Thursday, March 22, 2012

Pour money into mortgage to dump PMI?

Dear Dr. Don,
I owe $72,000 on a condo worth $80,000. Consequently, I'm paying a $50 per month private mortgage insurance, or PMI, premium. I have $12,000 cash available to invest. Would it make sense to make a lump payment on my mortgage to bring me below 80 percent, so I can eliminate my PMI? Seems this would be by far my best return on investment when compared to investing in my 401(k), stocks, etc. Thanks.-- Jason Jump-start

Dear Jason,
Paying down the principal balance on your mortgage to get out from under PMI can make sense as an investment as long as you understand the rules. There are two sets of rules concerning terminating PMI. The first are the provisions of the Homeowner's Protection Act, or HPA, of 1998; the second are more consumer-friendly guidelines established by Freddie Mac and Fannie Mae.

The Homeowner's Protection Act requires the lender to cancel PMI when your loan balance reaches 78 percent of the original purchase/appraised value. You can petition the lender to drop the PMI requirement when your mortgage loan balance reaches 80 percent of the original purchase/appraised value.

There are other conditions that have to be met as well. You have to be current on your loan and have had no payments that were 30 days late within 12 months of the request. The lender may also require evidence that the value of the property has not declined below its original value and that there is no second mortgage on the property. Your lender is required to provide you with information about canceling your PMI at least annually. The mortgage service also is required to provide a telephone number you can call for information about termination and cancellation of the PMI policy.

Fannie Mae and Freddie Mac guidelines consider the current appraised value of the property, not the original purchase price/appraised value, in determining whether you can cancel PMI. The loan has to be seasoned, meaning you've made payments for at least two years. You can't have had a 30-days-late payment in the past 12 months or a 60-days-late payment in the last 24 months. You initiate the request to terminate the PMI policy and are responsible for the cost of an appraisal acceptable to the agency and the lender -- so don't just hire any appraiser. You can terminate PMI if the mortgage loan balance is 75 percent or less of the appraised value after 24 months or 80 percent of the appraised value after five years of making payments.

Getting out from under a $50 monthly payment by investing $12,000 in prepaying your mortgage is equivalent to earning 5.12 percent on your money on a pretax basis. Is it a smart investment? Yes, unless by spending the money you're leaving yourself with no emergency fund. It also doesn't make sense if you're not contributing up to the limits of any employer match on your 401(k) plan. In most cases, that means you're giving up a 50 percent return on your contribution, and 50 percent trumps 5.12 percent.

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