Overview
Private Mortgage Insurance (PMI) is an insurance policy provided by private insurance companies to protect lenders against losses resulting from borrower default on conventional loans. Typically, PMI is required when the home’s loan-to-value (LTV) ratio exceeds 80%, meaning the borrower has put down less than 20% of the home’s value as a down payment.
Detailed Explanation
The Homeowners Protection Act of 1998 mandates certain procedures for PMI cancellation to protect consumers. Under this law, borrowers can request PMI cancellation when their loan principal balance reaches 80% of the home’s original appraised value, assuming the mortgagor is in good standing. PMI cancellation becomes automatic when the loan principal balance falls to 78% of the original cost, irrespective of current market value.
Examples
Example 1:
Lawton wishes to secure a conventional loan covering 90% of his home’s value. His lender requires him to purchase PMI because his down payment is less than 20%. Because Lawton’s loan-to-value ratio is high (90%), the lender requires PMI as insurance against potential default.
Example 2:
Sara bought her home with an 85% loan-to-value ratio. Over the years, as she pays down her mortgage, Sara’s loan balance reaches 80% of the original appraised value of her home. She contacts her lender to request the cancellation of her PMI. According to the Homeowners Protection Act, the lender must honor her request, assuming her mortgage payments are current and she has a good payment history.
Frequently Asked Questions (FAQs)
What is Private Mortgage Insurance (PMI)?
PMI is insurance provided by private companies for lenders, protecting against losses when a borrower defaults on a mortgage with less than 20% down payment.
When is PMI required?
PMI is generally required for conventional loans with loan-to-value ratios above 80%. In simpler terms, if a homebuyer makes a down payment of less than 20%, they are likely required to purchase PMI.
How can PMI be canceled?
Under the Homeowners Protection Act, borrowers can request PMI cancellation when their loan balance reaches 80% of the home’s original value. PMI will cancel automatically when the loan balance reaches 78%.
Who benefits from PMI?
While lenders primarily benefit from the protective aspect of PMI, borrowers may benefit by securing home loans with smaller down payments than typically required.
Does PMI provide coverage for the homeowner?
No, PMI protects the lender, and does not cover the homeowner should they default on their mortgage payments.
Related Terms
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Mortgage Insurance: Mortgage insurance protects lenders from the risk of borrower default on a mortgage. It can be provided by government agencies or private insurers.
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Loan-to-Value (LTV) Ratio: The LTV ratio is the loan amount compared to the appraised value of the property, expressed as a percentage.
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Homeowners Protection Act (HPA): The HPA, also known as PMI Cancellation Act, provides guidelines and conditions under which PMI can be canceled.
Online Resources
- Consumer Financial Protection Bureau (CFPB)
- Federal Housing Finance Agency (FHFA)
- U.S. Department of Housing and Urban Development (HUD)
References
- Consumer Financial Protection Bureau. “What is Private Mortgage Insurance?” Available at: CFPB Website
- Federal Housing Finance Agency. “Private Mortgage Insurance.” Updated 2023. Available at: FHFA Website
Suggested Books for Further Studies
- Home Buyer’s Guide to PMI by John Narel
- Mortgage and Mortgage-Backed Securities Markets by Frank J. Fabozzi
- Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan by David Reed
