It's long been one of the crummiest deals around: private mortgage insurance, or PMI. Now, thanks to a federal law that took effect July 29, homeowners have a better chance of breaking free of this annoying cost.
PMI is insurance to protect the mortgage lender from loss if the borrower defaults on the loan. Typically, it's required whenever a loan represents more than 80 percent of the property's value. Borrow $90,000 to buy a $100,000 home, you'll probably pay PMI. Borrow $80,000 or less, you probably won't.
PMI charges are folded into the monthly mortgage payment, typically costing about 0.5 percent of the loan amount. So if you borrowed $100,000, you might pay $500 a year, or about $42 a month. That could add up to $15,000 over the 30-year life of a loan. If you could forgo the PMI payment and invest $42 a month at 8 percent for three decades, you'd end up with nearly $60,000. So PMI is not, by any means, a small, incidental cost.
Of course, no one should have to pay PMI for 30 years. To the extent there is a legitimate case for PMI -- not a very strong case, in my view -- it's that the lender needs to be sure of recovering its money if it has to foreclose and sell the property. PMI assures the lender will come out whole even if the property fetches less than it cost when the loan was issued.
The mortgage industry argues that PMI makes it possible to lend money to borrowers who otherwise would be considered too risky. Without PMI, the argument goes, borrowers would have to come up with larger downpayments or pay higher interest, and some people might not get mortgages.
Maybe, but foreclosures aren't all that common. And most homes appreciate, so lenders' chances of unloading a foreclosed property for more than the remaining debt are usually pretty good. Besides, why shouldn't lenders shoulder some risk? Isn't that what lending is all about?
Even if you believe that PMI is justified when a loan is first issued, it clearly is not years later, after the borrower has paid off a chunk of the loan and the property has gained value, eliminating the lender's risk of loss.
But once a mortgage is issued, the typical mortgage lender usually continues charging for PMI indefinitely. Savvy homeowners have known for years that once their outstanding debt totals less than 80 percent of a property's value, they can ask the lender to drop the PMI requirement. But lenders didn't have to comply, and they rarely told borrowers this potential saving was possible.
Now that has changed. The federal Homeowners Protection Act of 1998 describes conditions under which the PMI requirement should be terminated.
For loans issued on or after July 29, the PMI requirement should end automatically when the remaining loan amount falls to 78 percent of the property's value at the time the loan was made.
In addition, any homeowner, including those with older mortgages, can apply to have the requirement dropped by providing evidence that the loan represents no more than 80 percent of the property's current value. Thus, a homeowner can benefit from property appreciation, even if only a small amount of the debt has been paid off.
Homeowners should have little trouble getting the PMI dropped, unless there is a history of late payments. But you may have to spend several hundred dollars to have the property appraised.
Since the appraisal fee is non-refundable, best do some research first. The annual mortgage statement received from the lender every January will give an idea how much is still owed on the loan, and you can get an updated figure from the lender. …