Should you refinance to remove mortgage insurance?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated October 20, 2020

In general, it usually does not make sense to refinance if the only reason is to remove mortgage insurance but the answer to your question depends on what type of loan you have as well as your current mortgage terms.  We review multiple scenarios below to help you decide when refinancing -- and eliminating mortgage insurance -- is right for you.

If you have a conventional mortgage and you are paying private mortgage insurance (PMI), you should refinance if you are also able to lower your mortgage rate.  Refinancing into a lower rate and removing the monthly PMI fee  should significantly reduce your monthly mortgage payment and save you money.  This assumes your mortgage balance remains near its current level.

Use ourMORTGAGE REFINANCE CALCULATORto determine how much you can save by refinancing

If you are paying PMI but you are not able to lower your mortgage rate, then refinancing offers less of a financial benefit and may even cost you money, depending on your closing costs.  Instead of refinancing, you should request to have the PMI removed when your loan-to-value (LTV) ratio falls below the required threshold as outlined in your loan documents, which is usually 78% to 80%.  In this scenario, your monthly payment decreases because you stop paying PMI but you do not incur the costs associated with refinancing.  

Reasons for your LTV ratio to decrease include paying down your mortgage balance or your property value increasing due to improvements you made or home price appreciation in your area.  If you believe that you have met the necessary requirements, you should contact your lender and submit a request to have PMI removed from your loan.  You may be required to pay for an appraisal report to confirm your property value but this is usually less expensive that the closing costs for a refinance.

Review How to Remove PMI From You Mortgage 

The analysis is different for an FHA loan because in most cases FHA mortgage insurance premium (MIP) is non-cancellable, which means you are required to pay it for your entire loan, regardless of your LTV ratio. In this case it may make sense for you to refinance your mortgage to remove the MIP even if you pay a slightly higher mortgage rate.

To determine if you should refinance an FHA loan to remove mortgage insurance, compare your current interest rate and monthly payment, including the MIP fee, to your new rate and monthly payment, excluding the fee.  Even if you cannot reduce your mortgage rate, it may still be a good idea to refinance if you can lower your total monthly payment by eliminating the MIP fee.

For example, if your current mortgage payment is $2,000 and you pay a $200 monthly MIP fee -- so your total monthly payment is $2,200 -- and your new mortgage payment is $2,100 but you no longer pay MIP, it may make sense to refinance depending on the closing costs. 

This is why in addition to understanding how much money you save, it is important to determine how long it takes you to break even, or recover your closing costs.  A good rule of thumb is that you should break even within six months of refinancing.  For example, if you pay $1,800 in total closing costs, you should save at least $300 per month on your new mortgage payment, including the savings from eliminating mortgage insurance, to justify the cost of refinancing

$1,800 (closing costs) / $300 (monthly savings) = 6 months to recover closing costs

The final point to keep in mind is, if possible, we recommend that you not increase your mortgage balance significantly when you refinance, so you should consider paying for closing costs out of pocket instead of adding them to your loan amount.  Also, if you have any funds remaining in an impound or escrow account on your current loan, you may be able to apply those funds to help pay your refinance costs.

Your other alternative is to use a no-cost refinance program.  As the name suggests, with a no-cost refinance you are not required to pay closing costs and your loan balance should remain the same but you are typically required to pay a higher mortgage rate, which reduces the benefit of refinancing. That said, a no-cost refinance makes sense for some borrowers and you should apply the same method of comparing your new and old rates and payments to determine if this option is right for you.

Review How a No Cost Refinance Works

In closing, in most cases eliminating mortgage insurance should not be the sole reason to refinance your loan.  Your interest rate, monthly payment and closing costs are other factors you should take into account when deciding if you should refinance.

The table below shows refinance rates and fees for top-rated lenders near you.  We recommend that you shop multiple lenders to find the best terms for your refinance.

Sources

"B-8.1-04: Termination of Conventional Mortgage Insurance."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, May 15 2019.  Web.