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Canceling Private Mortgage Insurance (1)

Canceling Private Mortgage Insurance (1)

November 6, 2000

"Is it true that if my house appreciates to where I have 20% equity, I can have my mortgage insurance cancelled?"

"My lender refuses to cancel my mortgage insurance because [Fill in the blank with any of a dozen reasons]. Is this legitimate?"

"Is FHA insurance cancelable like other types?"

Questions about terminating mortgage insurance such as these are asked frequently by readers. I haven�t written a column about it before because the topic irritates me.

The rules regarding termination are devilishly complicated, which makes many questions difficult to answer. But what really raises my blood pressure is that the problem shouldn�t exist.

If lenders paid for mortgage insurance and passed on the cost in the interest rate, which is the way it should work, lenders would decide when to terminate. Borrowers wouldn�t be vexed with complicated termination rules because they would not be involved.

The problem arises only because mortgage insurance premiums are paid by borrowers. Since lenders are protected by the insurance but don�t pay for it, many refuse to terminate voluntarily. They must be forced to terminate by government. And that�s where the trouble starts.

Governments begin with the principle that since borrowers are not required to buy mortgage insurance if they put 20% down or more, the insurance ought to terminate when their equity rises to 20%.

For example, a home buyer who borrows $95,000 to purchase a $100,000 home is putting only 5% down and must purchase mortgage insurance. But when that borrower has paid down the loan balance to $80,000, the insurance ought to terminate. That seems simple and fair.

It also seems fair to terminate if part of the increase in the owner�s equity is a result of appreciation in market value. For example, the borrower would have 20% equity if the property value rose to $110,000 while the loan balance was reduced to $88,000.

But suppose virtually all the increase in equity resulted from appreciation within just a few months after purchase? In areas where prices jump sharply, they can also drop sharply, which suggests that there be some minimum period for retaining the insurance.

Termination rules also must take account of other developments that may affect the lender�s risk. For example, it wouldn�t be fair to the lender to require termination if the borrower has been chronically late on his payments, has taken out a second mortgage, or has moved out and is renting the house.

A major issue in government-mandated termination rules is where responsibility lies for initiating termination? Lenders can be made responsible if termination is based on the current loan balance and the original property value, because the lender has that information. But lenders can�t be made responsible for termination based on the current property value, because they don�t have that information and it would be inordinately costly to maintain it for every borrower.

There is no alternative to making borrowers responsible for initiating termination based on current market value. They know better than the lender what their property may be worth.

But how do borrowers become aware of the rules and procedures to follow in initiating the termination process? For example, what must the borrower do to establish the current value?

Government requires lenders to disclose the rules and procedures at the time the loan is made. So borrowers already suffering from information overload at the closing table, get one more set of disclosures that they can ignore.

Now introduce the additional complication that there are multiple government entities with somewhat different agendas setting termination rules.

*Fannie Mae, a US Government-sponsored enterprise, has established the termination rules for the mortgages it purchases from lenders.

*Freddie Mac, another US Government-sponsored enterprise, has established the termination rules for the mortgages it purchases from lenders.

*Congress in the Homeowners Protection Act of 1998 set out ground rules for termination of private mortgage insurance on all mortgages originated after July 29, 1999.

*Ten states, including California and New York earlier had passed similar legislation.

*Termination rules for mortgage insurance provided by the Federal Housing Administration (FHA) are completely different than those applicable to private mortgage insurance, and are based on earlier Federal legislation and regulations of the FHA.

Borrowers paying for private mortgage insurance who have 20% equity in their properties may be able to terminate at their own initiative. The specifics of who can and who can�t are very complicated and will be sorted out in another column. It will not apply to FHA borrowers, who require a column of their own.

Copyright Jack Guttentag 2002



Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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