What Is the Homeowners Protection Act?

The Homeowners Protection Act of 1998 is a law designed to reduce the unnecessary payment of private mortgage insurance (PMI) by homeowners who may no longer be required to pay it. The Homeowners Protection Act covers all private, residential mortgages purchased after July 29, 1999. The act, also known as the PMI Cancellation Act, mandates that lenders disclose certain information about PMI.

The law also stipulates that PMI must be automatically terminated for homeowners who accumulate the required amount of equity in their homes (and thus, are no longer required to have purchased PMI).

Understanding the Homeowners Protection Act

Most lenders require a down payment that is equal to approximately 20% of the home's purchase price. This standard is meant to ensure that the borrower has enough financial interest in the property to continue making payments, and—in the event that the borrower is unable to make mortgage payments—that the lender has sufficient equity available to cover lender foreclosure costs.

If a borrower can't—or chooses not to—come up with that amount, a lender may decide that the loan is a risky investment, and, as a result, require that the homebuyer take out PMI. In the event that a borrower defaults on their mortgage—and their home goes into foreclosure—the purpose of PMI is to provide extra protection for the lender.

An additional reason that a homeowner may be required to purchase PMI coverage is if the mortgage the homeowner seeks has a high loan-to-value (LTV) ratio.

LTV is one of the measures of risk that lenders use in underwriting a mortgage. LTV divides the amount of the loan by the value of the home. Most mortgages with an LTV ratio greater than 80% require that the borrower have PMI because they are considered more likely to default on the mortgage.

With PMI, homeowners are responsible for purchasing insurance coverage for their mortgage and for paying insurance premiums. These premiums may either be added to the borrower's monthly mortgage payments, or the additional cost may be absorbed by the borrower’s interest rate (resulting in a higher interest rate). PMI can be removed once a borrower pays down enough of the mortgage's principal (usually when their equity reaches 20%) or when their LTV ratio reaches 80%. However, before the Homeowners Protection Act, many homeowners had problems canceling PMI. In some instances, lenders may have agreed to terminate coverage when the borrower’s equity reached 20%, but policies for canceling PMI coverage varied widely among lenders, and homeowners had limited recourse if lenders refused to cancel PMI. The Homeowners Protection Act protects homeowners by prohibiting life-of-loan PMI coverage for borrower-paid PMI products and establishing uniform procedures for canceling PMI coverage. The Consumer Financial Protection Bureau (CFPB) supervises and enforces compliance with the Homeowners Protection Act.