State Law to End Unneeded PMI Payments

Convincing a lender to cancel private mortgage insurance on a home loan is no easy task. But thanks to a new California law, some homeowners will get some relief from paying for PMI that’s no longer necessary.

The new law requires mortgage loan servicers to automatically cancel PMI if the borrower’s loan-to-value ratio reaches 75% and other conditions are met.

The law applies to both purchase money and refinance mortgages and also covers mortgages by out-of-state lenders, as long as the home is in California.

Lenders typically require borrowers to pay PMI premiums with their monthly mortgage payments if they make a down payment of less than 20% of the home’s purchase price. Even though the borrower pays for PMI, it protects the lender from financial loss if the borrower defaults on the mortgage.

In 1995, lenders required PMI on 65,000 purchase money mortgages and 17,000 refinance mortgages in California. Monthly premiums range from $40 to $100, depending on the size of the loan.

Logically, borrowers should be able to stop paying for PMI when their loan-to-value ratio reaches 80%, the equivalent of a 20% down payment. But many borrowers have had a tough time persuading their loan servicers to stop billing them for PMI. The new California law is intended to eliminate those difficulties by forcing lenders to cancel PMI automatically when certain conditions are met.

Although the new law may sound like a windfall for consumers, the benefits will only be felt a decade from now and only by several thousand homeowners annually, for two reasons.

The first is that the bill won’t become effective until Jan. 1, 1998, and it won’t be retroactive. Only mortgages originated on or after that date will be eligible for the automatic PMI cancellation.

Further, it takes about 10 years of scheduled payments to reduce a 90% loan-to-value ratio to 75%. Under the new law, lenders do not have to include appreciation in the calculation.

That means most borrowers who obtain a mortgage with a 10% down payment next year won’t reach the 75% loan-to-value ratio for automatic PMI cancellation until 2008. And, since the median turnover for homes in California is 11 years, half of those borrowers will move before their PMI is canceled.

The author of the bill behind this law, first-term Assemblyman Kevin Shelley (D-San Francisco) intended to make the law retroactive, said an aide in his Sacramento office, but the lending community objected. The lenders said retroactivity would have interfered with existing contracts and would have been impossible for them to implement.

“It would have been difficult for lenders to suddenly go back and recalculate loans, many of which are at different stages of their maturity, to provide for automatic PMI cancellation,” said Maurine Padden, senior legislative counsel and vice president of the California Bankers Assn., an industry organization.

The lenders also wanted time to implement the law. The biggest task will be reprogramming loan servicers’ computers to calculate loan-to-value ratios and stop billing borrowers for PMI when the loan-to-value ratio drops to 75%.

A spokesperson for one major Southern California lender said the company’s loan servicing division wasn’t even aware of the new law and had not started planning how to implement it. That’s not altogether surprising, given that large numbers of lending-related bills float around Sacramento without ever becoming law.

The second reason the new law is limited in scope is that it doesn’t apply to loans sold in the secondary market.

“This bill has an express provision that says when you have institutional third-party standards--Fannie Mae, Freddie Mac or other--that your compliance to those standards is deemed compliance with the bill,” Padden said. “Those loans are carved out from the application of this bill.”

Although California’s law doesn’t affect Fannie Mae and Freddie Mac, it sends a strong public policy message encouraging them to make PMI cancellation more feasible for consumers, said Ron Kingston, a lobbyist for the California Assn. of Realtors. The Realtors group and Consumers Union were the primary supporters of Shelley’s bill.

That public policy message is being heard in Washington. The secondary market purchasers already have some provisions for PMI cancellation, and Fannie Mae is working on new guidelines that will be even more favorable for consumers than the California law.

Fannie Mae’s director of consumer affairs, Bonnie O’Dell, said lenders can cancel PMI without notifying Fannie Mae if the borrower’s loan-to-value ratio drops to 80%, based on the purchase price of the home or a fresh appraisal ordered and paid for by the borrower.

“The problem right now is it’s on the consumer,” O’Dell said. “We are planning to make a change in our guidelines that will require all our lenders to track [loan-to-value ratios] and remove PMI automatically. They will track it and notify the consumer every year.”

Meanwhile, Congress also has been taking a look at PMI cancellation, and any federal law would affect the secondary market entities. A House bill was passed in April and became the impetus for Shelley’s markedly similar bill.

A Senate proposal differs significantly from the House bill and is stalled in committee. Lenders object to the bill because, as introduced, it preempts state laws regulating PMI and does not allow lenders to keep PMI if the borrower has made late payments on the mortgage.

For those homeowners who eventually will benefit from California’s law, the three requirements for automatic PMI cancellation are straightforward.

1) The 75% loan-to-value ratio is based solely on the value of the home when the loan was originated and the current loan balance. Market value is not a factor and no appraisal is required. Second mortgages and home equity loans are not added to the loan balance.

2) The borrower must be current on his or her mortgage payments and cannot have made more than one 30-day late payment in the previous 12 months.

3) The lender cannot have filed a notice of nonmonetary default against the borrower in the previous 12 months. A nonmonetary default is a rare situation that can occur if the borrower doesn’t obtain homeowner’s insurance, doesn’t pay property taxes or violates other provisions of the loan agreement.

The advantages of the new law are that it places the responsibility for tracking the loan-to-value ratio on the loan servicer and that it sets a specific objective standard for automatic PMI cancellation on loans that aren’t sold into the secondary market.