If you want to buy a home with less than 20 percent down, lenders will insist that you obtain something called "private mortgage insurance" (PMI). The purpose of such coverage is to protect the lender in case the home is foreclosed. In effect, PMI allows you to substitute insurance coverage for the cash it would otherwise take to build a huge down payment.

The controversy concerning PMI does not hinge on whether such insurance is or is not a useful product -- it is a valuable form of insurance because it allows people to buy homes without waiting years to accumulate massive down payments. Instead, the issue is this: Should borrowers continue to pay PMI premiums once they have 20 percent equity in their homes?

Legislation enacted by Congress and forwarded to President Clinton in the past few days would curtail the worst examples of overcharging homeowners for unneeded insurance coverage.

"Every day, thousands of hard working Americans striving to afford a house of their own are unfairly paying for mortgage insurance they don't need. We must stop this fleecing of the American homeowner with unneeded insurance," says Sen. Alfonse M. D'Amato (R-NY), sponsor of the Senate version of the legislation.

In practice this is what happens now: A home is bought with less than 20 percent down and so there is a need for PMI coverage. Over time property values rise and loan balances decline so that the owner has at least 20 percent equity. Even though a lender should have plenty of default protection with 20 percent equity in place, some lenders -- but not all -- require PMI premiums to continue.

The Homeowners Protection Act of 1998 provides that consumers can ask lenders to end PMI coverage when owners have 20 percent equity. Many lenders -- if asked -- already allow cancellation once the difference between market value and debt is at least 20 percent, the owner has a good credit history, and an appraisal confirms market value. When equity reaches 22 percent, PMI policies must be automatically canceled under the new federal rules.

The "cancellation date" under the automatic termination provision is defined as the date when the loan is "first scheduled to reach 78 percent of the original value of the property securing the loan." The optional "cancellation date" occurs when the amortization schedule requires the loan balance to be "80 percent of the original value of the property securing the loan" -- or sooner, if a borrower has made extra payments to reach the 80 percent level.

For their part, consumers will have to weigh the costs and benefits of seeking an end to PMI once they have paid down a loan by 20 percent. As an example, is it better to pay for an appraisal and seek to end PMI at 20 percent, or is it cheaper to continue PMI payments a little longer and let coverage automatically lapse when the loan balance is reduced 22 percent?

The new guidelines require lenders to provide extensive disclosure information:

• Fixed-rate borrowers will receive an amortization schedule showing exactly when PMI can be cancelled.

• The requirements for a "good payment" history are defined. Generally you're in good stead if you do not have one payment 30 days late within one year of a cancellation request, or one payment 60 days late within two years of seeking an end to PMI payments.

• Defines the "original value" of the property as either the purchase price or the appraised value at the time of purchase, whichever is less.

• Requires borrowers to show that the property's value has not declined when seeking to end PMI at the optional 20 percent level.

Under the legislation, lenders can continue PMI up to 15 years for so-called "high-risk" loans, regardless of equity. The bill applies to mortgages made in the future and not to loans now in place. FHA financing is not covered under the legislation.

The Homeowners Protection Act contains important disclosure requirements, allows PMI to continue as an important financing option, and curbs the most abusive lender practices. For consumers, the bill at least suggests that now would be a good time to ask lenders about current PMI cancellation policies.

Question Of The Week

Q We have received a seller disclosure form which suggests that the house we are considering is in good shape. Can we rely on this form?

A A seller disclosure form in the best case sets out what the seller knows about the physical condition of the home. But the seller may never have opened an electrical service box, spotted a roof leak, looked into a crawl space, noticed rotted wood in an attic or a growing crack in the basement.

Despite the best efforts of sellers to disclose what they know, buyers are best served by getting a home inspection.

Weekly Resource

Credit scoring programs are now used by many lenders as part of the underwriting process. A good resource explaining how credit scoring works can be found at the Fair Isaac site. The company is a pioneer in the credit scoring field.

Mr. Miller welcomes your questions, comments, and news releases. All correspondence shall become the property of Mr. Miller upon receipt. He can be reached by e-mail at OurBroker.

Editorial Notice: Content on this page reflects the opinions of Mr. Miller only and not necessarily the views of any publication, organization or Website owner.

Published: July 28, 1998

Use of this article without permission is a violation of federal copyright laws.