October 2, 1998 98-R-1157
FROM: Helga Niesz, Principal Analyst
RE: Private Mortgage Insurance
You asked for background information on private mortgage insurance. You want to know how it works, when it is required, at what point people can eliminate it, and what happens with PMI when a loan is refinanced. You asked who has jurisdiction over it, whether Congress has taken any recent actions in this area, and what legislative options the General Assembly has.
Private mortgage insurance (PMI) is an insurance policy sold by a private insurance company that protects the lender on a home mortgage if the borrower defaults. The borrower pays the premiums. These can take the form of a single one-time premium or a smaller up-front payment of a small percentage of the loan amount combined with monthly premiums added to the mortgage payments. Without this insurance, lenders usually require a 20% downpayment; with it, the borrower might have to put down only 10%, 5%, or less. Historically, whether and at what level people could get rid of PMI depended on the mortgage holder's policies, except in a few states that have specific requirements. Fannie Mae and Freddie Mac have allowed cancellation when equity reaches 20%. When a loan is refinanced, the original loan is paid off and the PMI policy ends. But it is up to the new lender to decide whether to require a new PMI policy.
Connecticut law currently requires PMI companies to be licensed by the Insurance Department and requires lenders to make certain disclosures concerning potential cancellation of the insurance, but it does not set a specific time when the lender or mortgage holder has to cancel the insurance.
A new federal law, passed in July 1998, generally preempts state laws concerning PMI, with some exceptions. It takes effect July 29, 1999 and, for new mortgages after that date, requires cancellation of PMI at the borrower's request when the equity reaches, or is scheduled to reach, 20% if the borrower meets certain conditions. It further requires automatic termination of the insurance when the equity reaches 22% (a 78% loan-to-value ratio) if the borrower is current on his payments. The law contains some exceptions for high-risk mortgages, but prohibits continuation of the insurance beyond the midpoint of the amortization period in any case. It also requires lenders, starting in July 1999, to make specific disclosures informing the borrower of his rights concerning PMI, both for new loans and existing loans.
The new federal law grandfathers certain existing state laws that are not inconsistent, such as Connecticut's current disclosure requirements. It also gives states that have these “protected state laws” a two-year window to make limited modifications that are not inconsistent with the federal law.
BACKGROUND: HOW PMI WORKS
PMI protects the lender on a residential mortgage loan from financial loss in case the borrower defaults on the payments. It is called “private” mortgage insurance to differentiate it from government guarantees. The borrower usually pays the premium, but gains the benefit of being able to buy a house sooner or being able to buy a larger house than otherwise because a smaller downpayment is needed. Without PMI, lenders usually require a 20% downpayment. PMI protects the top 20% of the loan in situations where the borrower makes a smaller downpayment. Since most defaults happen in the early years of a loan, while the owner's equity is still low, PMI allows the lender to make higher-risk loans than otherwise.
The borrower can pay an initial premium at the closing (often half of 1% of the loan amount) and monthly premiums along with the monthly mortgage payment. Alternatively, he might pay a one-time single premium. Premiums vary among companies. They are based on the amount of the downpayment, whether the loan is fixed-rate or adjustable, whether the premiums are paid in a lump sum or monthly, and whether any part of the premiums is refundable.
Lenders usually require PMI on loans with an initial loan-to-value ratio higher than 80%, particularly if the lenders sell the loans on the secondary mortgage market. Historically, PMI could stay on a mortgage for the full 30-year term or until the loan was paid off, unless the borrower requested its removal and the lender or holder of the loan agreed. Fannie Mae and Freddie Mac have for years permitted cancellation of the insurance for borrowers with good payment histories whose equity reaches 20%. But no federal law and only a few state laws, like Connecticut's, required anyone to inform borrowers of this option.
Connecticut law allows state-chartered banks to make loans above a 90% loan-to-value ratio if they are covered by a PMI policy from a private mortgage guaranty company licensed by the insurance commissioner to do business in the state and approved by the banking commissioner (CGS § 36a-261(I)(8)).
Unless it is cancelled, the original PMI contract lasts for the life of the loan. Refinancing at any point removes that particular coverage, but it is up to the new lender to decide if PMI is needed on the new loan, based on the new loan-to-value ratio.
At the state level, the Insurance Department licenses private mortgage insurance companies and the Banking Department administers a law requiring lenders to make certain disclosures to borrowers about PMI. The law requires any lender making a consumer first mortgage loan on one- to four-family residential property to disclose to the borrower at the time he files the loan application:
1. that the insurance's purpose is to protect the lender against loss if the borrower defaults on his payments;
2. that the insurance is required as a condition of obtaining the mortgage and under what, if any, conditions the lender may release the borrower from this obligation; and
3. a good faith estimate of the insurance's initial cost and monthly cost (but if the loan is subject to the federal Real Estate Settlement Procedures Act (RESPA), as most consumer mortgages to purchase a home are, the law allows the lender, in place of these estimates, to state that the cost will be disclosed on the RESPA closing costs disclosure).
Under the state law, a lender that does not require mortgage insurance but does charge a higher interest rate for residential first mortgage loans above an 80% loan-to-value ratio must disclose this fact to the applicant when he files the application.
The law exempts from these disclosure requirements any first mortgage loan insured or guaranteed by any federal, state, or municipal government or quasi-government agency that requires such insurance for the loan (CGS §§ 36a-725, 36a-726).
At the federal level, new legislation (1) requires lenders, at the borrower's request, to remove the insurance if certain conditions are met when the loan balance sinks to 80% of the property's value, (2) requires automatic termination of the insurance at 78% under certain conditions, and (3) mandates specific disclosures of the borrower's rights concerning cancellation for both new and existing mortgages. The new law preempts inconsistent state laws, except for certain states that have existing requirements that are not inconsistent with the federal law (California, Connecticut, Maryland, Massachusetts, Minnesota, Missouri, New York, and Texas, according to an article in the Congressional Quarterly, p.1952, 7/18/98).
THE HOMEOWNERS PROTECTION ACT OF 1998
PL 105-216 (S. 318), requires the lender to cancel private mortgage insurance on a residential mortgage loan transaction on a single-family home that is entered into on or after July 29, 1999 if the borrower submits a written request for cancellation to the loan servicer. In order to cancel, the borrower must also have a good payment history on the loan and satisfy the mortgage holder's other requirements for evidence that the property's value has not declined below its original value and that the borrower's equity is unencumbered by a subordinate lien.
The law defines this “cancellation date” for a fixed rate mortgage as either, at the borrower's option, the date on which the mortgage's principal balance:
1. based solely on the initial amortization schedule and regardless of the outstanding balance on that date, is first scheduled to reach 80% of the property's original value or
2. based solely on actual payments, reaches 80 % of the property's original value.
For an adjustable rate mortgage, the first option above is based on “amortization schedules” instead of the “initial” amortization schedule. For the second option, the law refers to the point when the loan principal balance “first” reaches 80% of the original value.
“Automatic Termination Date”
In addition, the new law requires automatic termination of PMI payments on a “termination date” if, on that date, the borrower is current on his payments, or on a subsequent date when he becomes current on his payments. The law defines the “termination date” as the date on which, based solely on the initial amortization schedule for a fixed mortgage and on amortization schedules for an adjustable rate mortgage, the principal balance is first scheduled to reach 78% of the original property value.
The law also prohibits PMI that is not otherwise cancelled under one of the options above from being continued beyond the first day of the month after the date the loan is one-half amortized (the midpoint of the amortization period).
Notices to Borrower
Within 30 days after the cancellation or termination date, the servicer must notify the borrower in writing that the insurance has been terminated and that the borrower no longer has PMI and that he no longer has to pay premiums, payments, or other fees in connection with the insurance.
If the servicer determines that the mortgage does not meet the requirements for cancellation or termination, he must notify the borrower in writing of the grounds for the determination. The law also specifies the timing of this notice.
Transfer of Funds
If the borrower has made premium payments which the insurer has not earned by the time of the cancellation, the servicer has 45 days to return them to the borrower. The insurer has 30 days after notification by the servicer to transfer the unearned premiums to the servicer.
High Risk Loans
The cancellation and automatic termination provisions above do not apply to high-risk loans, but some of these must be cancelled when the loan is scheduled to reach a loan-to-value ratio of 77%. The final midpoint termination provisions do apply to them.
The law gives the comptroller general of the General Accounting Office two years after the law's enactment date to report to Congress on the volume and characteristics of mortgages that are exempt from the cancellation requirements.
Disclosures for New Mortgages
The law requires certain disclosures for new mortgages at the time of the transaction, starting July 29, 1999, except for the high-risk exempt mortgages. The lender must provide a written initial amortization schedule and written notice that (1) the borrower can cancel the insurance as of the cancellation date based on the amortization schedule, (2) he can request cancellation earlier than that date based on actual payments, (3) the requirement for PMI will automatically terminate on a specified termination date, and (4) there are exemptions to these rights and whether such exemptions apply.
Disclosures for adjustable rate mortgages must include a written notice that (1) the borrower may cancel the requirement on the cancellation date and that the servicer will notify him when the cancellation date is reached; (2) the insurance requirement will automatically terminate on the termination date, at which time the borrower will be notified of the termination or, alternatively, that the insurance will terminate as soon as the borrower becomes current in his payments, and (3) there are exemptions to these rights and wheter such an exemption applies.
For exempted high risk transactions, the lender must notify the borrower in writing when the transaction is consummated that in no case can private mortgage insurance be required beyond the midpoint of the loan's amortization period.
The servicer must also give the borrower an annual written statement disclosing the borrower's rights under this law and an address and telephone number where he can contact the servicer to determine whether he can cancel the insurance.
Disclosures for Existing Mortgages
For mortgages entered into before July 29, 1999, the servicer must disclose in an annual statement that the borrower may, under certain circumstances, cancel the insurance with the consent of the mortgage holder or under applicable state law and the address and phone number for contacting the servicer to determine whether he can cancel the insurance.
All these annual disclosures can be combined with the annual escrow account disclosures or as part of the annual disclosure of interest payments for tax purposes.
The law also exempts lender-paid PMI from these disclosure provisions and imposes other specific requirements on it. Lender-paid PMI is less common. It eliminates the borrower's premiums, but usually involves a higher interest rate instead.
The law makes lenders, mortgage holders, mortgage servicers, and mortgage insurers who violate the law civilly liable to the borrower for actual damages and interest in cases of individual actions (or class actions where the liable party is not a regulated banking institution). It also allows statutory damages up to specified limits, costs, and attorneys' fees.
The law requires enforcement of its provisions by the appropriate federal banking agencies.
Effect on State Laws
The new federal law preempts state laws relating to requirements for obtaining or maintaining private mortgage insurance in connection with residential mortgage transactions, cancellation or automatic termination of such insurance, any disclosure of information addressed by this law, and any other matter specifically addressed by this law. But it does not preempt “protected state laws,” except to the extent they are inconsistent with the federal law. It defines “protected state law” as one that
1. concerns any requirements relating to private mortgage insurance in connection with residential mortgage transactions;
2. was enacted not later than July 29, 2000 (two years after the date of the new federal law's enactment); and
3. is the law of a state that had in effect, on or before January 2, 1998, any state law concerning PMI that is not inconsistent with the new federal law.
The law states that a protected state law is not considered inconsistent with the federal law if it:
1. requires termination of PMI at a date earlier than required in the federal law or when a mortgage principal balance is achieved that is higher than in the federal law or
2. requires disclosing more information than the federal law requires.
The Office of Legislative Research is not authorized to give legal opinions and the following should not be considered one.
The federal law does not name the states that have qualifying “protected state laws.” But it appears that Connecticut's existing law may fit the requirements. Thus, it could theoretically take advantage of the two-year window to further modify the law to:
1. require earlier cancellation opportunities or automatic or final termination than under the federal law; or
2. expand on the disclosure requirements to provide more information than the new federal law requires.
The federal law appears to preempt any other actions besides these, and prohibits any action after the two-year window closes in July 2000. States which do not already have these “protected state laws” appear to be preempted from taking any action on PMI.