A much sought after federal private mortgage insurance (PMI) reform law, effective July 29, isn't the panacea many consumers may think it is -- it could raise as many questions as it answers.
First, the new law doesn't extend its benefits to all mortgage holders. Also, new reduced PMI premium mortgages could effectively undercut the new rule.
Dubbed the Homeowners Protection Act of 1997 , the new law amends the Federal Truth in Lending Act and could save some homeowners more than $1,000 a year in PMI payments.
The key provision in the new law forces most lenders to automatically cancel PMI when a homeowner pays his or her mortgage balance down to at least 78 percent of the home's original purchase price. Home owners also may apply to have the insurance removed when the mortgage bill drops to 80 percent of the original value. Both provisions require that the borrower be current with his or her mortgage payments.
The new law doesn't exempt stronger state laws, but the federal law does take precedence over weaker ones. California, the first state to offer a similar automatic PMI cancelation law, along with Connecticut, Maryland, Massachusetts, Minnesota, Missouri, New York and Texas, are among a handful of states with various PMI protection laws.
Why a PMI law?
PMI, which protects lenders from borrowers defaulting on the mortgage, is required on most loans with down payments of less than 20 percent. That's because borrowers making smaller down payments are more likely to default than those with larger down payments.
The insurance adds $50 to $100 to the monthly mortgage payment, carries no protection for borrowers who must pay for it, nor is it tax deductible. Lenders say those with low down payments often can't otherwise obtain a loan without PMI.
Lenders also say when mortgages are originated they disclose to borrowers when and how they can cancel PMI. Later, critics charge, when PMI was no longer necessary, lenders weren't quick to tell borrowers they could cancel the coverage.
Some homeowners, including legislators on Capital Hill, unnecessarily paid PMI premiums years longer than necessary. The abuses led to the amendment to the Federal Truth in Lending Act.
PMI Reform Not For All
Only loans written July 29 or later are covered by the new law, but the small print on many other mortgages could exclude still more consumers from the new benefits.
Federal Housing Administration (FHA) and Veteran's Administration (VA)loans come with a different type of mortgage insurance, Mutual Mortgage Insurance or MMI When FHA or VA loans require MMI premiums, the premiums are required for set periods from a few years to the life of the loan, depending upon the down payment and the type of purchase.
The new federal legislation notwithstanding, both Fannie Mae and Freddie Mac allow eligible homeowners to request PMI cancellation when increased property values have pushed the equity in their homes to 20 percent. However, that doesn't include mortgages that are part of "negotiated" packages purchased by Fannie or Freddie from major lenders.
The packages are routine pooled transactions that allow Fannie and Freddie to buy loans that carry higher than typical risks. To cover the extra risk, the loans come with extra PMI coverage that could be locked in for years no matter how much equity the mortgage holder gains.
Since the new PMI reform legislation was drafted, among the options offered by the trade group Mortgage Insurance Companies of America is a choice to finance the entire premium along with your mortgage. The questionable option effectively renders the premium tax deductible, but it could also undercut the new law. Unless you refinance the mortgage later, you'll carry the premium, albeit financed, for the life of the loan, perhaps beyond the period when you could have canceled it.
So called "no-PMI" mortgages warrant caution too. Instead of a PMI premium, Seattle-based Washington Mutual Bank , for instance, gives home buyers with only 10 percent down the option to pay an adjustable mortgage rate about a half point higher than those with 20 percent down. The higher rate is about the same cost as a PMI premium for the same loan. Effectively financing PMI premiums, like the PMI industry option, the loan makes them tax deductible.
Washington Mutual also says it will cut the rate to the 20 percent down level whenever the loan balance is amortized down to 80 percent of the home's purchase value. If appreciation pushes your equity to 25 percent or higher Washington Mutual says it will also cut your interest rate.
Both cancellation features are similar to provisions in the new PMI reform law, but the loan and other methods of financing PMI payments raise serious questions.
"What if" Questions Remain
What happens to financed premiums if you decide to pay down or pay off your mortgage before cancellation kicks in? That's not an unlikely scenario in high-tech mecca Silicon Valley, CA. The area's $80,000 median household income is due in part to many of the area's residents earning over-night riches from stock options and other Wall Street investments.
Will you get a refund? Can you get the reduced interest rate sooner? Can you cancel your insurance sooner?
PMI has been a volatile consumer issue for years. The federal PMI reform law goes a long way toward addressing some of the abuses and answering some of the questions. Some questions remain.
Likewise, consumers must remain vigilant and press lenders and the PMI industry about those questions. Demand honest, full disclosure -- without small print -- about the money you spend on what's likely the most expensive purchase you'll ever complete.