Conventional loans and private mortgage insurance
A conventional loan is any mortgage loan that is not insured or guaranteed by the government (CFPB key terms). The lender, or whoever later buys the loan, carries the risk of default. FHA, VA and USDA loans, covered in the next lesson, are the government-backed alternatives.
Conforming and nonconforming
Most conventional loans are sold to Fannie Mae or Freddie Mac after closing. A loan that fits their rules, including the maximum loan size, is a conforming loan.
- The conforming loan limit is the largest loan Fannie Mae and Freddie Mac will buy. It is set each year by Fannie Mae, Freddie Mac and their regulator, the Federal Housing Finance Agency (FHFA), and it is higher in high-cost areas.
- A loan larger than the limit is a jumbo loan. Jumbo loans are allowed; they just cannot be sold to Fannie or Freddie, and the CFPB notes they may cost more than a conforming loan.
A loan that does not meet the Fannie/Freddie standards, whether because of its size or some other feature, is called nonconforming. The lender keeps it in its own portfolio or sells it to a private investor.
The limit changes every year, so the exam tests the idea, not the dollar figure.
Private mortgage insurance (PMI)
PMI protects the lender, not the borrower, if the borrower defaults. The CFPB explains that it is usually required on a conventional loan when the down payment is less than 20%. The borrower pays the premium, but the lender collects on the policy.
Ending PMI: the Homeowners Protection Act
The Homeowners Protection Act (12 U.S.C. 4901 and following) gives borrowers three ways out of borrower-paid PMI. It applies to mortgages on a single-family principal residence that closed on or after July 29, 1999. All of the percentages are measured against original value, which is the lesser of the contract sales price or the appraised value at closing (4901(12)).
| Rule | When | Conditions |
|---|---|---|
| Borrower-requested cancellation, 4902(a) | Balance first scheduled to reach 80% of original value (or reaches it early through extra payments) | Written request, good payment history, current on payments, value has not fallen below original value, no subordinate liens |
| Automatic termination, 4902(b) | Balance first scheduled to reach 78% of original value | Borrower is current; if not, it ends once the borrower catches up |
| Final termination, 4902(c) | Month after the midpoint of the amortization period (15 years on a 30-year loan) | Borrower is current |
The midpoint rule matters for loans that never reach 78% on schedule, such as interest-only or balloon designs.
Two exceptions to remember: the CFPB notes that lender-paid mortgage insurance follows different rules, and FHA and VA loans have their own requirements. The HPA protects borrowers on conventional loans with borrower-paid PMI.
Working the numbers
A buyer pays $250,000 for a home that appraises at $245,000. Original value is the lower figure, $245,000.
- 80% of $245,000 = $196,000: the borrower can ask to cancel when the scheduled balance hits this.
- 78% of $245,000 = $191,100: PMI ends automatically when the scheduled balance hits this.