MONEY MANAGEMENT

A column on personal finance prepared by the Virginia Society of Certified Public Accountants

PRIVATE MORTGAGE INSURANCE: WHO BENEFITS?

(September 23, 2003) – Experience shows that the less a homeowner has invested in a home, the greater the probability of default. For this reason, lenders require private mortgage insurance (PMI) on conventional mortgage loans with less than 20 percent down. The primary goal of PMI is to protect the lender in the event the borrower defaults on a loan.

Even though it appears that private mortgage insurance favors the lender, PMI can benefit the borrower as well. In fact, thanks to PMI, lenders are willing to offer loans and make homeownership available to those who can’t afford the customary 20 percent down payment. PMI also benefits those who may want to purchase a larger or more expensive home. For example, a $20,000 down payment could represent a 20 percent payment on a $100,000 house or, with PMI, a 10 percent down payment on a $200,000 house.

The Virginia Society of CPAs answers some frequently asked questions about PMI:

How much does private mortgage insurance cost?

PMI premium payments vary based on the size of the down payment, the type of mortgage, and the amount of insurance coverage. The charges typically amount to 0.5 percent to 1 percent of the loan annually. Generally speaking, the PMI premium for a median priced home is likely to fall between $50 and $100 a month. Shopping around for a lower rate isn’t an option since the lender chooses the policy. The premium is usually incorporated into the monthly mortgage payment.

When can I stop paying PMI?

Under the federal Homeowners’ Protection Act (HPA) of 1998, on loans made on or after July 29, 1999, lenders must provide borrowers with certain disclosures concerning PMI. The Act includes provisions for the automatic termination of PMI and the borrower’s right to request PMI cancellation. Prior to the Act, some homeowners paid premiums for years after they had reached 20 percent equity in their homes.

How does automatic termination of PMI work?

Under the Homeowners’ Protection Act, for loans closed on or after July 29, 1999, mortgage insurance that is paid directly by the borrower will be canceled automatically when the mortgage balance reaches 78 percent of the home's original value, provided that the borrower is current on payments. Homeowners, whose mortgages originated prior to the enactment of the law, are protected by the Act’s requirement that lenders notify them of their right to cancel PMI.

Can you tell me more about my right to cancel PMI?

Borrowers also have the right to request cancellation of PMI when the mortgage is paid down to the point that it reaches 80 percent of the home’s value at the time the loan was closed.

Since home appreciation is added directly to your equity, even though the amount you owe hasn’t changed, you may be eligible to have your private mortgage insurance cancelled if you can demonstrate that the value of your home has increased. To qualify, most lenders require that you have the house appraised (at your expense) by a lender-approved appraiser. Be aware that, regardless of the increase in value, some lenders require you to have owned your home for a year or two before they will consider dropping PMI.

Refinancing is another way to eliminate PMI payments. With interest rates at a 40-year low, it is possible that you can refinance to a lower interest rate mortgage. If your home has appreciated sufficiently in value, you may drop below the required threshold for private mortgage insurance.

Is mortgage life insurance the same as private mortgage insurance?

No, but consumers often confuse the two. Mortgage life insurance is a type of life insurance policy that pays off your mortgage balance should you die or become permanently disabled. If you’re interested in this type of protection, CPAs suggest that you consider a standard term life insurance policy instead of mortgage life insurance.

For one thing, a standard life insurance policy gives your survivors more flexibility in determining how to use the policy’s proceeds, whereas mortgage life insurance can only be used to pay off the policyholder’s mortgage. There’s another good reason to choose regular term insurance over mortgage life insurance: standard policies often feature a tiered rate structure, with healthy policyholders paying lower premiums. Most mortgage life insurance policies do not provide that option.

If you have additional questions about PMI, a CPA can help you navigate through the details.

The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.