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Last Updated Jul. 2, 2004

As more people buy homes with less than a 20 percent down payment, the frequency of Private Mortgage Insurance (PMI) policies grows.

PMI covers the lender, not you, in case you default on the mortgage. PMI was created to reassure lenders, who traditionally refused to approve mortgages with down payments of less than 20 percent. PMI protects lenders from the increased risk they face, when they finance more than 80 percent of a homes purchase price.

The PMI law

The Homeowners Protection Act of 1998 allows you to request the cancellation of your PMI, once you have 20 percent equity in your house. Your mortgage holder has the option of canceling it, but as long as your payment record is good, you shouldn't have a problem ending it. Once your equity reaches 22 percent, lenders are required to cancel PMI. If it isn't canceled, the lending institution is subject to fines and payment of your legal fees. The lender also must return any premiums you paid beyond what you really owed.

You must be informed, in writing, when you close on your house that you have private mortgage insurance. Lenders must explain PMI, and when you can cancel it. Your lender must notify you annually about when you can cancel your PMI. The law applies to mortgages taken out as early as July 29, 1999.

What the law doesn't do

Only PMI policies written on or after July 29, 1999, are subject to the automatic-termination provision. Furthermore, the bill doesn't cover mortgage insurance provided through the Federal Housing Administration (FHA). Certain high-risk loans might have different provisions.

The Federal National Mortgage Association (Fannie Mae) requires institutions servicing its loans to disclose to consumers, at the time the loan is originated, information about PMI and how it can be canceled when certain conditions are met. Lenders are also required to provide that information yearly to borrowers.

While the Homeowners Protection Act of 1998 applies only to mortgages taken out on or after July 29, 1999, Fannie Mae has instituted some PMI reforms for all mortgages.

Fannie May requires lenders to cancel PMI on mortgages taken out before July 29, 1999, once the term of the loan is half over. That means on a 30-year mortgage, PMI must be cancelled by year 15. The Federal Home Loan Mortgage Corporation (Freddie Mac) is enforcing a similar policy.

These requirements don’t apply to mortgages backed by the FHA. PMI remains in effect on FHA loans until they are paid off.

Are you paying too much for PMI?

Despite regulations dictating when PMI policies must end, a study suggests some homeowners are still paying too much for private mortgage insurance. studied died home sale price increases in 61 cities. It found in 95 percent of the cases, the homes had gained enough equity to qualify for PMI cancellation. For example, a typical resident of the San Francisco Bay Area who bought the median priced home in June 1997 with only a 10 percent down payment attained 42 percent in equity by June 2000.

"PMI becomes a burden after you've faithfully made payments over time," according to Bradley Inman, founder and CEO of HomeGain. "The secret lenders and PMI companies still don't divulge is that the lender's true risk evaporates once the gap between what's owed and what the home is worth today stretches past 20 percent. You don't need PMI anymore. More consumers should learn if price appreciation has kicked in for them so they can get PMI off their backs and out of their wallets."

Good medicine?

Lenders say PMI is good for them. It provides default protection for 20 to 30 percent of a defaulted mortgage. Lenders also claim PMI is good for you, because it allows lenders to approve mortgages they otherwise wouldn't.

First-time homebuyers, and other savings-poor-but-income-rich buyers, stand to benefit most. PMI allows them to buy a home without having to save for a 20 percent down payment.

PMI grumbling

Hazy disclosure practices have left some homeowners confusing PMI coverage with mortgage life insurance. PMI protects the lender, not you.

As the Mortgage Insurance Guarantee Corporation points out, "Unfortunately, some people continue to confuse private mortgage insurance with mortgage life insurance. Private mortgage insurance puts people in homes; mortgage life insurance pays all or a portion of your mortgage in the event of your death."

Dont think you can shop around for the best premium. Lenders decide which PMI company will insure your loan. Moreover, even though you pay the premiums, its highly unlikely your lender will give you a copy of the PMI policy.