I'm going to answer this question from my own personal experience. I purchased my first home in Denver with a 3.5% Down FHA loan. Are you are using FHA? I made improvements and bought in a very good location that appreciated about 20% over several year. I thought with that appreciated Loan To Value that I could ask/apply for the removal of Mortgage Insurance. What I learned is that with FHA Loans, the LTV (Loan To Value) will always be calculated by your Purchase Price. An appraisal implying 20% equity will not do you any good. I had to wait till my loan was paid down to 78% (that is the FHA regulation for automatic removal of PMI)! You can early pay interest to get it down faster, but the % will be based on Purchase Price. So that is my experience based on my FHA loan. I would suggest checking with your lender. Best of luck!
I think you are in a similar situation here that I am in. I think the advice given is all nice and accurate but many are missing the point that you have given (and have probably researched). You do have an FHA loan and the PMI can't be removed til a 78% LTV AND at least 5 years of payments (which I'm sure you knew already as well). However, with your great "deal" and continued improvements, you believe the house will have 20% equity within the next two years based on a new appraisal.
If that were to be true, to remove the PMI, you would refinance to a conventional loan. On a conventional loan refinance, down payments aren't required, and the 20% equity you are looking for is based on the APPRAISED value and not the sales price (as it is with FHA loans). Using this method, you would remove the PMI (from FHA Loan) and could potentially avoid the MIP (Conventional Loan) as long as you have the 20% equity.
The bigger questions here are the following:
1) On the refinance to conventional, will the closing costs paid offset the PMI you would be paying if you stayed with your FHA loan. If it can be made up in a few years, I would say yes. The MIP would be non-existant from the beginning and there are 1000s of threads on homeowners not being able to remove FHA PMI at even 65% LTV as lenders continue to find ways to keep the PMI on the note.
2) Although the equity seems to be there, will you actually get it on the appraisal. The big issue here is most appraisals will consider comparables in the neighborhood. This could be the axe that kills it all as there might not be enough comparable houses in the neighborhood to give an accurate value of your current home.
I'm not a lender, just an educated borrow. I'll be closing on a short sale of $170k where the home tax assesment was $256K in 2012. This doesn't always equal the appraisal. I'll be using a 203K loan to put up to $35K in renovations PLUS up to $8k in energy efficient appliances. After the 203K (a FHA loan) has met its seasonal period (the time the loan needs to exist before it can be refinanced), I'll look at a conventional refinance to remove my PMI as well.
All of this is well documented (for 203k but would essentially apply to standard FHA loans if you have the equity) in a very informative youtube video. Look for 203k 2 step process by Brent Kluge.
I hope this was helpful and good luck!
Good to see you here again. More good answers below. When you do the remodeling and updating you might consider doing a conventional loan with a 15 year mortgage if that fits into your budget. You will be able to take care of paying off your home quicker and addressing the MIP at the same time. Please know that many new buyers think they are purchasing he home of their dreams for a lifetime. But the fact is that most homeowners move (up or down) in 5-7 years. You are making some great moves at a young age. Please let us know how things go with your short sale closing. Again, best of success to you with your endeavors.
Robert McGuire ASR
Your Castle Real Estate
Direct - 303-669-1246
Sounds like a good plan, but as someone mentioned below, you have to make 5 years of scheduled payments to be eligible to remove mortgage insurance on an FHA loan. You'll have to consider your options as well as rates and fees at the time of the refinance to make sure it makes sense. Congratulation on getting a "steal of the century", those are becoming more and more rare. Enjoy your new home!
Jon is correct in that new value will be calculated on 78% of the original purchase price (or the original appraisal, whichever is lower). But it also must be paid for a minimum of five years on an FHA loan. So if you do want to remove the mortgage insurance prior to the five years passing, you would have to refinance. However, that may not be the best decision for you, since more than likely interest rates will be higher, and you'll have closing costs and an appraisal to pay for on the refinance. Again, a good mortgage professional should be able to walk you through your options to help you decide the best route for you to take when the time comes.
Ask your lender if you can do pre-paid MI. This is more cash up front, which you may not have, but it is a one time fee that you never have to worry about getting rid of. Depending on your upgrades and the market coming back favorably is uncertain. The rules the lender has in place to drop it may require you to have 25% equity before they are required from stopping the monthly MI.
You can read over the paperwork from the lender, or ask them for the rules; they would be your best source for the most reliable information.