PMI, or private mortgage insurance, is an insurance paid to a trustee or lender when an individual, couple, or company takes out a mortgage loan. PMI is used to offset potential losses in the event the individual or organization taking out a loan (mortgagor) is not able to pay back the loan and the lender is not able to fully recover costs after subsequent foreclosure and sale of the property in question. The insurance is commonly associated with various loan types in the United States where the mortgagor is unable to pay 20% of the loan value as a down payment.
What is Loan to Value (LTV) Ratio?
When taking a look at PMI, a common term that arises is the LTV (loan to value) ratio of a mortgage. This is the figure that the potential lender examines in order to assess whether or not the mortgagor will be required to pay PMI. The LTV is also used to determine with PMI can stop being paid. To calculate the LTV ration, you divide the total amount of the mortgage due by the assessed home value and multiply by 100. For example, if your mortgage is $300,000 and the assessed home value is $400,000, then the LTV will be 75%. When purchasing a new home or property, lenders will calculate the formula by subtracting the amount of the down payment from the sales price. For example, if you purchase a $400,000 home and put $40,000 down, the LTV will be 90%. Most lenders will require PMI be paid for LTVs that are 80% or greater.
What is PMI?
When applying for a home loan or other mortgage, the lender will want to ensure there is sufficient equity available to pay off the loan should the mortgagor default and put the property into a foreclosure status. Since most homes sold at foreclosure go for a significantly reduced price, the lender will want to have a buffer to ensure as little money as possible is lost in the sale of the property. This “buffer” is typically 20% of the assessed value of the property.
Instead of not allowing potential lenders to pursue mortgages when sufficient capital is unavailable for a 20% down payment, they allow the mortgagor to obtain the loan through using PMI to cover the difference. In actuality, private mortgage insurance is a policy issued by an insurance company specializing in real estate that benefits the mortgage lender in the event the property goes into foreclosure and the full amount is not able to be recouped in the foreclosure sale. PMI will pay the difference to the bank who owns the loan in this case.
PMI is not used for mortgages made by pubic mortgage lenders or government agencies. For programs such as VA or FHA mortgages, there is an equivalent insurance to PMI, but is managed and enforced in a different manner. A primary difference in the two insurance types, is that unlike PMI, insurance on VA and FHA loans continues to be paid after the LTF has dropped below the 80% threshold.
What Consumers Need PMI?
There are several cases that may require a mortgagor carry PMI. First, if the LTV on the property is greater than 80% on the private loan it will require PMI. Other cases that can require insurance be carried include: a poor credit history on the part of the person / organization obtaining the mortgage, have previously been foreclosed upon, have an unsteady or undocumented income source, or are generally considered to be a “high risk.” The requirement to obtain private mortgage insurance will be laid out in the loan documents and should be reviewed prior to signing any loan documents.
How to Avoid Paying PMI
The easiest method to avoid having to pay PMI on a mortgage is to have enough money to pay a down payment to ensure the LTV ratio is beneath the threshold that requires insurance be covered on the mortgage. Another option that was more common in years past to avoid PMI, was to obtain a “piggyback mortgage” also known as the 80-10-10 option. This option uses a combination of a home equity loan or second note/mortgage along with the down payment to bring the LTV below the threshold requiring private mortgage insurance be paid.
If the mortgage already has PMI and you desire to quit paying the required fee, there are two options to do so: 1 – Ensure the mortgage ratios meet the required LTV to eliminate PMI, or 2 – Refinance the mortgage. In the first case, if the loan is close to the 80% LTV threshold, you should ask the lender when they will remove the PMI on the note. Many lenders will wait until the LTV reaches 78% to automatically remove the insurance. If your home has appreciated in value, you can also obtain a professional appraisal and provide this to the bank to prove the value of the property has increased and the LTV has fallen to levels that no longer require PMI.
Another option to avoid paying PMI is to refinance the note. In this case; however, most consumers will only pursue a refinance if there is also an equivalent drop in interest rates that make the new loan financially feasible.
What is the Homeowner’s Protection Act (HPA) of 1998?
The Homeowner’s Protection Act (HPA) of 19998 applies to any residential mortgage obtained from July 29th, 1999 onward. The new law does not cover loans guaranteed by the FHA or VA and includes different requirements for loans that are classified as “high-risk.” Signed into law on July 29th,1998 and later amended on December 27th, 2000,the Act directly addresses difficulties that homeowners’ experienced with canceling PMI. The Act also defines the requirements for cancelling coverage and requires the return the unearned premiums. From January 1st, 2000, mortgages in the amounts of $252,700 or less are considered conforming loans under the act. For loans that exceed this amount, the lender may designate them as “high risk” depending on their own requirements.
What Defines a Residential Mortgage Transaction?
Under HPA, there are four conditions required to be met for a mortgage transaction to be considered “residential.” These include: 1 – A deed of trust or mortgage must be created, 2 – The property the loan covers must be a single-family home or dwelling, 3 – The dwelling must be the primary residence of the person obtaining the loan, and 4 – The purpose of the loan has to be for financing the initial construction, acquisition, or refinancing the dwelling.
How Do You Cancel or Terminate PMI under HPA?
HPA provides the consumer the right request their mortgage company cancel PMI when the mortgage is paid down to the point that it is equivalent to 80% or less of the home’s purchase price or the appraised value of the home at the time of purchase (whichever is the lesser amount). Additionally, HPA requires the consumer have a good payment history. This is defined by not being 30 days late on loan payments in the past year, or not being 60 days or more late in the past two years. Lenders may require the mortgagor show proof that the value of the home has not declined since the original loan was taken out and that there are no new second mortgages on the property before approving the termination of PMI.
Automatic Termination of PMI
HPA mandates that lenders automatically cancel PMI once a loan is paid down the 78% of the value of the note if the mortgagor is current on the loan. If the loan is in a delinquent status on the date that automatic termination would normally take place, the lender does not have to terminate PMI until the loan is current. The Act also requires that lenders cease PMI coverage within 30 days of the automatic termination date. Unearned premiums are required to be paid within 45 days of the termination date. For loans labeled as “high risk” under the Act, lenders are not required to cancel PMI until the mortgage is paid down to 77% of the value of the property if the mortgagor is current on the loan. .
Final Termination of PMI
HPA requires that if PMI is not canceled by the midpoint of the amortization of the mortgage, that it should be removed at the mid-way point. For example, on a 30 year mortgage, this point would occur after 180 payments have been made on the home. The Act requires that final termination of PMI be concluded within 30 days of this point of the loan and that the borrower be current on the mortgage.
What are the Disclosures Required by HPA?
There are three events or timeframes required by HPA that a mortgage lender must notify the consumer of their rights. These include annually, upon loan closing, and upon termination of private mortgage insurance. Each of the disclosures will vary based on the following factors: 1 – Is the loan high risk or not?, 2 – Is the loan an adjustable or fixed rate mortgage?, and 3 – is the PMI lender or borrowed paid? The required notifications to borrowers at the time of closing a loan include: 1 – When PMI can be cancelled, 2 – The requirement for when PMI will be automatically terminated, 3 – Exemptions to the right to cancel PMI (either automatic or by request), and 4 – a written amortization schedule for fixed rate mortgages.
The annual disclosure statement from the lender must include: 1 – The right of the consumer to cancel or terminate PMI, and 2 – The telephone number and address to contact a loan representative to help determine when PMI can be cancelled. Once PMI is terminated, the lender must send a notification to the consumer that includes: 1 – The fact of PMI being terminated and coverage is not being provided any longer, and 2 – That no additional PMI payments or premiums are required.
HPA Disclosure Requirements for Loans Obtained Prior to July 29, 1999
If a mortgage was obtained prior to July 29th, 1999, the mortgage company must send an annual statement that includes an explanation of the situations that PMI may be cancelled. This statement must also include the phone number and address to contact a loan servicing representative to help the consumer determine if PMI can be canceled. HPA does not require any additional rules be applied to loans made before July 29th, 1999; however, many lending institutions have chosen to follow HPA requirements for all loans. To determine if a specific institution is applying new loan rules to legacy ones requires a phone call to the lending institution.