PMI - What Exactly Is It?
You’ve located your dream home. You’ve filled out what seemed like literally reams of forms. You have provided tax documents, earnings statements, and explanations of anything on your credit report that your lender had questions about. You’ve even followed the advice of your lender to close unused accounts to improve your “debt ratio.”
Today, you and your realtor sit down to go over a proposed closing statement for your mortgage loan. And the payment is about $100 a month more than you anticipated it being. The culprit is “PMI” which your realtor explains to you is “Private Mortgage Insurance.”
What is Private Mortgage Insurance, and what if you don’t want it? Well, let’s start with what it is. Private Mortgage Insurance, or PMI, exists to protect lenders who are financing homes at over 80% of the appraised value of the home. That is, you, the borrower, are able to put down less than 20% of the value of the home as your down payment. In a very simple example, if you are purchasing a home valued at $150,000, a 20% down payment would be $30,000. If you are unable to come up with a $30,000 down payment, or 20% of the value of the home, you will find yourself paying PMI, or Private Mortgage Insurance. But PMI does not exist only to protect lenders. If lenders did not have the assurance that PMI provides, it is very unlikely borrowers would be able to purchase homes with 5% or 10% down payments as they can today.
There are ways to avoid or to eventually cancel PMI if you find yourself paying it. First, some lenders create “piggy back” loans for borrowers who are able to put down less than a 20% down payment, but who have incomes which can support larger monthly payments. Considering the example of the $150,000 home, if the borrower can put down only $10,000 instead of $30,000, the lender may be able to create a “piggy back” loan in addition to the first mortgage loan of $140,000. In this example, the “piggy back” loan would be for $20,000 so that the first mortgage was actually reduced to $120,000---and the lender would not, therefore, require PMI because the total down payment was 20% of the appraised value of the home. This borrower can afford the combined monthly payments for the $140,000 first mortgage and the $20,000 piggy-back loan, and can thereby avoid paying PMI.
In 1998, the Homeowner’s Protection Act (HPA) came into effect. This regulation applies to residential mortgages obtained on or after July 29, 1999. Prior to HPA, homeowners might have continued to pay PMI premiums even after they had paid down their mortgages to the point where their outstanding balance was 80% of the value of the property or less. With escalating home prices, some homeowners arrived at this goal earlier in their payment histories than they may have realized. If we go back again to the $150,000 home in the example, this situation is easy to understand. Let’s assume that the purchaser of this home put down $10,000 on the purchase of the home, and financed $140,000. He was paying PMI premiums since he financed more than 80% of the value of the home.
Now three years have passed. The homeowner has not made much of a dent in moving toward a 20% equity position in his home ownership by paying on his mortgage. But what if the home’s value has gone up significantly? What if this home is now worth $200,000? The homeowner still has a mortgage balance of approximately $140,000, yet his equity is suddenly $60,000 because the price of the home has gone up so much. He suddenly is in a position of owing only 70% of the value of the home. And he is no longer required to pay PMI premiums. Before HPA went into effect, some homeowners continued to pay PMI premiums long after they no longer had to do so. HPA provides for both consumers and lenders sharing responsibility of keeping track of the need for PMI where prior to HPA, consumers alone were responsible for being aware of where they stood in regards to the requirements to pay PMI.
There are requirements for notifications to borrowers regarding PMI, and these generally are at the inception of the loan, annually, and when PMI is cancelled. However, lenders are not required to cancel PMI based only on property value increase. Your lender may require a current appraisal to do so. There are other circumstances in which PMI may not be cancelled once the homeowner has a 20% equity position in the home. If loan payments have not been made regularly, the lender may not have to cancel PMI, and if the loan is a very large one, the lender may not have to cancel PMI.
You should receive an annual communication from your lender if you are paying PMI. This statement should address your rights to cancel PMI and contact information to do so. When PMI is cancelled, the lending institution must notify the borrower that PMI is cancelled and that no further PMI premiums are due.
If you would like more information about PMI, please contact one of the following:
727 15th Street, NW, FL 12
Washington, DC 20005-2168
U.S. Dept. of Housing and Urban Development
Attn: Customer Service
451 7th Street, S.W.
Washington, DC 20410