What Is the Homeowners Protection Act?

By Malea Ritz

These days, it can be challenging to save up for a house—some people work extra jobs, move in with their parents, get financial assistance, or even sell personal belongings to build up their house savings. On average, it takes millennial three full years to save up for a down payment, while it takes Generation Xers two years and nine months, and baby boomers two and a half years to save enough.

According to Mortgage Professional America, 45 percent of prospective millennial homebuyers, 38 percent of Gen Xers, and 31 percent of baby boomers can’t afford a down payment and closing costs because of the cost of everyday living.

For homebuyers who can’t come up with a 20 percent down payment, private mortgage insurance (PMI) is a means for lenders to have an added layer of security. It protects lenders and is used in high-risk loan situations where the loan to value (LTV) ratio exceeds 80 percent. PMI allows lenders to reclaim costs associated with a foreclosed property resale should the borrower default—this includes interest payments and taxes which are paid before reselling the property. 

When you have PMI, you’ll continue to pay it until it’s terminated (when your mortgage loan balance has reached 78 percent of your home’s original value), canceled (when your equity has reached 20 percent of the purchase price or appraised value), or until you reach the midpoint of your loan term (if you have a 30-year loan, this will be after 15 years). For some, this can be daunting to take on, but thankfully, there’s an act in place that protects homeowners from overpaying.

What is the Homeowners Protection Act?

The Homeowners Protection Act (HPA), also known as the PMI Cancellation Act, became mandatory on July 29, 1999, and shields homeowners from overpaying for PMI once they no longer need to. Before the creation of the HPA, many homeowners had trouble terminating their PMI after their equity reached 20 percent.

Now, the Act prohibits life of loan PMI coverage for borrower-paid PMI products and establishes set procedures for cancelling and terminating policies. The law also enforces PMI be automatically terminated for homeowners who accumulate the required amount of equity for their homes. Consumers who have residential mortgages or loans for single-family homes, multi-unit properties, and condos qualify for the act.

Private mortgage insurance vs. lender paid mortgage insurance

Private mortgage insurance is your standard, default PMI. With this borrower-paid insurance, the homeowner pays off a monthly payment that’s included with their monthly mortgage until they’ve reached 20% of the equity threshold. The PMI percentage is based on the original purchase price or current appraised value, whichever is less. This is a good option for someone who’s unsure how long they’ll be in their current home.

The term, lender paid mortgage insurance, can be deceiving because like private mortgage insurance, you still pay—although the process is slightly different. In lender paid mortgage insurance, the lender arranges the mortgage insurance.

Your options include:

  • A lump-sum payment—You pay this one-time payment at the beginning of your loan as a prepayment for coverage. This is known as single-premium PMI and is typically less common than an adjustment to your mortgage. The lender identifies the amount needed to cover their costs in order to buy mortgage insurance.
  • Split premium PMI—This allows the homeowner to pay a portion of insurance in a lump sum at closing. The remaining amount is then paid in monthly installments and the homebuyer gets a discount on their PMI having paid a chunk of it upfront. This is a good option for someone who has extra cash but is still above the debt-to-income ratio.
  • A higher interest rate on your mortgage loan—In this case, your interest rate will increase on a monthly basis for the entirety of your loan. The lender will adjust the rate of your loan to pay for insurance. The higher the interest rate, the higher your payments will be, but that higher payment should mean that you pay less than you would if you were billed for a separate PMI charge each month. The downside of this option is that you won’t be able to cancel the extra cost as you pay down your loan.

The HPA’s cancellation and termination provisions don’t apply to residential mortgage transactions in the case of lender paid mortgage insurance. For regular PMI, lenders are required to disclose these capabilities.

Disclosure requirements

According to the FDIC, the lender is required to disclose information to the borrower that details their rights for cancelling and terminating PMI. The act ensures that borrowers are not charged for any disclosure. Some disclosures may vary based upon the type of mortgage—fixed-rate, adjustable, or high-risk. The borrower must receive annual and other notices concerning PMI cancellation and termination.

How homeowners can cancel PMI

Most homebuyers keep their mortgages for an average of seven years before selling or refinancing. With rising home values, many homeowners are able to refinance out of their PMI after a few years.

A homeowner can cancel PMI when the equity on their home has reached 20 percent. You can ask the lender to cancel once the mortgage balance on the house has been paid down to 80 percent of the home’s original appraised value. Once the balance reaches 78 percent, the mortgage servicer must eliminate the PMI by law of the Homeowners Protection Act.

If you’re looking to shake those PMI payments, you have a few options:

Pay down your mortgage balance

Take the purchase price of your home and multiply it by 80 percent. If your home costs $400,000, you would multiply that by .80 to get the minimum needed to ditch the PMI—in this case, it would be $320,000. If you prepay the loan principal, you’ll reduce the balance, build equity faster, and save on interest payments. If you pay a lump sum to the principal or make an extra mortgage payment, you’ll get closer to that 20% equity level even faster.

Refinance your mortgage

When interest rates are low, you can refinance your mortgage to escape PMI and reduce your monthly mortgage payments. If your home has gained substantial value since you first purchased it and took out the mortgage, this could be a good option for you. If you purchased a home four years ago with a 10 percent down payment, and the home’s equity has reached 15 percent, you owe less than 80 percent of its worth.

With this example, you’d be able to refinance without having to pay for PMI. Many of these loans tend to have a clause that requires homeowners to wait at least two years before you can refinance to remove PMI. If you have a loan that’s less than two years old, you can try refinancing to cancel PMI, but you’re not guaranteed to be approved. 

Reappraise your home if its value has increased

If your home is in a hot real estate market and you’ve seen its value spike quickly, it’s possible that the value has increased enough to get you out of paying PMI. If this is your situation, get your home appraised to potentially cancel your PMI. Appraisals typically cost between $450 to $600.

Renovate your home to increase its value

If you’re planning to make upgrades or add amenities to your home, you could increase the equity on your home to 20 percent, allowing you to skip out on PMI. Whether it’s a newly finished basement or updated kitchen, these additions can increase your home’s market value. The exception here is that you cannot cancel Federal Housing Authority (FHA) insurance unless you refinance with a non-FHA insured loan. It’s important to remember not to put yourself further in the hole by draining your bank accounts to escape PMI. Without liquidity or a rainy day fund for financial emergencies, you could find yourself in trouble. Speaking with a financial advisor is always a good idea to ensure you’re on the right track.

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