Financial days

As noted earlier, the essential feature of mortgage insurance is that it allows homebuyers to acquire a house with a small down payment. Usually, home-buyers who can afford only a small down payment also have low or moderate incomes; in this sense, mortgage insurance promotes home ownership for such households.

Over the past several years, PMI companies have introduced new programs targeted at low-and moderate-income households.(24) Often these programs involve other parties, including Fannie Mae and Freddie Mac and state housing finance authorities. Working with secondary market agencies through programs such as Fannie Mae’s Community Home Buyers and Freddie Mac’s Affordable Gold, the PMI companies expand their regular 95 percent loan-to-value ratio programs by allowing the borrower to use gifts and other nonborrower sources of funds as part of the down payment. These programs also use more flexible underwriting criteria. To offset the additional potential risk anticipated from such loans, borrowers are required to complete a homebuyer education course. Often the prepurchase counseling for homebuyers is undertaken with community groups and other nonprofit organizations.

State housing authorities generally issue taxexempt bonds to fund mortgages with high loan-to-value ratios granted to first-time homebuyers. PMI companies issue a special form of mortgage insurance (“pool insurance”) to enhance the credit quality of these bonds.

Another recent PMI industry initiative provides insurance for mortgages with 97 percent loan-to-value ratios. As with the programs described above, financial counseling is typically a mandatory component of these products. In addition, PMI companies use early intervention techniques in these programs for households that fall behind in their mortgage payments. Mortgages generated through these programs may be held in portfolio by the lender, whereas others may be sold into the secondary market.

Finally, the industry is examining and modifying its traditional products to make them more attractive to all households, including low- and moderate-income households. For example, PMI companies have recently introduced monthly payment programs that allow the borrower to pay the initial premium over time rather than as a lump-sum advance payment. This type of initiative lowers the amount of funds the borrower needs at closing to acquire a house and thereby allows households with fewer assets to become homeowners.

A calculation of the expenses incurred by a 1993 borrower purchasing a $100,000 home with the minimum required down payment (table 3) shows that the cash required at closing would be substantially greater for a mortgage with PMI ($8,250) than for one with FHA insurance ($,615).(15) The lower cash outlays associated with the FHA-insured mortgage mainly reflect the FHA’s willingness to allow the borrower to finance the closing costs and the FHA insurance premium. As described in the example below, an FHA-insured mortgage will be more attractive to households with fewer assets.

3. Generalized comparison of mortgage financing under FHA insurance and

private mortgage insurance for a typical mortgage on a $100,000 house Dollars except as noted

                 Item                FHA           PMI
Sales price of home                100,000      100,000
  PLUS: Closing costs financed(1)    2,300            0
EQUALS: Acquisition cost           102,300      100,000
  LESS: Minimum down payment(2)      4,615        5,000
EQUALS: Maximum mortgage amount
   (before initial mortgage insurance
   premium)                         97,685       95,000
  PLUS: Initial mortgage insurance
   premium financed(3)               2,931            0
EQUALS: Total financed             100,616       95,000
Loan-to-value ratio (percent)(4)
  FHA calculation                       95.5        ...
  Actual                               100.6         95
Cash required at closing
  Closing costs                          0        2,300
  Down payment                       4,615        5,000
  PMI(5)                               ...          950

     Total                           4,615        8,250

Total monthly payment(6)
  Years 1-10                           778.97       735.87
  Years 11-30                          778.97       716.87

NOTE. … Not applicable.

(1.)Assumed to be 2.3 percent of selling price, determined by calculating the ratio of the average closing costs to the average sales price of homes purchased in 1993 under the FHA section 203(b) home loan program.

(2.)Minimum FHA down payment equals 3 percent of the first $25,000 plus 5 percent of the remaining amount financed, excluding the initial mortgage insurance premium. Minimum down payment for PMI is 5 percent of the sales price.

(3.)Initial mortgage insurance premium is 3 percent of the maximum mortgage amount.

(4.)FHA loan-to-value is the maximum mortgage amount divided by the acquisition cost. Actual loan-to-value is the total amount financed divided by the sales price.

(5.)Initial premium of 1 percent of the maximum mortgage amount.

(6.)The mortgage in both the FHA and PMI cases is assumed to be for thirty years at 8 percent. The monthly payment is the sum of the loan payment (principal and interest) plus the monthly insurance premium, which under FHA is 0.5 percent (annual rate) of the maximum mortgage amount. The premium charged for PMI typically declines after a specified period; here it is assumed to be 0.49 percent (annual rate) of the maximum mortgage amount for the first ten years, and 0.25 percent (annual rate) thereafter.

(1.)For a comprehensive history of the PMI industry, see Charles Rapkin and others, The Private Insurance of Home Mortgages: A Study of Mortgage Guaranty Insurance Corporation, Institute for Environmental Studies (University of Pennsylvania, 1967).

(2.)During the period preceding the Depression, the industry developed a business similar to the current one for mortgagebacked securities. The companies offered “participations,” which involved the issuance of certificates to a group of investors who were entitled to receive periodic payments based on the interest income and principal repayments generated by the underlying mortgages. However, one significant difference between current and former market practices was that issuers of participations retained the right to substitute mortgages underlying a specific certificate so long as the substitute had the same face value as that of the original loan. The abuse of this right contributed to investor losses during the Depression.

(3.)Establishment of the Mutual Mortgage Insurance Fund was authorized by section 202 of title II of the 1934 National Housing Act. As the purposes of the act have expanded over the years, the FHA has added new insurance programs to its portfolio.

(4.)The Veterans Administration became the cabinet-level Department of Veterans Affairs (VA) on March 15, 1989. Technically, the VA offers loan guarantees rather than mortgage insurance, but the two forms of assurance are similar in function and both are referred to here as mortgage insurance. Other government agencies also provide home loan insurance but on a much smaller scale.

(5.)The tighter underwriting practices of recent years have helped reduce the proportion of insured loans with loan-to-value ratios of greater than 90 percent, from 47.6 percent in 1985 to 32.4 percent in 1993. The share of other higher-risk loans, such as mortgages secured by condominiums and non-owner-occupied properties and mortgages that allow negative amortization, has also declined. See David M. Graifman, “Mortgage Insurance: The Party Continues,” Standard and Poor’s Structured Finance (May 1994), pp. 13-17.

(6.)A few other PMI firms exist, but they do not currently write new mortgage insurance. For additional information about the PMI industry, see Mortgage Insurance Companies of America Factbook & Directory of Membership (Washington: Mortgage Insurance Companies of America, 1994).

(7.)Amerin Guaranty Corporation is new to the PMI industry.

(8.)Some lenders will grant low-down-payment mortgages without insurance. Most often such mortgages are extended as part of an affordable housing program, although lenders may choose to self-insure other low-down-payment mortgages as well.

(9.)Research has consistently found that mortgages with higher loan-to-value ratios default more frequently than those with lower ratios. See Roberto G. Quercia and Michael A. Stegman, “Residential Mortgage Default: A Review of the Literature,” Journal of Housing Research, vol. 3 (1992), pp. 341-79.

(10.)In recent years, the ninety-day delinquency rate for adjustable rate mortgages purchased by Fannie Mae has been roughly 50 percent to 100 percent higher than the delinquency rate on fixed rate mortgages. See John M. Dickie, “Residential Delinquencies and Foreclosures: First Quarter 1994″ (memorandum, U.S. Department of Housing and Urban Development, July 14, 1994).

(11.)For further information about the risk diversification and monitoring practices of PMI companies, see Roger Blood, “Managing Insured Mortgage Risk,” in Jess Lederman, ed., The Secondary Mortgage Market: Strategies for Surviving and Thriving in Today’s Challenging Markets, rev. ed (Probus, 1992).

(12.)The VA mortgage guarantee program is open only to veterans. It is usually the first choice of eligible households that can afford only a small down payment.

(13.)Recently, PMI companies have allowed part or all of the initial fees for insurance to be paid monthly.

(14.)However, the FHA discontinues the annual premium after a specified number of years for mortgages with loan-to-value ratios of less than 95 percent. For example, for FHA mortgages originated in 1993 that had a loan-to-value ratio of less than 90 percent, the FHA will discontinue the annual premium after seven years.

(15.)In 1994 the FHA lowered its initial premium from 3 percent of the mortgage to 2.25 percent.

(16.)The wealth advantage of the FHA borrower during the first year (shown in row 1 of table 4) reflects the lower cost of FHA insurance if the borrower holds the FHA-insured mortgage for only one year. This lower cost is a consequence of the FHA insurance refund policy. However, if to acquire the refund the FHA borrower incurs closing costs when taking out a conventional mortgage, the refund advantage may be lost.

In addition, the conditions placed on the PMI borrower’s ability to drop the PMI insurance affect this cost advantage. Some lenders allow borrowers to drop PMI with minimal charges once sufficient equity has accumulated in the property; other lenders do not allow PMI to be dropped, forcing the PMI borrower to refinance in order to drop the insurance. If the PMI borrower must refinance, then the relative advantage of the FHA refund is maintained. Furthermore, PMI companies may refund part of the initial premiums if a mortgage is terminated within the first year.

(17.)The maximum mortgage limit of $151,725 became effective March 15, 1993. The FHA also establishes higher limits for properties with two, three, or four units and for properties in Alaska and Hawaii. For instance, in 1993 the single-family limit in Honolulu was $227,550. See 58 Fed. Reg. 13950, March 15, 1993.

(18.)When this article was written, the data described were still subject to revision. Final data, which are available to the public, may differ somewhat from the data used here.

(19.)That is, in the case of depository institutions, the HMDA rule for reporting property location is based on office location, whereas mortgage companies are deemed to have an office in an MSA if they receive applications for, or purchase, five or more loans in a given year on property in that MSA.

(20.)About 23 percent of the PMI application records submitted to the FFIEC lacked data on race or ethnic origin. This proportion is much larger than that for HMDA records and reflects, according to industry representatives, the initial complications of starting a new data collection process.

(21.)FHA Trends of Home Mortgage Characteristics: Section 203(b) Mortgages Insured, U.S.A., Calendar Year 1993, FHA Comptroller, Information Systems Division (Department of Housing and Urban Development, n.d.).

(22.)The approval rate for one PMI company, Amerin Guaranty Corporation, is 100 percent because the firm delegates the decision to approve an application for insurance to the lending institution. Thus, Amerin is notified about applications for insurance only when a lender has selected them as the insurance provider.

(23.)If multiple applications are removed from the sample, denial rates for all racial groups are lower: 17.9 percent for Asian applicants, 19.4 percent for black applicants, 22.2 percent for Hispanic applicants, and 10.3 percent for white applicants.

(24.)PMI companies, like many government programs, do not use uniform definitions for low- or moderate-income households.

(25.)The Community Affairs staffs of the Federal Reserve Banks indicate that lenders generally are aware of the affordable housing initiatives of only the largest two or three PMI companies.

COPYRIGHT 1994 Board of Governors of the Federal Reserve System
COPYRIGHT 2004 Gale Group

Federal regulators from the FSLIC (Federal Savings & Loan Insurance Corporation) have discovered that consumers are overpaying on their adjustable rate mortgages by more than $8 billion as a result of interest rate miscalculations. Between 50 and 60 percent of all adjustable rate mortgages contain some sort of error in the way interest is charged, their study shows.

Banks make two extremely serious mistakes in handling ARMs. One is failing to make proper initial disclosures on ARMs that feature discounted “teaser” rates. The second is some banks – reportedly a great many – are not making correct rate adjustments on outstanding ARMs.

The potential magnitude of both problems is daunting. With respect to inaccurate initial disclosures, there have been instances in the past several years of banks being required to reimburse customers hundreds of thousands of dollars for errors that arose out of innocent but careless mistakes.

Payment Adjustments

The other potentially huge error that banks make is failing to adjust the payment properly on outstanding ARMs.

This issue hit the front pages of newspapers last year when a former FSLIC employee conducted a study which found errors in 50 percent of the ARMs it examined. He charged that lenders are requiring payments at rate adjustment time that exceed the amount called for by the initial disclosures and/or contracts.

Among the most common potential sources of trouble are ambiguous contract language, inadequate computer programs, incorrect completion of documents, and calculation errors. In the last category, the mistakes include everything from clerical errors in data entry to carelessness in entering index values or rounding of results. For example, sometimes staffers uses the wrong date in selecting the index value or use the wrong index altogether. Index values change frequently, sometimes by the hour! This makes it difficult to calculate the interest charges. Sometimes adjustment amounts are not rounded off in conformance with the method in the initial documents. And that’s only the beginning!

The biggest problem for ARMs is the fact that loans are sold – oftentimes more than once – into the secondary market – to other banks, Fannie Mae and to investors. Overcharges develop as data is transferred between computer system.

Overcharges that are not corrected continue to compound monthly with each payment at the rate being charged on the note. To understand how quickly even small errors can skyrocket, on a $650,000 loan at 10 percent, the yearly rate would only have to be off 0.462 percent to result in an overcharge of $250 each month. If not corrected, the total overcharge in just 3 years would amount to $10,532.

Banks and mortgage companies are now rushing to comply with new accounting guidelines issued by the Federal National Mortgage Association for adjustable-rate mortgages. This comes four years after the disclosure of widespread overcharges by thrifts holding such mortgages. Many lenders since then have put audit programs into place. Inaccuracies, however, are said to persist.

It is important to understand that under truth is lending, lenders – with some exceptions – receive no leniency for errors because the institutions meant no harm. Nor is there leniency on the grounds that customers were given the correct information on some other form and understood the transaction.

Trust in lending is a technical regulation, and reimbursement penalties are imposed almost automatically for certain technical mistakes, regardless of cause or effect.

It is generally wise to correct understated APRs or finance charges that come to light by reimbursing the customer in accordance with agency guidelines. Unlike redisclosure or nonaction, reimbursement within 60 days of discovering the error will cure the violation and cut off further liability under truth in lending.

The Indianapolis Business Journal reported that Banc One Mortgage Corp., a division of Columbus, Ohio-based Banc One Corp., agreed to settle a class-action law suit charging that it miscalculated adjustable-rate mortgages. The case is one of more than a dozen filed against financial institutions throughout the U. S. by mortgagors who claim to have been overcharged on their adjustable-rate loans. To avoid a potential law suit – or, worse yet, a classaction suit – a bank should audit its loan portfolio.

Fannie Mae’s directive is aimed at reducing the number of faulty loans still circulating. The agency lists criteria that lenders must follow and details the results of adjustable-rate loan miscalculations and their effect on banks and consumers. The agency is requiring servicers to have in place systems and procedures to verify the accuracy of ARM adjustments.

ARMS Auditor

Audit firms are taking advantage of the new regulations to drum up business. Many assist businesses in reducing their monthly mortgage payments – and obtain refunds for any overcharges paid to the Lender. Typically they will advise the client of any errors – including those in Escrow Accounts (taxes and insurance) and charges for late payments – and provide the lender with all documents to recover any overcharges. If the mortgagor lacks any necessary papers, the ARMs auditor will normally obtain them from the lender. Since the index values on an ARM change frequently – sometimes by the hour – a thorough ARM audit requires specialized training and expertise.

The ARMs auditor typically will negotiate with the lender to obtain retroactive credit for any overcharges made to the mortgagor’s account over the life of the loan. Overbilling in the adjustable rate mortgage arena is real and oftentimes represents significant dollar amounts. For that reason, ARMs auditors often do not charge a fee for audit. If a refund/credit has been obtained, they will typically charge 50 percent of all recovered funds. This includes 50 percent of all overcharges on past payments.

Thus, if $150,000 were recovered from the bank, the mortgagor would receive $75,000 (half of $150,000).

The current noteholder is responsible for all overpayments, regardless of the number of times that the loan has changed hands. The mortgagor is not legally responsible for returning any money resulting from a bank’s error. Furthermore, since the audit typically is performed without charge on a contingency fee basis, the mortgagor has no downside risk. Upon completion of an audit, the mortgagors will either recover lost money or at least be satisfied in knowing that they have not been overcharged.

And here’s something to keep in mind: Even if the ARM already has been paid off, the mortgagor may still be able to recover overcharges.

Ian L. Renert is a partner at Hawthorne-Sterling & Co., a Stamford, Connecticut-based auditing firm that specializes in the recovery of overcharges involving ARMs, telephone, utilities, freight, commercial leases and workers compensation.

COPYRIGHT 1995 Hagedorn Publication
COPYRIGHT 2004 Gale Group

New legislation designed to increase loan limits under the National Housing Act for multifamily housing mortgage insurance has received unqualified support from the Hudson River Property Owners and Conservators Association (HRPOCA).

In a letter to Marge Roukema (R-NJ), co-author of “H.R. 1629″ with fellow New Jersey Congressman Bob Frank, the Hoboken, N.J.-based group of propertyowners along the Hudson River’s “Gold Coast” praised the effort to increase the Housing and Urban Development mortgage insurance statutory limits by 25%, which it contends will permit continued redevelopment in New Jersey’s urban areas.

“As you are well aware, it has become very expensive to develop and produce moderate and middle-income housing throughout New Jersey,” according to the letter, which is signed by developers Joseph Barry and Carl Goldberg, HRPOCA’s Co-Chairmen.

“High labor costs, permitting costs and high land values all make it extremely difficult to develop multi-family housing unit’s within the present statutory limits — especially in the older urban centers which require mid- or high-rise construction.

Thus, it is critical to New Jersey’s Master Plan, which intends to keep green areas green and put development where the infrastructure already exists, that the mortgage insurance statutory limits be increased.”

Introduced in April of this year, “The FHA Multifamily Housing Mortgage Loan Limit Adjustment Act of 2001,” has been recently referred to the House’s Committee on Financial Services.

COPYRIGHT 2001 Hagedorn Publication
COPYRIGHT 2001 Gale Group