Cancelling Private Mortgage Insurance (PMI) in California

In a previous blog post, we explained what private mortgage insurance is and how it affects you as a home buyer. Today, we’ll explore the process of cancelling private mortgage insurance (PMI) in California.

So, PMI can be cancelled upon request or automatically, depending on the situation. But let’s cover some basics before we explore the cancellation process.

What is Private Mortgage Insurance (PMI)?

• PMI is a type of insurance policy that protects the mortgage lender if the borrower defaults on the mortgage.
• In this context, a “default” occurs when the homeowner can no longer make their monthly mortgage payments.
• PMI is usually required for conventional loans when the down payment is less than 20% of the home’s purchase price.
• PMI is usually rolled into the monthly mortgage payments and paid over the long term. But it can also be paid up front.

Why Do Some Borrowers Have to Pay It?

• In California, PMI is usually required when the loan-to-value (LTV) ratio is above 80%. This means the borrower has less than 20% equity in the home.
• Borrowers who put down 20% or more end up with an LTV of 80% or lower, so they usually don’t need to pay mortgage insurance.
• The lender requires PMI to reduce their risk in cases where the borrower makes a relatively small down payment.

Does PMI Benefit the Borrower or Lender?

• While the borrower pays for PMI, the policy protects the mortgage lender from financial losses relating to default (failure to repay).
• But mortgage insurance also benefits home buyers by allowing them to purchase a home with a low down payment.
• In California, PMI makes homeownership more accessible to buyers who may not have 20% saved up for a down payment.
• In short, mortgage insurance allows Californians to purchase a home sooner rather than later, and with less money down.

What’s the Basic Process for Canceling PMI?

• PMI can usually be canceled when the borrower’s LTV falls to 80%. (The loan-to-value ratio drops over time, as you make monthly mortgage payments.)
• In California, homeowners can request PMI cancellation in writing when they believe they have reached 20% equity in their home.
• Additionally, loan servicers are required to cancel the policy once the LTV drops to 78%, as long as the borrower is current on payments.

In Depth: How the Process Works in California

Home buyers who make down payments of less than 20% typically have to pay for private mortgage insurance on their loans. These policies protect the lender against losses resulting from borrower default. But it’s the buyer / homeowner who actually pays the premium.

PMI is unique in that way. It’s one of the only forms of insurance where the person who pays for the policy is not actually covered by it.

PMI requirements are mandated by secondary organizations like Freddie Mac and Fannie Mae. These two organizations buy home loans from lenders and sell them to investors through the secondary mortgage market. But they’ll only purchase loans that meet specific requirements, including PMI for LTV ratios over 80%.

As mentioned, there are two common methods for cancelling a private mortgage insurance policy in California. It can be done upon request from the homeowner, and it can also happen “automatically.”

But in both cases, the current mortgage balance must drop to a certain level relative to the property value. That’s the basic requirement for PMI cancellation.

Option 1: Requesting PMI Cancellation

In accordance with the Homeowners Protection Act, California homeowners can ask their mortgage loan servicers to cancel PMI when the loan-to-value (LTV) drops to 80%. This occurs when the outstanding loan balance falls to 80% of the original home value.

In this context, the “original value” usually means (A) the contract sales price or (B) the appraised value of the house when you purchased it.

If you have private mortgage insurance disclosure documents on file, you can refer to those to see when your LTV is scheduled to hit 80%. If you don’t have those documents, you can contact your loan servicer to find out. In most cases, the “servicer” is the company that actually sends out the mortgage statements.

There are some other criteria for cancelling a PMI policy:

• You must request it in writing.
• You have to be current on your payments.
• You might have to certify that there are no junior liens on your home, such as a second mortgage.
• The home might have to be appraised again, to make sure the value hasn’t declined below the original value.

So that’s the “request” method to cancel private mortgage insurance in California. Let’s move on to talk about the automatic cancellation or termination, which is also tied to the LTV.

Option 2: Automatic PMI Termination

Homeowners can also have their PMI cancelled automatically, once the loan-to-value ratio falls to a certain level.

The Homeowners Protection Act states that a loan servicer must automatically terminate a PMI policy when “the principal balance of the mortgage is first scheduled to reach 78 percent of the original value…”

It goes on to explain that (once again) the borrower must be current on their mortgage payments. So this requirement applies to both the request method and the automatic method for cancelling private mortgage insurance. Otherwise, the PMI policy would be terminated shortly after the payments are brought up to date.

Different Rules for FHA Loans

Everything mentioned above applies to conventional mortgage loans in particular. A conventional loan does not receive government backing or guarantee. This sets them apart from FHA and VA loans, which do receive federal backing.

(The “private” part of private mortgage insurance indicates that the policy is provided by a private-sector company, as opposed to coming from the government.)

The FHA program also requires mortgage insurance for borrowers. But it works differently from PMI. Unlike a PMI policy, which can be cancelled through the two methods outlined above, FHA mortgage insurance is often required for the full life of the loan.

Most borrowers in California who use FHA loans make down payments below 5%. That’s the primary appeal of this particular program. It allows borrowers to put down as little as 3.5% when buying a house.

But those same borrowers usually have to pay an annual FHA mortgage insurance policy for the full mortgage term.

Glossary of Terms Relating to This Topic

Here are some of the key terms relating to PMI cancellation. If you continue to research this topic (and you should), you’ll likely encounter some or all of these terms.

• Private Mortgage Insurance: A type of insurance that protects the lender if a borrower defaults on their mortgage and can no longer make payments.
• Loan-to-Value (LTV) Ratio: The ratio of the outstanding loan balance to the property’s estimated market value. The primary factor that determines when you can cancel PMI.
• Default: Failure to meet the legal obligations of a loan, such as not making the required monthly payments.
• Equity: The difference between the property’s value and the outstanding loan balance.
• Conventional Loan: A mortgage loan that is not insured or guaranteed by the government.
• FHA Loan: A mortgage loan insured by the Federal Housing Administration, which is part of HUD.
• VA Loan: A mortgage loan guaranteed by the Department of Veterans Affairs, available to military members and veterans.
• Secondary Mortgage Market: A market where mortgage loans are bought and sold.
• Freddie Mac and Fannie Mae: Government-sponsored enterprises that purchase mortgage loans from lenders.
• Homeowners Protection Act: A federal law that protects borrowers from paying PMI for longer than necessary.
• Servicer: A company responsible for collecting mortgage payments and handling other loan-related tasks, including PMI cancellation.