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ONE OF THE HOTTEST CONSUMER ISSUES of the late 1990s has been the overpayment of private mortgage insurance (PMI) by thousands of unsuspecting homeowners. After a series of class action lawsuits, much controversy and debate, Congress passed the Homeowners Protection Act of 1998 which took effect July 29, 1999. Eight states, including California, now have PMI disclosure and cancellation statutes as well.
The new federal law provides for the automatic cancellation of PMI for loans originated after July 29, 1999. It also requires loan servicers to send annual disclosures to all mortgage borrowers about PMI and how to initiate early cancellation.
What is Private Mortgage Insurance?
Private mortgage insurance is a type of insurance which protects the lender in the event the borrower defaults on the loan. Most lenders require borrowers to pay PMI premiums whenever they make a down payment of less than 20 percent of the purchase price. Those fortunate enough to have a mortgage with a loan-to-value ratio (LTV) of 80 percent or less pay lower interest rates, less closing costs and don’t have to pay PMI premiums.
Annual PMI premiums range from about 1/2 to 1 percent of the amount borrowed, with the borrower sometimes paying up to a full year of premiums at closing. Monthly payments range from about $20 to $100, depending on the LTV, the amount borrowed and the loan term. The loan servicer collects these monthly premiums and pays them to a private mortgage insurance company. In some cases, the PMI premiums are an un-itemized component of the mortgage payment, so the home buyer may not even be aware of the extra monthly expense.
Homeowners sometimes confuse private mortgage insurance with two other common types of insurance. Mortgage life insurance pays off all or a portion of your mortgage in the event of your death. Homeowners insurance protects you from loss due to home damage from fire, floods and other disasters.
Most conventional (non-government) lenders – including banks, savings and loans, mortgage companies and credit unions – require home buyers to make a down payment of at least 20 percent. The theory is that borrowers with at least a 20 percent equity stake in their home are more committed to their investment, more likely to keep up with their payments and less likely to default on the loan. For this reason, few lenders allow 100 percent financing, even if part of the loan is financed by the seller or another lender.
Lenders have had to lower their down payment requirements over the years because rising home prices have far outstripped the rise in wages and savings. Roughly half of all current home buyers now make down payments smaller than the standard 20 percent. Some pay as little as 3 to 5 percent.
Non-conventional (government) loans – including VA (Veterans Administration) and FHA (Federal Housing Administration) loans – also offer low down payment loans, but require a different type of mortgage insurance. VA and FHA borrowers pay these insurance premiums for the life of the loan without the option of cancellation.
PMI Benefits and Consumer Abuse
Private mortgage insurance has dramatically increased the purchasing power of home buyers, helping to boost the rate of household home ownership in this country to a record 66 percent. PMI has brought the dream of home ownership within the reach of those who might never have thought it possible. The insurance companies argue that the benefits of private mortgage insurance probably outweigh the abuses.
The problem is that most loan servicers have not bothered to inform home buyers when they became eligible for PMI cancellation. As a result, many borrowers have paid monthly PMI premiums long after their home equity passed the 20 percent threshold, and well beyond the point at which the lender was at risk for default or foreclosure. The new law makes it easier for these borrowers to stop making unnecessary payments and get refunds.
Borrowers have always had the option to cancel PMI on most home loans. Their loan servicers just never bothered to tell them about it or help them with the process. Borrowers who have tried to cancel their mortgage insurance in the past have found it to be a frustrating experience.
Congressman James Hansen (R-Utah) introduced the first PMI legislation in February 1997 after his own unpleasant experience trying to cancel the mortgage insurance on his Washington DC condominium. PMI abuse was later featured on NBC News in its “Fleecing of America” segment. Senate Banking Committee Chair Alfonse M. D’Amato (R-New York) even held a hearing on the PMI issue.
Loan Originators, Lenders and Servicers
Part of the difficulty in canceling mortgage insurance results from the confusion over who is who in the lending business. Many borrowers get their home loans with the help of a mortgage broker, who helps them fill out the paperwork and find the best loan. The mortgage broker is the loan originator. The mortgage broker finds someone to fund the loan such as Countrywide (a mortgage company), who becomes the lender. Countrywide immediately turns around and sells the loan on the secondary mortgage market to Fannie Mae (FNMA – the Federal National Mortgage Association) or Freddie Mac (FHLMC – Federal Home Loan Mortgage Corporation) so Countrywide can get more money and make more loans. Fannie or Freddie is now the new lender. The borrower still mails their monthly mortgage payment to Countrywide, who becomes the loan servicer.
The Homeowners Protection Act of 1988 makes the loan servicer responsible for automatic cancellations, owner-initiated early cancellations and annual PMI disclosures. However, the lender sets their own policies for early PMI cancellation.
Automatic Cancellation
Under to new law, If you took out a home loan with private mortgage insurance after July 29, 1999, the insurance will be automatically cancelled when your remaining mortgage balance drops to 78 percent of the original value of the property securing the loan. For the typical home loan this could take 5 to 15 years, because the formula does not consider the value added by home appreciation.
Borrowers must have a good payment history, and automatic cancellations don’t apply to any loans which are defined as high risk.
How Do I Know If I Qualify for Early PMI Cancellation?
Under the new law, you can request early PMI cancellation when your remaining mortgage balance is 80 percent of the current market value of your home. Here’s how to calculate how much your home must be worth in order to request PMI cancellation.
- Look at your most recent mortgage statement and find the “principal balance.”
- Get out your calculator and divide the principal balance by .80 (the loan-to-value ratio).
- The answer is what the current market value of your home must be in order to request PMI cancellation.
- For example, if your principal balance is $150,000, dividing by .80 will give $187,500 as the minimum market value of your home needed to cancel PMI.
There are a number of things which could cause the value of your home to rise.
- Major home improvements can increase market value. Some improvements add more value than others, and most contribute much less than their cost.
- Rising values in the local real estate market can increase the market value of your home. Compare your home with similar homes in your neighborhood (or comparable neighborhoods) which have recently sold. Be sure to find the actual selling prices. Listing prices can be considerably higher than the selling price.
- Neighborhood revitalization (new home construction, major remodeling, street improvements, etc) can increase the value of your property, even if there have been no recent sales.
Refinancing
The average age of an insured loan is only four years, probably because most borrowers refinance when they have enough equity. If you have at least 20 percent in home equity, refinancing might be your best option, especially if you can get a lower interest rate. You will still have to pay closing costs, so consider how long you plan to live in your home before deciding to refinance. If you plan on living in your home at least 5 more years, refinancing might be the way to go.
Early PMI Cancellation
If you think you have at least 20 percent in home equity and have decided against refinancing, you should consider applying for early PMI cancellation. The first step is to contact your loan servicer (the company you mail your mortgage checks to) and ask them for a letter explaining how to cancel your PMI. Be sure you get these instructions in writing.
Early PMI cancellation requirements can vary considerably from one lender to the next. Some lenders require a loan balance as low as 68 to 75 percent of current market value. Other lenders require that your loan be “seasoned” from 1 to 5 years. At a minimum, your lender will expect you to have a good payment history.
The Appraisal
Most lenders require some sort of appraisal to support the current market value of your home. They may let you hire a local appraiser of your choice, or they may insist on using one of their own staff appraisers. Some lenders still have archaic “fee panels” and “approved appraiser lists,” which were common prior to the state licensing of appraisers in 1991. Other lenders may accept a broker’s price opinion or even a computerized automated valuation.
Regardless of who appraises your house or who pays the appraiser’s fee, the appraiser’s client is almost always the lender. If you select your own appraiser be sure to show him or her the written PMI cancellation instructions.
Now comes the classic appraisal dilemma. You need an appraisal, but it’s of little use to you if the value isn’t high enough to cancel your PMI. The appraiser would like the work, but it’s unethical to accept an assignment contingent on reporting a pre-determined result.
Some appraisers have approached this dilemma by offering a “staged” appraisal. The appraiser charges you a portion of the fee (usually half) to inspect your house, search for comparable sales and estimate the most probable range of value. If it looks like your house won’t appraise high enough to cancel the PMI, then you only pay half the appraisal fee and the appraiser only does half the job.
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Chet Boddy, Real Estate Appraisal, Sales and Consulting
43300 LR Airport Road, #59, Little River, CA 95456
707-937-4011, office
707-937-4818, fax
chet@chetboddy.com
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Copyright © 2002 Chet Boddy, All Rights Reserved
Chet Boddy is a Certified General Real Estate Appraiser, Realtor“ and real estate consultant who has lived on the Mendocino Coast since 1976. Look for this and other real estate columns on Chet’s web site at www.chetboddy.com
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