Understanding (And Avoiding) Private Mortgage Insurance

When you buy a house and have to borrow money from a mortgage lender, that lender will want to make sure there is adequate security (called equity) in the house. In the event you cannot make your monthly mortgage payments (i.e. are in default) and the lender has to foreclose on your property, they want to be able to re-sell the house and at least break even on the transaction.

Thus, for years, lenders would lend no more than 80 percent of the "loan to value ratio". This means that if your house costs $400,000, the most that a lender would lend you would be $320,000.

Obviously, many people just do not have twenty percent (i.e.$80,000 in our example) to put down when they purchase their new property. Keep in mind that a purchaser will also have closing and moving costs.

Thus, the Federal Housing Authority (FHA) loan was born. Under an FHA loan, you could borrow sometimes as much as 100 percent of the purchase price. However, to protect the lender, the FHA gave an assurance that should you go into default, and the lender was not made whole when the property was sold at a foreclosure sale, the government would back up -- i.e. insure -- that the lender would be made whole.

Over the years, a new industry was born -- called "private mortgage insurance". Here, instead of the government insuring the lender, the private mortgage company would be the insurer -- and you (the borrower) would be required to pay monthly insurance premiums in order to obtain a mortgage with a loan-to-value ratio of more than 80 percent.

However, consumers faced with private mortgage soon found that it was next to impossible to get rid of these monthly mortgage insurance premiums. Congress was besieged with horrible examples of abuse in this area, and finally enacted a consumer protection law -- called the "Homeowners Insurance Protection Act -- designed to relieve some of these abuses.

The effective date of this new law was July 29, 1999. Under this new law, private mortgage insurance 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 -- at closing -- when the mortgage will reach that 78 percent mark.

However, if your mortgage loan was placed prior to July 29,1999, you will still have to discuss your specific situation with your lender. If the lender refuses to allow you to drop this PMI, you might want to consider refinancing and paying off the old loan.

Finally, many lenders are offering potential homeowners an "80-10-10" loan arrangement. Under this procedure, the homeowner obtains a first mortgage (also called a "deed of trust") in the amount lf 80 percent of the purchase price. This avoids the private mortgage requirement. The homeowner also obtains a second deed of trust in the amount of 10 percent of the purchase price. This second trust usually carries a higher rate of interest -- but the interest is tax deductable and the mortgage should have no prepayment penalty. Under the 80-10-10 process, the homeowner is still required to put up 10 percent cash -- his own money -- in order to close on the property.

Before you commit yourself to any loan, do the numbers and compare the costs associated with a refinance. Make sure you know all of the facts and have done your comparative shopping. 


Written by Benny L. Kass

Nancy M. Alexander Stone Harbor and Avalon NJ Real Estate, Long & Foster Avalon