Private Mortgage Insurance

Buyer Beware

In the excitement of closing, private mortgage insurance (PMI) sometimes passes unchecked through closing documents. PMI insures the lender against mortgage loss, while the homeowner pays the insurance to get the loan. Many homeowners (especially low-income homeowners) wonder why they not only have to fight for a good mortgage, but then also have to back up that promise with expensive insurance. PMI is not homeowners’ insurance – it is strictly for the protection of the lender against unpaid mortgage losses.

I believe that PMI is so poorly understood because people blind themselves to not-so-positive aspects of their agreements. They are focused only on getting the house and are happy with the amount of money they put down, so they assume that PMI is inevitable or just too complicated to dismiss. This is incorrect. The sheer amount of money generated by PMI means that consumers need protection. At least 15 million people in the U.S. have bought homes with mandatory PMI, and that is a lot of money in the pockets of insurance companies.

How does PMI work? PMI is almost automatically applied to any mortgage in which less than a 20% down-payment is made. Anyone who is even remotely considering refinance also should considering addressing a current PMI. Let’s discuss why.

Canceling PMI demands that you have an accurate account of the equity in your home. Since the establishment of the Homeowners Protection Act on July 29, 1999, mortgage holders have the right to force their lender to cancel PMI once the equity in a home reaches 22%. Some loan documents actually will have an automatic cancellation rate of 25% equity, because good lenders recognize that giving a PMI discount makes for a better business and happier borrowers.

State laws often vary a bit from this federal law, so you will want to check your local guidelines. Also, if you have an FHA loan, there is no right to cancel mortgage insurance.

Otherwise, you have a right to cancel PMI under certain conditions. Once a lender is protected by the value of your home, it makes no sense to have “double safety”. Since cancellation is your right, lenders in some states leave it up to you to enforce the cancellation.

Increasingly, however, states are requiring that you be notified when the equity has reached sufficient levels (around 20%) to trigger a PMI cancellation. Still, it is better to be proactive, so re-evaluate your PMI if you are considering refinance. When automatic cancellation is applicable, your loan must be current in order for you to qualify.

Keep in mind that refinancing will carry its own costs. Certainly try to avoid a situation in which you are eligible to stop paying PMI, but because of refinancing you must continue PMI coverage. After all, your main goal is to invest in yourself. Many people creatively structure loans by which the primary lender is not exposed to risks of more than 80% of the home’s value, for example by purchasing from a family estate. Negotiate with your lender to confirm whether or not PMI is necessary in your specific case.

In another debthelp.com article, we discuss another aspect of PMI. It is vital that your appraisal accurately captures the equity in your home. Federal rules estimate equity based on the original purchase value, but many state laws allow an appraisal based on market value. With the thriving realty market of the last decade, you need to know your own state rules and select an appraisal that will work the best for you. Depending on how you handle it, PMI can spell either major savings, or unnecessary payments for you.