally, my answer to Kristie discusses equity, loan-to-value, and assessed vs appraised values.
Refinancing My Home to Remove Mortgage Insurance
By Kristie from City
Hi Kate. I'm a little new to the whole mortgage thing, so here's my story in a nutshell.
I bought my first house in March 2013 for 90k. My down payment was only $3200, so I pay $90 a month in PMI. Since then, my house value has appreciated to roughly 120k.
My question is, does is make sense to refinance in order to be rid of that PMI? My interest rate should stay about the same.
Also, how does that work with the appreciation? If my house is worth 120k and I owe 87k on my current mortgage, would I just take out a loan for what I owe my current note holder, and then receive cash back for the difference?
Any clarification on how this all works would be appreciated!
Ask Kate answers: Refinancing My Home to Remove Mortgage Insurance
Thanks so much for asking! That's an excellent mortgage insurance question!
Mortgage insurance becomes a thorn in the flesh to many buyers who used a low down payment to purchase their home. It is costly to continue paying MI each month but costly also to remove from the mortgage payment!
Get Rid of PMI by Refinancing IF It Makes Sense
One way of getting rid of MI is to refinance. But make sure the end result lowers your payment. There is no sense refinancing to get rid of MI if the house payment barely decreases.
Are you wondering why I say removing mortgage insurance might not lower your payment? Here's why! When closing costs (refinancing fees) are financed, they increase the loan amount which raises the proposed monthly payment.
Removing PMI by Cancellation and Termination
Under certain circumstances set forth in The Homeowners Protection Act signed into law in 1998, mortgage borrowers can also get rid of PMI by means of cancellation and termination.
Learn if cancellation or termination would be a better avenue for you (vs refinancing) at How Do I Cancel Mortgage Insurance .
Equity, Loan-to-Value, and Mortgage Approval
Again, your question on cash-back refinancing is excellent. Thanks!
When properties that are financed appreciate in value due to increases in the local real estate market, the loan-to-value (LTV) decreases.
Unlike credit scores, a low LTV is good! Why? Mortgage approvals are based on loan-to-value, that is the amount borrowed divided by the appraised value or purchase price
(in the case of home buying), whichever is less.
Let's calculate your LTV based on the numbers you supplied in your letter. If you divide your loan amount ($87,000) by your home's value ($120,000), you'll arrive at the loan-to-value ratio (73%) which in your case is pretty low. The flip side is to say you have 27% equity.
The higher the LTV, the less equity a homeowner has, and the more the lender stands to lose if the house ends up in foreclosure. That is why borrowers with low loan-to-values are often rewarded by lower rates and closing costs.
Rate-and-Term Mortgage Refinance
There are two categories of mortgage refinancing, rate-and-term and cash-out. Each category has a unique set of underwriting guidelines based in part on equity and loan-to-value.
Rate-and-term (no-cash-out) refinances are chosen by borrowers who want to get rid of PMI and/or lower a mortgage payment. Another motivation would be to shorten their loan term, for example, to transition from a 30 year down to a 15 year payoff .
Using your numbers once again, at 73% LTV and if you were to borrow only as much as you currently owe plus enough to cover closing costs, you would ask for a rate-and-term refinance.
All things being equal in your qualifications, you would get a premium rate because a rate-and-term refi is considered a lower risk.
Cash-Out Mortgage Refinance
However, let's say you want some of your home's equity in the form of cash. This is called cash-out mortgage refinancing and falls into a riskier lending category. Translated, that means higher rates and closing costs.
So let's say you were approved for a cash-out refi up to 80%. ($120,000 x 80% = $96,000) After your current loan and closing costs are subtracted from the new loan amount ($96,000), you get the difference in cash.
Your monthly payment will now be based on borrowing $96,000 and the equity in your home is reduced accordingly. But even though you have raised your loan-to-value, it is still under 80.01% which means federal law prohibits a lender from charging you mortgage insurance.
Refinancing Your Home - Assessed Value vs Appraised Value
One more clarification. Don't confuse assessed value with appraised value. They are two different animals and only one, in general, directly influences mortgage approvals.
Assessed Value: Your local governing body, usually the county, assesses the value of your land + dwelling + additional structures to determine the amount you owe for property taxes. The lower the assessed value, the better!
Appraised Value: A licensed real estate appraiser compares your land + dwelling + additional structures to at least 3 nearby, similar, and recent property sales to determine a value that will be used in your mortgage approval process. The higher the appraised value, the better!
I hope this was helpful. Let me know if you have any other questions.