Private Mortgage Insurance (PMI)

PMI is a dreaded word to many consumers hoping to purchase or refinance a home and most will do almost anything to avoid it.  However PMI serves an important function in assisting prospective homebuyers who have little available cash to apply towards a down payment purchase a home and it also helps those homeowners who are seeking to refinance with only minimal equity in their home get a new loan and hopefully a lower rate of interest along with it.  While PMI permits prospective home buyers to purchase a home with a minimum down payment, even as little as 3%-5%, the trade off is that a borrower in turn must pay for the insurance premium.  Therefore, while the down payment is lower, the monthly payment will be higher due to the additional cost of the insurance.  A borrower is essentially covering the expense for the lender to carry an insurance policy on their loan in the event they were to default on making their mortgage payment. The loan is considered a higher risk for the lender due to the borrower’s smaller down payment and their resulting minimal equity investment in the property.

How to Avoid PMI

PMI may be avoided by getting a mortgage with a higher rate of interest up front that would compensate the lender for the additional risk thereby eliminating the requirement for PMI.  The lender can purchase the policy of mortgage insurance directly and the borrower can pay the added cost by way of a higher interest rate over the life of the loan.  Note that while mortgage interest is tax deductible, PMI however is not. 

The financing package by which you purchase your home or refinance your loan can also have an impact.  For example if you were to obtain what’s referred to as an 80-10-10 loan; this means that your primary first mortgage is for 80% of the value of the home and a second mortgage is taken out for 10% of the value of the home then you either make a 10% down payment or have 10% equity in your home.  Structuring the loan this way will keep the first mortgage lender’s risk at 80% which will in turn eliminate their requirement that you carry PMI on the loan. 

Every case is different and each potential homebuyer or existing homeowner must perform a cost-benefit analysis of their own to determine whether accepting PMI or structuring their financing to avoid it makes sense for them.  

Cancelling PMI – for loans originated after July 29, 1999

Once the Homeowner’s Protection Act (HPA) of 1998 was effective lenders now became required to cancel PMI when the loan balance falls below 78% of the purchase price, essentially when a borrower has paid down 22% on the loan.  Cancellation of the policy is to be automatic by the lender and any premiums paid to the lender by the borrower after this point are to be returned to the borrower within 45 days of cancellation or required termination of the PMI policy.  The purpose of HPA was to inform borrowers of their rights by requiring that lenders disclose when a policy of PMI may be cancelled.   Prior to this time, most borrowers were completely unaware of their option to ultimately have their policy of PMI eliminated.

Lenders of loans closing after July 29, 1999 are required to disclose the following to borrowers who have PMI at the time their loan closes:

1. The right to request cancellation of the PMI policy and the estimated date upon which this request may be made.

2. The requirement of the lender that PMI be automatically terminated along with the estimated date upon which this will occur.

3. Any exceptions to the borrower’s right to cancellation or automatic termination of PMI.

4. An amortization schedule of the borrower’s loan (required for fixed loans only).

Once the PMI coverage has been terminated by the lender, the borrower must be notified in writing by the lender that their PMI coverage no longer exists and that payment of premiums is no longer required.

Cancelling PMI – for loans originated before July 29, 1999

Annual statements are required to be sent to PMI borrowers outlining the circumstances under which their PMI may be cancelled.  Typically this is subject to the consent of the lender and may be requested once the borrower’s equity position in the property exceeds 20%, however termination is not required automatically.  The annual statement should also provide contact information, the address and phone number, by which to reach the lender or loan servicer to determine whether or not a borrower’s PMI may be eligible for cancellation.

Cancelling PMI in Either Case

Note that in either of the aforementioned cases for cancelling PMI, state laws vary so it is important to determine them and to take them into consideration before attempting to cancel your PMI.  Also, if any of the following conditions apply in your case, then all bets are off and you may have difficulty getting your request for cancellation of your PMI approved: 1) You have had delinquent mortgage payments in the previous year. 2) You now have additional liens on the property.  3) Your loan is considered high risk.  If any of these situations apply then you need to contact your specific lender or loan servicer directly to determine their policy to cancel PMI under these circumstances.   Also, if you have the good fortune of living in an area which is experiencing higher than normal rates of home appreciation, your property value may have increased to a level where you’ve reached the lender’s target of 78%-80% much faster, if you think this is the case then you may be able to cancel PMI on your mortgage sooner.  Although the lender may not be required to cancel PMI in this instance, it is certainly worthwhile to contact your lender or loan servicer to see if they may be willing to consider it and ask them what documentation is required to demonstrate the increased property value.

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