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November 6, 2000
"Is it true that if my house
appreciates to where I have 20% equity, I can have my mortgage insurance
cancelled?"
"My lender refuses to cancel my
mortgage insurance because [Fill in the blank with any of a dozen reasons]. Is
this legitimate?"
"Is FHA insurance cancelable
like other types?"
Questions about terminating mortgage
insurance such as these are asked frequently by readers. I haven�t written a
column about it before because the topic irritates me.
The rules regarding termination are
devilishly complicated, which makes many questions difficult to answer. But what
really raises my blood pressure is that the problem shouldn�t exist.
If lenders paid for mortgage insurance
and passed on the cost in the interest rate, which is the way it should work,
lenders would decide when to terminate. Borrowers wouldn�t be vexed with
complicated termination rules because they would not be involved.
The problem arises only because mortgage
insurance premiums are paid by borrowers. Since lenders are protected by the
insurance but don�t pay for it, many refuse to terminate voluntarily. They
must be forced to terminate by government. And that�s where the trouble
starts.
Governments begin with the principle
that since borrowers are not required to buy mortgage insurance if they put 20%
down or more, the insurance ought to terminate when their equity rises to 20%.
For example, a home buyer who borrows
$95,000 to purchase a $100,000 home is putting only 5% down and must purchase
mortgage insurance. But when that borrower has paid down the loan balance to
$80,000, the insurance ought to terminate. That seems simple and fair.
It also seems fair to terminate if part
of the increase in the owner�s equity is a result of appreciation in market
value. For example, the borrower would have 20% equity if the property value
rose to $110,000 while the loan balance was reduced to $88,000.
But suppose virtually all the increase
in equity resulted from appreciation within just a few months after purchase? In
areas where prices jump sharply, they can also drop sharply, which suggests that
there be some minimum period for retaining the insurance.
Termination rules also must take account
of other developments that may affect the lender�s risk. For example, it
wouldn�t be fair to the lender to require termination if the borrower has been
chronically late on his payments, has taken out a second mortgage, or has moved
out and is renting the house.
A major issue in government-mandated
termination rules is where responsibility lies for initiating termination?
Lenders can be made responsible if termination is based on the current loan
balance and the original property value, because the lender has that
information. But lenders can�t be made responsible for termination based on
the current property value, because they don�t have that information and it
would be inordinately costly to maintain it for every borrower.
There is no alternative to making
borrowers responsible for initiating termination based on current market value.
They know better than the lender what their property may be worth.
But how do borrowers become aware of the
rules and procedures to follow in initiating the termination process? For
example, what must the borrower do to establish the current value?
Government requires lenders to disclose
the rules and procedures at the time the loan is made. So borrowers already
suffering from information overload at the closing table, get one more set of
disclosures that they can ignore.
Now introduce the additional
complication that there are multiple government entities with somewhat different
agendas setting termination rules.
*Fannie Mae, a US Government-sponsored
enterprise, has established the termination rules for the mortgages it
purchases from lenders.
*Freddie Mac, another US
Government-sponsored enterprise, has established the termination rules for the
mortgages it purchases from lenders.
*Congress in the Homeowners Protection
Act of 1998 set out ground rules for termination of private mortgage insurance
on all mortgages originated after July 29, 1999.
*Ten states, including California and
New York earlier had passed similar legislation.
*Termination rules for mortgage
insurance provided by the Federal Housing Administration (FHA) are completely
different than those applicable to private mortgage insurance, and are based
on earlier Federal legislation and regulations of the FHA.
Borrowers paying for private mortgage
insurance who have 20% equity in their properties may be able to terminate at
their own initiative. The specifics of who can and who can�t are very
complicated and will be sorted out in another column. It will not apply to FHA
borrowers, who require a column of their own.
Copyright Jack Guttentag 2002
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