Seal of the Board of Governors of the Federal Reserve System

BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D.C.  20551

DIVISION OF CONSUMER
AND COMMUNITY AFFAIRS

CA 99-11

July 1, 1999

TO THE OFFICERS AND MANAGERS IN CHARGE OF CONSUMER AFFAIRS SECTIONS:

SUBJECT: Homeowners Protection Act of 1998

As you may be aware, in July 1998, the President signed into law the Homeowners Protection Act of 1998 (copy enclosed). The Act, which becomes effective July 29, 1999, requires lenders or servicers to provide certain disclosures and notifications concerning private mortgage insurance (PMI) on loans secured by the consumer’s primary residence consummated on or after July 29, 1999. The Act also contains disclosure provisions for mortgage loans that close before July 29, 1999. In addition, the Act includes provisions requiring borrower-requested cancellation and automatic termination of PMI.

For mortgage loans consummated on or after July 29, 1999, the Act requires that borrowers receive initial amortization schedules and disclosures concerning cancellation of PMI at the time of loan consummation, and additional disclosures annually. Disclosures vary depending on whether the loan has "borrower paid PMI" or "lender paid PMI", or is classified as a "fixed rate mortgage" or "adjustable rate mortgage" or designated as a "high risk loan."

For fixed rate mortgages containing borrower-paid PMI and not classified as high-risk loans, the lender must provide at consummation the initial amortization schedule and a written notice disclosing the borrower’s PMI cancellation and termination rights. Such notice must include the following statements:

  1. that the borrower may submit a written request to cancel PMI on the date the loan balance is scheduled to reach 80 percent of the original value of the property securing the loan and the date on which such a request may be made based solely on the initial amortization schedule;1
  2. that the borrower may request cancellation earlier than provided for in the initial amortization schedule based on actual payments;
  3. that PMI will automatically terminate on the date the loan balance is first scheduled to reach 78 percent of the original value of the property securing the loan, based solely on the initial amortization schedule if the loan is current, or on the date on which the borrower becomes current on the payments; and
  4. that certain exemptions apply to the right of cancellation and automatic termination; and whether such exemptions apply at that time to that transaction.

For adjustable rate mortgage loans containing borrower-paid PMI and not classified as high-risk loans, the lender must provide at consummation a written notice that includes the following statements:

  1. that the borrower may submit a written request to cancel PMI when the amortization schedule(s) or actual payments results in a loan balance that represents 80 percent of the original value of the property securing the loan;2
  2. that the servicer will notify the borrower when the loan balance represents 80 percent of the original value of the property securing the loan;
  3. that PMI will automatically terminate when the loan balance is first scheduled to reach 78 percent of the original value of the property securing the loan if the loan is current, or, if not current, on the date on which the borrower becomes current on the payments, and that the borrower will be notified of the termination; and
  4. that certain exemptions apply to the right of cancellation and automatic termination and whether such exemptions apply at that time to that transaction.

For high-risk loans, the lender must provide written notice that PMI cannot be required beyond the midpoint of the amortization period of the loan if the consumer is current on payments at that time.

If PMI is required in connection with a residential mortgage transaction, servicers are required to provide annual disclosures stating the consumer’s cancellation and termination rights and an address and telephone number that the consumer may use to contact the servicer to determine whether they may cancel the PMI.

For loans containing lender paid PMI (LPPMI), a written notice is required no later than the date of commitment. Such notice should state that LPPMI:

  1. differs from borrower paid PMI in that LPPMI may not be canceled by the borrower whereas borrower-paid PMI could be canceled by the borrower or could automatically terminate in accordance with the provisions of the Act;
  2. usually results in a residential mortgage having a higher interest rate than would be the case with borrower paid PMI;
  3. terminates only when the mortgage is refinanced, paid off or otherwise terminated;
  4. and borrower-paid PMI both have benefits and disadvantages (including a 10 year analysis reflecting the differing costs and benefits); and
  5. may be tax deductible for purposes of federal income taxes.

In addition, not later than 30 days after the termination date that would apply in the case of borrower paid PMI, the servicer shall provide written notice to the borrower indicating that the borrower may wish to review financing options that could eliminate the requirement for PMI in connection with the residential mortgage.

If PMI was required in connection with a residential mortgage entered into before July 29, 1999, the servicer must disclose to the borrower in an annual written statement:

  1. that PMI may, under certain circumstances, be cancelled by the borrower with the consent of the lender, or in accordance with state law; and
  2. an address and telephone number that the borrower may use to contact the servicer to determine whether the borrower may cancel the PMI.

The new law permits lenders and servicers to use standardized forms to provide the required disclosures, but does not mandate that specific forms be used. In addition, the Act specifically allows the annual disclosures to be included with other disclosures such as the disclosure of interest payments required by the Internal Revenue Service, or on the disclosure relating to the escrow account made as required under the Real Estate Settlement Procedures Act of 1974.

The new law raises a number of issues. One such issue pertains to how the law impacts disclosures under the Truth in Lending Act (TILA), specifically, the calculation of the annual percentage rate, finance charge and payment schedule for mortgage loans involving PMI. As you know, mortgage insurance premiums are considered finance charges in calculating the annual percentage rate and payment schedules. During such calculations, the existing rule assumes that mortgage insurance is required for the life of the loan unless stated otherwise in the legal obligation. A revision to the official staff commentary for Regulation Z released on March 31, 1999, clarifies that the payment schedule should reflect the consumer’s mortgage insurance payments until the date on which the creditor must automatically terminate coverage under applicable law. For example, for a fixed-rate (non-high risk) loan, TILA disclosures should reflect automatic termination of PMI when the loan is first scheduled to reach 78 percent of the original value of the property securing the loan provided state law does not require automatic termination earlier.

Another issue pertains to the cancellation date for adjustable mortgages. The new law indicates that the cancellation date for adjustable rate mortgages should be measured with reference to the date the principal balance of the loan is first scheduled to reach 80 percent of the original value of the property based solely on "amortization schedules" for that loan or actual payments. By contrast, fixed rate mortgages are analyzed with reference to the "initial amortization schedule." The question is determining when the adjustable rate mortgage is first scheduled to reach the required loan to value ratio based on "amortization schedules." A legislative effort is underway in the Congress to clarify this issue. Similarly, under the new law, PMI must be terminated when the loan balance is first scheduled to reach 78 percent of the original value of the property securing the loan. An issue has been raised pertaining to the impact of rounding on determining the 78 percent threshold. For example, must the loan to value ratio correspond exactly to 78 percent, or could the threshold for termination be met when the ratio is at 78.4 percent. This issue will be addressed in the Commentary for Regulation Z later this year.

To assist in your efforts to ensure that the state member banks in your district comply with the new law, we have enclosed a sample letter to be distributed to all state member banks alerting them to the new law.

While the Board and the other federal financial regulatory agencies have been granted enforcement authority under the Act, neither the Board nor the other banking agencies have rule writing authority under this legislation. However, the Federal Financial Institutions Examination Council member agencies are currently developing interagency examination procedures. We will send you the procedures once they are finalized. In the meantime, examiners should be aware of the new law and ensure, during routine compliance examinations, that state member banks have established a mechanism to achieve compliance with the new statute.

If you have any questions regarding this matter, please contact your review examiner or Anthony Iwuji at (202) 452-3254.

Sincerely,
(signed)

Shawn McNulty
Assistant Director

Notes:

1.   The lender is required to cancel PMI upon request if the borrower has a good payment history, and has satisfied any lender requirements for determining that the value of the property has not declined and is unencumbered by suboardinate liens.  Return to text

2.   Ibid.  Return to text

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