Is there a different rule if a prior home was foreclosed?

We lost a home to foreclosure over three years ago. We withdrew $200.000 from a 401k to pay cash for another home at auction. We did not have to pay any penalties for early withdrawal as we are both over 60. We paid $165,000 for the property and thought we had enough money to also pay income taxes on the withdrawal. After purchasing the home, we found out that the interior was completely gutted including wiring and plumbing. We had to use the extra money to make the home livable. We are in the process of trying to get a loan on this home to pay the taxes and do some landscaping and other small fix-up jobs. The home now appraises at $333,000. We want to borrow $125,000 on this home. There is no mortgage on this property as it was a cash buy. Our credit rating is between 716 and 725, which is good to very good. However, the lending company has approved our loan amount only if we pay PMI due to our foreclosure. The amount we want to borrow is less than 1/2 the current value of the house and they will be lienholder on the house. We thought if one had at least 22% equity there was no need for PMI. Is this legal?