Hello everybody who answered my question. Thank you so much.
I agree that one of the problems is that the owners who pay for the PMI insurance never get a copy of the terms and conditions of the PMI insurance and that's why we don't know if the PMI can refuse to pay on the banks claim in a short sale situation unless the borrower makes a contribution by signing the note. Frankly, I very much doubt it. I think the PMI has to pay one way or the other and they basically just ask the lender to make it a condition. Depending on how much is at stake for the bank by waiting, they may very well try to hold out till the last minute. In my particular transaction, it's very likely that the PMI coverage would cover the entire deficiency even in the worst case scenario because my client's deficiency is not really that big (most likely not more than the 20% of the loan amount that's covered by the PMI). This means that the lender may try to hold out as they know that they have nothing to lose. The problem with that is, the buyer we have will not stick around for another 4 months (we have already lost the first buyer and are dealing with a new buyer).

Since my client can't afford to make the payments on the note because her monthly absolute fixed expenses are already pretty close to her monthly take-home. If she agreed to the note, she'd make a promise that she knows she won't be able to keep and she'd most likely become insolvent and just end up filing for bankruptcy. My client does not want to agree to the note to buy the lender's approval. She decided that if the lender has not given us an unconditional short sale approval by the time our current offer expires, we'll take the property off the market and let it go into foreclosure as there's no point in marketing the property when the lender continues to insist on getting the note signed for the PMI. We informed the lender of this course of action just so they don't think that they have another 4 months to hold out. We are not bluffing. I just want to make sure that the PMI will also understand that their deadline for withdrawing the note requirement is at the end of April, not in 4 months. If they want to pay out a higher claim at foreclosure, we can't help that. We are trying to mitigate everybody's damages and we are up front with everybody. Since we are on the topic of being up front, the PMI rep told me that the note was only for $25,000 while the lender negotiator told me it was for $30,000. I don't think that the PMI rep had a reason to give me a lower amount than what he had told the lender.

The escrow agent got back to me and said she's only had one PMI request a Promissory Note and she's done quite a few of these. Each PMI doc will read a bit differently. I guess it's good to understand and be aware that a PNote may be presented but may not be a 'condition', if what David said is common.

It is common for the loss mitigation department of a bank to TRY to get the seller to unknowningly sign a promissory note for the amount of the deficiency or in some cases the full loan amount. The most common tactic is to wait until the last day or two before the auction or extended date to agree and/or return the documents submitted with a promissory note inserted expecting the seller (property owner) and agnet to quickly rush through signing for it to close.

Two things I'm thinking about here- in general, since PMI is insurance, any payments made to it should have activated the insurance coverage. Unless there were no payments made on the mortgage prior to the default I would wonder how that could be a condition of a short sale. I.e. Consider a car insurance coverage; you make a couple payments then get into an accident, you're fully covered. The insurance company isn't going to require you to pay your coverage in full in order to pay insurance benefits. I would doubt PMI could legally work much differently than that. And secondly, somewhere in the recorded docs from escrow the buyers had to sign a PMI agreement which should describe the details of their coverage. I personally have never read one in any detail so I don't know the contents. I know buyer's have it in their packets and they probably never read them either. But they would be required to have received something that defines the terms of the PMI agreement; but they probably don't know one word about what that doc says. I know I wouldn't have read it as a buyer at closing. I've contacted a local escrow officer to inquire because this has me very curious as well. I've asked for a copy of a PMI agreement typical of what buyer would sign at closing. I'll let you know what I find out.

Hi June. Thanks for your answer. While I understand that the PMI can try to tie the short sale approval to the seller's agreement to sign a note, I am wondering if the lender can approve the short sale without that condition. The way I see it, the lender is either entitled to a payout in a short sale situation or they are not. The problem is that buyers who are required to pay for PMI never get to see the terms and conditions of the PMI that they are paying for. I doubt very much that the PMI has any recourse against the seller/borrower if the PMI has to pay a claim because the house went into foreclosure. It would be interesting to find out what the mortgage insurance policy says.

My understanding is that the PMI can attempt to recoop losses it incurs from having to pay the lender when a borrower defaults. Your client would benefit from a real estate attorney at this point to help understand what they should do at this point; I.e. file bankruptsy (which in some cases 'stays' the foreclosure proceedings, etc..