Understanding How PMI Gets Eliminated in Conventional Loans

Under what circumstance will PMI be automatically eliminated from a conventional loan?

• A. after 5 years of payments
• B. upon borrower becoming disabled
• C. when the loan is sold to Fannie Mae
• D. when the loan to amount is reduced to 78% LTV

Answer: (D)

PMI, or private mortgage insurance, is typically required on conventional loans when the borrower makes a down payment of less than 20%. The primary purpose of PMI is to protect the lender in the event of default. However, it is possible for PMI to be eliminated under specific circumstances. The correct answer highlights that PMI will be automatically removed when the loan-to-value (LTV) ratio is reduced to 78%. This means that once the borrower has paid down enough of the loan such that the remaining balance is 78% of the home's original appraised value, the lender is required to cancel the PMI. This rule is in place to ensure borrowers are not paying for unnecessary insurance once their equity in the property has reached a satisfactory level. The other scenarios presented do not meet the standard criteria for PMI elimination. For instance, simply after a certain number of payments or due to a borrower’s change in circumstance, such as being disabled, does not automatically trigger the cancellation of PMI, nor does the sale of the loan to Fannie Mae. The focus remains on the LTV ratio, reinforcing the importance of equity in determining the necessity for PMI.

When it comes to securing a conventional loan, knowing the ins and outs of private mortgage insurance (PMI) can feel like unraveling a puzzle. PMI often becomes a necessary partner when a borrower pays less than 20% down. But here's the kicker: Get familiar with the circumstances under which it can bail on you—because nobody wants to pay for extra insurance if they don’t have to!

So, when does PMI get the boot? Well, the magical number you're looking for is 78%. Yep, once your loan-to-value (LTV) ratio dips to that sweet spot, your lender is required to cancel the PMI. What does this mean for you? It’s simple—if you’ve paid down your loan enough that what you owe is just 78% of your home’s original value (based on its appraisal), then bye-bye insurance payments! It's like gaining a weight off your shoulders.

Now, let’s clear this up a bit. Many might think that after five years of payments (Answer A) or even if life throws you a curveball like a disability (Answer B), those scenarios could lead to PMI being canceled. Nope! Neither will do the trick. And just because your loan got sold to Fannie Mae (Answer C), doesn't mean you’ll see your PMI go down the drain either. The secret sauce lies in how much equity you’ve built in the property.

Think of it this way: as you pay down your mortgage, you’re building equity, which is like growing your financial garden. When your equity hits a good level—78% LTV to be exact—you’re essentially saying to PMI, “I don’t need you anymore!” At that point, lenders want to reward you for your responsible financial behavior, and you're no longer at risk of defaulting. I'll tell you, it feels like a victory lap.

Understanding these aspects not only empowers you as a borrower but also gears you up for that pesky Arizona Real Estate License Practice Exam you may be preparing for. Know your PMI, know your LTV, and you'll be in a solid position! So, as you study, keep the focus tight on LTV—it’s your best friend when it comes to shedding that PMI burden. Remember, knowledge is power, especially when making big financial decisions like purchasing a home. And after all, you’re in the driver’s seat of your real estate journey—so steer it wisely!