PMI Requirements in the Homeowners Protection Act Examined

By James T. Bork, J.D., LL.M., editor, CCH BANKING COMPLIANCE LIBRARY.  Bork has practiced banking law and served as in-house bank counsel. He also has written articles and spoken on bank regulatory and compliance issues. 

The Homeowners Protection Act of 1998 has been in effect since July of 1999. It establishes conditions under which lenders may or must cancel borrower-paid private mortgage insurance (PMI). It also requires certain disclosures by mortgage lenders and servicers in connection with mortgages for which PMI is required. 

PMI AND MORTGAGE LENDING PRACTICES

Private mortgage insurance has been part of the residential real estate lending environment for about 40 years and is used extensively today to facilitate those loans with a loan-to-value ratio above 80 percent. PMI protects mortgage lenders against default risk and enables certain borrowers, generally the cash-tight but credit-worthy and the cash-flush but credit-risky, to obtain home mortgage loans.

Traditional underwriting principles for residential mortgage lending indicate that a borrower with a 20-percent or greater investment in a residence is less likely to walk away from that investment. For this reason, when a homeowner’s equity reaches a certain point—typically 20 percent—the PMI protection afforded to the lender (and paid for by the borrower) becomes less important.

Nevertheless, many homeowners are either not aware that they may be able to cancel the unneeded PMI or they experience difficulties in their attempts to have it cancelled. Some homeowners who do not refinance or move may continue to pay for the PMI coverage for the entire life of their mortgage loan.

Scope of the Act.—The Homeowners Protection Act permits a mortgagor who has met certain conditions to request the cancellation of PMI when the mortgagor has accumulated 20 percent equity in the mortgaged home. As a general rule, PMI must be terminated when the mortgagor has accumulated 22 percent equity in the mortgaged home. Also, the Act prohibits life-of-the-loan coverage for traditional borrower-paid PMI. Even for certain high-risk mortgage loans, PMI must be cancelled at the midpoint of the loan’s amortization period.

The Act’s requirements apply to “Residential Mortgages.” These are mortgage loans in which the lender takes a mortgage or other consensual security interest against a single-family dwelling that is the mortgagor’s primary residence for the purpose of financing the acquisition, initial construction or refinancing of that dwelling. These requirements involve disclosures, PMI cancellation and automatic PMI termination on all residential mortgages closed since July 29, 1999.

PMI CANCELLATION AND TERMINATION

Mortgagor-Requested PMI Cancellation.—PMI that is required in connection with a residential mortgage transaction must be cancelled on the “cancellation date” if the mortgagor complies with the following conditions:

1. the mortgagor must submit a written request that PMI be cancelled;
2. the mortgagor must have a “good payment history” with respect to the mortgage and must be current on payments; and
3. the mortgagor must satisfy any existing requirements to show that the value of the mortgaged property has not declined since the closing of the loan and that the mortgaged property is unencumbered by any subordinate liens.

For fixed-rate mortgages, the initial amortization schedule is used to determine when the outstanding balance is scheduled to reach 80 percent of the original value of the property. For adjustable rate mortgages the amortization schedule in effect at the time of the borrower’s request is used.

A borrower has a “good payment history” if she was not 30 or more days delinquent during the year before the cancellation date or the cancellation request and was not 60 or more days delinquent during the 12-month period that ends one year prior to that.

Automatic PMI Termination.—The Act also requires that PMI in connection with a residential mortgage transaction must be terminated:

1. on the “termination date” if the mortgagor is current on payments required under the terms of the loan; or
2. if the mortgagor is not current on the termination date, then the next date after the termination date on which the mortgagor is current on payments required under the terms of the loan.

PMI Termination for High-Risk Loans.— The PMI cancellation and termination provisions do not apply to certain high-risk loans, as determined under Fannie Mae and Freddie Mac guidelines. Certain other high-risk loans, however, are subject to automatic PMI termination as described above, but at a 77-percent threshold rather than the generally applicable 78-percent threshold.

Final PMI Termination.— If PMI required in connection with a residential mortgage transaction has not been cancelled or terminated in accordance with the provisions already described, then it must be terminated on the first day of the month immediately following the date that is the midpoint of the loan’s amortization period, provided that the mortgagor is current on payments required under the terms of the loan.

NOTICE AND DISCLOSURE REQUIREMENTS

The Homeowners Protection Act imposes disclosure and notice requirements on mortgage lenders and servicers regarding PMI. These involve additional work, time and expense for the party providing them, and the Act does not allow lenders or servicers to recover these expenses from borrowers through fees or other costs. 

Disclosures at or Before Commitment.—If a lender or a third party makes the PMI payments under the terms of a residential mortgage (lender-paid PMI), the Act requires different disclosures than those described above. These must be made no later than the date of the loan commitment.

The disclosures must inform the borrower of several differences between lender-paid PMI and borrower-paid PMI. Lender-paid PMI is not subject to the cancellation and termination provisions described above; it usually results in a higher mortgage interest rate than comparable loans with borrower-paid PMI and it terminates only when the mortgage is refinanced, paid off or otherwise discharged. To illustrate the differences, the lender must provide a generic analysis of the differing costs and benefits over a 10-year period. The lender must also inform the borrower that lender-paid PMI may be tax deductible.

Disclosures at or Before Closing.—At the closing of a residential mortgage transaction, lenders must disclose in writing a mortgagor’s right to have PMI for the loan cancelled on the “cancellation date” or at a later date when certain conditions in the law are met. In addition, lenders must disclose that PMI will automatically cease on the “termination date” or at a later date when payments are current.

For fixed-rate mortgages, the disclosure must identify the termination date. For adjustable-rate mortgages, however, the disclosure must state that the borrower will be notified of the PMI termination or notified that PMI will be terminated as soon as the borrower is current on loan payments.

When making a fixed-rate mortgage that is subject to the Act, lenders must also provide a written initial amortization schedule. Some mortgagors pay down their mortgage loans more quickly than the scheduled payments require. Because of this possibility, lenders must also inform mortgagors that they may request early PMI cancellation if their actual payments reduce the outstanding loan balance to 80 percent of the original value of the mortgaged property before that would occur under the initial amortization schedule.

Certain high-risk mortgage loans are exempted from the cancellation and termination provisions of the Act. A lender must disclose this fact and inform the mortgagor whether the exemption applies to his or her loan. Even for high-risk loans, however, the lender must inform the mortgagor at closing that PMI will be terminated at the midpoint of the loan amortization period if the mortgagor is current on payments at that time.

Annual Notice from Mortgage Servicers.—Once each year during the time that PMI is in place, mortgage servicers must provide to borrowers a written statement of their rights under the Act regarding PMI cancellation or termination. This notice must include an address and telephone number that mortgagors can use to contact the servicer to determine whether the conditions for PMI cancellation are satisfied.

Servicers must also provide an annual notice to borrowers paying for PMI whose mortgages were closed before July 29, 1998. This notice must inform the borrowers that under certain circumstances they may request cancellation of their PMI, and it must include an address and telephone number that mortgagors can use to contact the servicer to determine whether those circumstances exist.

Notices Following PMI Cancellation or Termination.—Within 30 days after the cancellation or termination of PMI with respect to a residential mortgage loan, a mortgage servicer must notify the borrower that PMI has terminated and that he or she no longer has PMI coverage on the loan. If a servicer determines that the conditions for PMI cancellation or termination are not met, however, the servicer must provide notice of the grounds on which that determination was made.

POINTS TO REMEMBER

When dealing with this Act, it is important to be aware of the following points:

• The Act applies to residential mortgage transactions. A mortgage loan secured by commercial property, a vacation home, a second home or a multi-family dwelling is not subject to the Act.
• The Act deals only with the cancellation or termination of PMI and various related disclosures and notices. It does not impose any requirement that PMI either must or must not be required in connection with particular residential mortgages.
• State law, investor requirements, and/or applicable safety and soundness guidelines may require PMI in connection with mortgages that are not subject to the Act.