Private mortgage insurance (PMI): New Rules Emerge
Loan options introduced in recent years continued to make it possible for buyers to purchase with as little as three percent down or even with no down payment (100 percent financing). To avoid the mortgage insurance rule that any home loan with less than 20 percent down payment required PMI coverage, much of the 100 percent financing was creatively completed via two loans: a first trust deed for 80 percent of the purchase price (thereby eliminating the need for PMI), and a second trust deed for the remaining 20 percent of the purchase price. As loan options became increasingly risky, the rules were revised; today’s lenders are required to provide better disclosure regarding PMI coverage and how it might be eliminated in the future.
The new rules (while continually revised) are contained in the Homeowner’s Protection Act of 1998, which became effective July 29, 1999. The Act provides borrowers with certain rights when private mortgage insurance is required as a condition for obtaining certain residential mortgages. The new rules for conventional loans only include:
- PMI must be canceled upon the borrower’s request under certain circumstances.
- PMI must be terminated automatically under certain circumstances.
- A borrower is entitled to receive notice of the right to cancel PMI, both at the consummation of the loan transaction and annually thereafter.
- Borrowers opting for lender-paid mortgage insurance programs must be provided with sufficient disclosures.
The general rule has been that PMI must continue for a minimum of two years, after which the equity in the home must have reached a minimum of 20 percent either via mortgage principal pay down, increased value due to home improvements (substantiated via a new appraisal), home appreciation, or a combination of these factors. Again, depending upon the investor, the combination of factors required to allow expunging the PMI could vary. In some cases, a borrower may be required to retain the PMI coverage for as long as five years, especially if the borrower is considered a high risk at the inception of the loan (see additional information below). Typically, a borrower signs a disclosure when signing loan documents that identifies the rules governing PMI coverage and its eventual elimination.
The rules indicate that a homeowner may cancel PMI when 20 percent equity is achieved. Automatic cancellation would occur when a 22 percent equity position is achieved. The only way a lender would “know” that the 22 percent equity position has been reached is via principal pay down, which could take many years. Thus, borrowers are advised to be aware of their equity position and petition their lender to have their PMI eliminated.
The rule applying to “lender-paid” mortgage insurance refers primarily to those cases where a 90 percent loan is acquired, supposedly without PMI. Most likely, the PMI premium was added as a part of the interest rate. This situation now requires greater disclosure at the time of acquiring the loan.
When the lender includes the PMI in its rate, the payments will never change, even when the loan-to-value reaches the level when it can generally be eliminated. At that point, the lender’s yield increases by the amount of the premium the lender no longer pays for mortgage insurance coverage. PMI as a separate payment that can eventually be expunged, is more often the choice of buyers anticipating long-term ownership.
Special note: With regard to when PMI can be eliminated, both the California and federal laws cover only new insured loans granted from January 1998 for the state law, and January 1999 for the federal law. Loans already on record prior to those dates are not affected. In both cases, FHA mortgage insurance (MIP) cannot be cancelled.
When the time comes to seek elimination of the PMI coverage, homeowners have to be current on their payments and have no subordinate liens against the property. With the past proliferation of second trust deed and/or equity loan financing, some borrowers could find themselves ineligible for PMI cancellation. This applies also to those borrowers who acquired 100 percent financing using two loans (noted above). Requests to cancel mortgage insurance must be in writing. Jumbo loans (those loans that exceed the Fannie Mae / Freddie Mac conforming loan amount of $417,000) will be eligible for PMI cancellation at the 77 percent equity position. The availability in some “high cost” areas, where a high balance conforming loan limit exceeds the $417,000 loan amount, raises questions that can only be answered by contacting the lender.
With the advent of “credit scoring,” borrowers are “risk rated” in relation to both their ability and willingness to pay back a mortgage. The lower the credit score, the higher the risk for the lender in making the loan. “High risk” mortgages, those made to borrowers with lower credit scores, may have additional conditions imposed for the elimination of mortgage insurance. Fannie Mae and Freddie Mac continually redefine industry guidelines that identify a “risky” borrower. For instance, in 2009, PMI companies reduced their risk exposure by refusing to cover loans in excess of 90 percent loanto- value. The reason provided for the change was the concern over declining values in many housing areas, increasing the risk of exposure when there was less than 10 percent equity available. The conventional loan landscape was dramatically altered and the result was a flight to government-backed loans (discussed in Chapter 6) for any borrowers requiring a low down payment loan option.