Question: During the time I was arranging my mortgage, the money I was going to use for a house down payment lost ground. Instead of having enough money to put down 20 percent, I could only muster 17 percent. Initially, I was going to get an 80 percent loan. My mortgage "coordinator" advised that instead of borrowing or taking a second mortgage for that small amount, I should opt to get private mortgage insurance to cover the difference.

Her rationale was that within a few months, the market value of my new house would have increased by 3 to 5 percent, at which time I could request that the PMI be dropped. With only a few days left before settlement, I followed her advice.

I now have to pay $105 additional each month. Recently, I approached my lender to determine the process for dropping this. I was shocked to find that they will not release me for two full years, and my equity must be at 25 percent.

Do I have any recourse or am I stuck with their terms? I have a favorable interest rate and certainly do not want to refinance.

Answer: You were given bad advice by your mortgage coordinator.

Private mortgage insurance should not be confused with homeowners insurance, also called hazard insurance. The latter protects the homeowner in the event of a problem, such as fire, theft or other home damage. PMI protects the lender against financial loss if the homeowner goes into default and the house has to be sold at foreclosure. For example, if your house has a loan of $250,000, but at foreclosure sells for only $200,000, PMI will pay the lender part of the difference.

You, the homeowner, pay these premiums. You generally have no choice -- if you take the loan, you must take the insurance, and the premiums are not cheap. If you put 10 percent down on a $200,000 house purchased with a 30-year fixed rate mortgage, you will pay about $75 per month in PMI premiums. On the other hand, if you put down only 5 percent, the premiums jump to $120 per month.

The private mortgage industry makes a strong argument in favor of PMI. According to the Mortgage Insurance Companies of America, the association that represents the insurers, "Private mortgage insurance is quite simply the easiest, most flexible and least costly way to buy a home with a low down payment. With private mortgage insurance, you can buy a home with as little as 3-5 percent down payment instead of the 20 percent down payment lenders traditionally have required for loans without insurance."

Lenders have learned that if you have less than 20 percent equity in your house, you are more likely to default on your mortgage loan. That is why the magic mark is 20 percent down.

If you do not have enough cash to make a 20 percent down payment -- and if you really want to buy a house -- PMI used to be the only way to go. But in recent years, lenders have come up with alternatives.

One such approach is known as the "80-10-10" loan. Under this arrangement, the borrower must have a minimum of 10 percent cash to put down. The lender makes you two loans: one in the amount of 80 percent (a first trust), and the other in the amount of 10 percent (a second trust). Because the first mortgage is only 80 percent of the purchase price, it is considered a conventional loan and no PMI is required. The second trust carries a higher rate of interest. Interest payments on both the first and second mortgage are tax deductible. Similar 80-15-5 loans are also available.

There are two major questions many people have about PMI: Are the payments tax-deductible? How do we drop the insurance?

Deducting PMI: As with many areas of tax law, there is no easy, clear answer. Many lenders will tell you that the premiums are not deductible, because the taxpayer can only deduct interest and real estate tax payments. However, some tax lawyers are taking a second look at this, and have concluded that PMI payments should be deductible. Congress has on several occasions attempted to change the laws so as to specifically allow the deduction of PMI payments, but to date has not done so.

Dropping PMI: Consumer complaints about the difficulty of dropping PMI used to be common. In response, in 1998, Congress enacted the Homeowners Protection Act, with an effective date of July 29, 1999. The law gives borrowers protections, but perhaps not as many as some would like.

PMI on most loans originated after that date will automatically terminate once the mortgage has amortized to 78 percent of the original purchase price of the house. Lenders are required to advise their borrowers when the mortgage will reach that 78 percent mark. This automatic cancellation has nothing to do with the increase in the value of your house, only with how much of the mortgage is paid down. That can take a long time.

Additionally, for most loans, the borrower has the right to request cancellation of PMI when the mortgage equals 80 percent of the original purchase price or appraised value of your home at the time the loan was obtained, whichever is less. Again, this has nothing to do with current market value.

The law does not require mortgage servicers to take into account increased market value, but many do. Generally, though, they won't allow cancellation of PMI after only a few months, no matter how much the value of the house has increased. For instance, the requirements your lender told you -- 75 percent equity on a mortgage at least two years old -- are the requirements of big mortgage investors Fannie Mae and Freddie Mac. Before a lender lets you drop PMI, it wants to establish that you do indeed have a history of prompt payments and you have built up equity.

After more years pass, servicers will let you cancel when you have 20 percent equity, as shown by an appraisal by an approved appraiser.

There are other complications and exceptions to these rules. Your loan documents should tell you more about such requirements.

If your loan is covered by the law, your lender must provide you information on how to cancel PMI. This information must be provided at the time you close on the loan as well annually thereafter.

Not all loans are covered by the law. Some "high-risk" loans are excepted. And the law only covers loans with PMI. Loans backed by the VA or FHA have a different type of insurance. In addition, borrowers with loans older than July 29, 1999, are not covered.

With this background, let's get back to your situation.

Your mortgage coordinator clearly gave you the wrong information about how long you would have to hold the loan before you could drop PMI. Your coordinator should have given you all the facts so that you would have had an opportunity to make an educated decision as to whether to pay PMI or take out a small tax-deductible second mortgage. You can always make additional payments on a second trust to reduce your long-term mortgage obligations or to pay off the loan completely.

You did not tell me exactly what type of loan you have, so I can't tell if it is covered by the consumer protection law. However, if it is, you should go back to the lender and ask to review the requirements of the 1998 law. While you will not be able to cancel PMI immediately, at least you and your lender should be aware of your rights.

What should you do? You say you don't want to refinance the loan, but if the lender refuses to allow you to drop PMI, you might want to reconsider. Keep in mind that even if your loan-to-value ration is more than 80 percent -- but less than 90 percent -- the 80-10-10 loan may be worth investigating. Do the numbers and compare the costs associated with refinancing.

If you keep the loan, I suspect you are stuck with the PMI payments for more than a year.

You should consider filing a complaint against the mortgage coordinator with the appropriate state and federal enforcement agencies. But first, send a letter to the coordinator, requesting an explanation of why you were given bad advice, and what the coordinator plans to do about this.

In the future, get all the facts and then do the numbers before committing yourself to a particular plan or program.

Published: January 3, 2005

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