The federal HARP mortgage refinance program can be a huge boon for underwater homeowners. But if you have PMI, there's a little hitch you should know about.

While refinancing a mortgage through HARP can cut your interest rate and save you money, it can also extend the length of time you need to carry private mortgage insurance (PMI), perhaps by many years. And that can significantly reduce the savings you get from refinancing.

PMI, of course, is what you have to pay on most mortgages if you buy a home with less than a 20 percent down payment (certain types of loans like FHA mortgages have their own insurance). You can ask to have it canceled once you reach 20 percent equity (your mortgage balance equals 80 percent of the current value of your home), which can occur through paying down your mortgage, rising home values, or both.

Automatic cancellation of PMI

Here's the issue: Though they may not realize it, most borrowers are entitled to have PMI automatically canceled once their mortgage balance falls to 78 percent of the original value of their home, even if the property is no longer worth that much. That's a federal law, established by the Homeowner Protection Act of 1998.

But if a borrower with PMI refinances their underwater mortgage through HARP, that process starts all over again. Their new mortgage will also have PMI, but now the 78 percent figure for automatic cancellation is based on the value of the new loan. That's according to rules set forth by Fannie Mae and Freddie Mac, which administer HARP, officially called the Home Affordable Refinance Program.

Of course, for most borrowers who are underwater on their mortgages, the savings they get by refinancing to a lower mortgage rate will exceed the cost of continuing to carry PMI. But if you're due to have PMI cancelled before HARP expires at the end of 2013, or if your savings from refinancing would be relatively modest, you might reconsider.

How soon can you qualify?

It usually takes about five to nine years for the loan balance on a 30-year mortgage to drop to the 78 percent level, depending on your interest rate and how much of a down payment you made. You can either use a mortgage calculator with amortization tables to figure out when you're scheduled to reach that point, or contact your mortgage servicer for an exact answer.

A few things to keep in mind. Automatic cancellation of PMI only occurs when the mortgage balance drops to 78 percent of the original property value through the normal amortization schedule. So you can't speed up the process by making larger mortgage payments.

(Where larger mortgage payments can help is in reducing your loan balance to 80 percent of the current, appraised value of your property - 20 percent equity - at which point you can request that your lender allow you to cancel PMI, but that's a different issue.)

Also, automatic PMI cancellation is only available on mortgages that were originated after the Homeowner Protection Act took effect in 1999. For certain mortgages designated by Fannie Mae or Freddie Mac as "high risk," the loan balance must fall to 77 percent to qualify for automatic PMI cancellation. You must be current on your mortgage payments any event.

Published on February 10, 2012