Can a federal bank grant a loan under 80% LTV and deny requested mortgage insurance on the basis that the risk is too high since the primary borrower has a physical disability (ie Myotonic Muscular Dystrophy)?

OR is it because the primary borrower doesn't have stable income or will not have future income? sorry, I don't know what the disability is.

The primary borrower does have a stable income and it will continue into the future. The sole difference between these borrowers and other, equally qualified borrowers, is the disability (which is permanent) of the primary borrower.

Here is section 805 of the Fair Housing Act.

(a) In general. It shall be unlawful for any person or other entity whose business includes engaging in residential real estate-related transactions to discriminate against any person in making available such a transaction, or in the terms or conditions of such a transaction, because of race, color, religion, sex, handicap, familial status, or national origin.

(b) Definition. As used in this section, the term "residential real estate-related transaction" means any of the following:

(1) The making or purchasing of loans or providing other financial assistance-

(A) for purchasing, constructing, improving, repairing, or maintaining a dwelling; or

(B) secured by residential real estate.

(2) The selling, brokering, or appraising of residential real property.

(c) Appraisal exemption. Nothing in this subchapter prohibits a person engaged in the business of furnishing appraisals of real property to take into consideration factors other than race, color, religion, national origin, sex, handicap, or familial status.

Section 802 defines "handicap" as follows:
(h) "Handicap" means, with respect to a person-

(1) a physical or mental impairment which substantially limits one or more of such person's major life activities,

(2) a record of having such an impairment, or

(3) being regarded as having such an impairment, but such term does not include current, illegal use of or addiction to a controlled substance (as defined in section 802 of title 21).

So to be sure I understand - you're asking if the bank can approve the loan to the disabled person, but deny the PMI? Does your bank make the decision on the PMI, or are there insurance company criteria that you have to follow?

Not sure about PMI, but many times with credit life insurance, the borrower would be approved for the loan, but denied for the credit life because of age, or some other criteria the insurance company set. No discrimination there. Anyone else? Is PMI different?

I'm not sure if the bank makes the decision on the PMI or the insurance company. This was not the institution I work for. One of the borrowers I am working with refinanced their house through the other institution (which is a national, very large bank) in 2006. They were told that they were not eligible for PMI (which they had on their previous mortgage through the same bank) because of the borrower's disabilty. The borrower passed away unexpectedly in December and without his income the co-borrower is now unable to repay the loan and not able to qualify for a refinance for the same reason.

Are you talking about disability insurance that would cover the payment in the event of accident/sickness?

Mortgage insurance that would cover the payments in the event of the death of the primary borrower.

That's different from PMI and it may have been the companies policy to not cover a known life threatening disease.

Sounds like credit life rather than PMI.