Banking theory holds that it's dangerous to lend anyone more than 80 percent of the value of a house. If the homeowner fell down on payments, and the house were seized and sold at a foreclosure auction, it might not bring enough to cover the loan, legal expenses of the sale, unpaid property taxes and lost mortgage payments. Then there could be the cost of holding the property till the sale -- possibly insurance premiums, heating bills, even lawn cutting.

So bank regulators ruled it was irresponsible to risk depositors' money (which is where mortgage loans came from in the simple good old days) by lending more than 80 percent of the property's value.

Where did the rest of the purchase price come from? Easy. In the old days, people didn't buy houses until they had considerable savings.

Then came the Great Depression, and with lots of housing standing empty, the government stepped in with a new idea: homebuyers could pay for insurance that would protect the lender against loss in case of default. (It wouldn't protect or reimburse the borrower, of course, just the lending institution.)

Once the buyer agreed to pay premiums for that FHA insurance, banks were safe in lending almost the full value of the property. Low down payment! But on only the modest houses the plan was intended to rescue.

Then came World War II, and the GI bill (the same one that sent millions of returning servicemen and women back to school) set up an even better deal. At no cost to the veteran, the government would guarantee the top 25 percent of a mortgage loan. With a guarantee like that, banks needed no down payment at all on a VA mortgage loan. Nothing down!

FHA and VA mortgages had some limitations, however, and gradually the concept of private mortgage insurance (PMI) evolved. Now lenders could offer a variety of conventional morgages, with less than 20 percent down, if the borrower agreed to pay PMI premiums.

The question that arises, of course, is -- must the borrower continue to pay for that protection once the debt has been paid down to less than 80 percent of value?

Some private mortgage policies contain varying answers. Some states have addressed the issue. In New York, for example, PMI can be cancelled (at least it's supposed to be) when the loan drops to less than 75 percent of the property's value.

The question always arises, though. Does that mean 75 percent of the original purchase price, or 75 percent of current value? If the latter, must the homeowner then pay several hundred dollars for a new estimate of value by the lender's appraiser?

And does the homeowner have to request that PMI be dropped, or will the lender do it on its own initiative?

The answers are all over the place.

Recently, the federal government stepped in with new regulations. For mortgages placed after July 29, 1999, PMI coverage can be dropped at the borrower's request when equity reaches 20 percent (that is, the loan drops to no more than 80 percent of value), and in any event it must be dropped when equity reaches 22 percent.

Light at the end of the tunnel!

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Published: April 19, 1999

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