Private mortgage insurance is a hidden expense that can add thousands of dollars to the price of a house over the lifetime of a mortgage.
However, without private mortgage insurance to allow lenders to make the sometimes riskier low-down payment mortgages, many people would be unable to afford to buy their own homes.
Private mortgage insurance, or PMI, is coverage purchased by the home buyer for the benefit of the lender. It insures the lender against possible losses if the homeowner were to default on the mortgage.
Homeowners usually have only one direct dealing with PMI, when one year`s premium is due at the time of closing. After that, PMI usually disappears into the maze of monthly escrow payments made to the lender, who pays it thereafter.
Guidelines for when PMI is required, and more importantly for the consumer, when it can be canceled, vary signicantly throughout the lending industry.
The consumer`s best chance for cancellation and saving money is knowing in advance what those regulations are.
The guidelines have been established on many levels, since PMI first emerged in the late 1950s, by lending regulators, individual lenders and investors who purchase mortgage-backed securities on the secondary market.
The Federal Home Loan Bank Board, which regulates federally insured savings and loans, stipulates that PMI is necessary any time the loan made exceeds 90 percent of the value of the house, or in other words, any time the down payment is less than 10 percent.
But because so many loans today are sold soon after being made on the secondary market, those loans are also subject to the various investors`
regulations, which are often stricter.
Two of the most dominant forces in the secondary market, Fannie Mae
(Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.) require PMI any time the loan exceeds 80 percent of the value of the house and until the loan is reduced to that 80 percent level.
Although there are no blanket policies, Freddie Mac will consider PMI cancellation on an individual basis before that time ”if the borrower feels that because of increased equity, appreciation or rehab efforts, the property warrants it.”
According to the most recent census information, more than half of today`s homebuyers fall into this category, making down payments less than 20 percent.
PMI costs those home buyers .25 to .4 percent more than their regular interest rate on the loan. That rate, which depends on the type and amount of the mortgage, could add up to $162 to $258 annually on a $65,000 mortgage, or $250 to $400 annually on a $100,000 mortgage.
In response to escalating claims, which have risen from 18.9 percent of premiums earned in 1980 to 73.8 in 1984, the mortgage insurance industry has developed different rate scales for fixed-rate and what they like to call
”nonfixed-rate” or adjustable mortgages.
”On the basis of an analysis of 30,000 mortgages we insured between 1981 and 1983, we found nonfixed-rate payment mortgages had a 35 percent higher delinquency rate,” said John Ochotnicky, vice president of Mortgage Guarantee Insurance Corp., the company that founded the PMI industry in 1957.
”Previously we had provided insurance coverage (for nonfixed-rate mortgages) on the basis of fixed-rate mortgages. Last year we filed for new rates to cover nonfixed-rate categories.”
PMI for a fixed-rate mortgage represents approximately 1.5 percent of the monthly principal and interest payments. For a nonfixed-rate mortgage the insurance rate is approximatley 2.5 percent of the monthly principal and interest payments, Ochotnicky said.
It is if, and when, PMI can be cancelled that is the crux of the controversy.
”As it is now, the regulations tell you all the conditions for which you need PMI, but are totally silent about what to do afterwards . . . there are no regulatory requirements after the loan reaches a certain value (80 percent of the original amount),” said Dallas Bennewitz, director of mortgage lending at the U.S. League of Savings Institutions.
”It could be done better. I think there`s a place to reward the borrower who is conscientious. It (cancellation of PMI insurance) could receive a regulatory blessing.”
Locally, lenders have fairly different policies, although all of the following use Fannie Mae and Freddie Mac guidelines for when PMI is required. Most of these lenders will not initiate the cancellation process themselves, but will consider individual requests.
At Talman Home Federal Savings and Loan Association of Illinois the policy is that PMI is an obligation for the lifetime of the loan.
”We are not willing to look into the foggy crystal ball and attempt to see the value of real estate in the future . . . vis a vis, the remaining unpaid balance of the loan,” said Tom Greuling, executive vice president of Talman.
The fact that eventually the borrower`s balance will reach 80 percent of the original value is ”one of the idiosyncrasies of the marketplace, but reflects the value the lender places on equity in the very beginning of the transaction,” Greuling said.
Talman might consider canceling PMI only under special circumstances, Greuling said, if for example, the borrower were to prepay the mortgage within a couple years, increasing his equity to the 50 percent mark.
On the other hand, Avondale Federal Savings Bank will allow PMI cancellation when the equity reaches 20 percent and the borrower has held the loan for a minimum of four years. ”Historically, if someone is going to default on a mortgage, it is in the first four years,” said Edward D. Palasz, executive vice president of Avondale.
If the loan has amortized naturally to that point the bank`s computer will pick it up automatically and cancel it.
If, however, the borrower feels that the value of the home has increased because of inflation or that he has invested a sufficient amount into home improvements in order to increase the value, he can request a reappraisal, Palasz said. The reappraisal must be paid for by the borrower.
Cancellation of PMI is possible at Crown Mortgage Co. once the equity has increased to not 20, but 25 percent, of the original purchase price. Both payments and market appreciation will be taken into account at Crown also.
However, at Citicorp Savings of Illinois, although cancellation of PMI is allowable once equity has reached 20 percent of the original value, the lender will recognize only payments and not market appreciation in the equation. ”In some ways, that protects the customer from weak real estate markets,” said Robert W. Webster, vice president of mortgage lending. ”We have customers who are close and will make a prepayment to drop it down below the 80 percent mark.”
The above policies are for conventional mortgages only. Federal Housing Administration (FHA) mortgages are another story, requiring PMI for the lifetime of a loan, unless they have been sold into the secondary market. If they haven`t, cancellation is again up to the individual lender.
Although the basis for most lender`s decisions regarding cancellation is the borrower`s payment history, there are other reasons for which a lender might not consider cancellation. The local real estate market may be particularly weak. The homeowner`s job could be jeopardy. Some adjustable mortgages involve ”negative amortization” which can increase the amount of principal owed. And lenders might be self-insured and the PMI premiums may mean additional income to them.
Part of the reluctance on the part of the lender may also be that no one, except the borrower, benefits from the cancellation. While it costs them nothing, lenders and investors only benefit from the insurance.
