WASHINGTON — In a surprise move that could lower thousands of homeowners' monthly mortgage payments this year, the nation's largest investor in home loans wants to require automatic cancellation of mortgage insurance coverage when borrowers build up substantial equity stakes in their properties.
The proposed policy change by the Federal National Mortgage Corp., or Fannie Mae, was outlined in a confidential memo distributed to a small group of mortgage companies late last year.
The new policy would also require that consumers with insured loans owned by Fannie Mae be notified in writing at least once a year about their rights to terminate mortgage insurance payments and how to apply to do so.
Fannie Mae's proposal attempts to defuse one of the most contentious issues in the home mortgage field during the last year: millions of dollars of payments by homeowners for loan insurance long after the economic need for such insurance has passed. The controversy has produced more than two dozen class-action suits against major mortgage companies, several of which ended in settlements on the behalf of borrowers.
It has also attracted attention in Congress, where legislators have considered requiring disclosure and mandatory termination of insurance coverage when requested by eligible borrowers.
At the center of the issue is a product--private mortgage insurance, or PMI--that millions of homeowners pay for every month but that is widely misunderstood. Often adding $50 to $100 to homeowners' monthly mortgage payments, the insurance is required by most lenders whenever the borrower obtains a loan with less than a 20% down payment. The insurance protects the lender--or the ultimate purchaser of the loan, like Fannie Mae--against financial loss in the event of a borrower's nonpayment of principal and interest.
Should a borrower default and the house go to a foreclosure sale, the insurance policy pays the lender's costs to some specified coverage level. Because the risk of loss declines once a borrower has built up at least a 20% stake in the property, some lenders and investors permit termination of monthly insurance payments at that point, provided the borrower files a written request.
But many borrowers are unaware of their rights to seek cancellation, so they continue paying for coverage far longer than necessary. In one case cited by private mortgage insurance critic Rep. James V. Hansen (R-Utah), a borrower continued paying insurance premiums for more than 20 years, when her equity stake was nearly 90%.
Fannie Mae, along with its rival, the Federal Home Loan Mortgage Corp., or Freddie Mac, allows borrowers to request termination of private mortgage insurance under certain circumstances.
But neither company has ever required its mortgage servicers to monitor loans or to terminate collection of premiums automatically at any point. Nor have they required that consumers be informed systematically of their termination rights.
Fannie Mae's draft policy memo, written by senior vice president Robert J. Engelstad, would change this dramatically in 1997. For starters, all 2.3 million borrowers holding Fannie Mae mortgages with private mortgage insurance would receive annual disclosure statements explaining the conditions under which their insurance payments could be ended.
For some borrowers, the termination would be automatic, requiring no request on their part. To be eligible for automatic termination, borrowers would have to have maintained an "acceptable" payment record--no 30-day-late monthly payments during the previous 12 months, and no 30- to 59-day-late payments during the previous two years.
Their loans would also have to have reached a minimum age: at least 7 years old for a mortgage with a 15-year or less original term to maturity, or at least 10 years of age for a loan with an original term of more than 15 years.
Other categories of borrowers with "acceptable" payment histories could request termination. If a homeowner believes the equity stake has reached 20% of the original value of their property, he or she could contact the mortgage servicer and request termination. The minimum equity standard would be higher--30%--for borrowers whose properties are used as second homes or rented out as investments.
Borrowers who believe market appreciation or improvements have increased the value of their equity significantly could also apply for insurance termination. Under this "current value" option, borrowers with loans 2 to 5 years old would have to meet a 25% minimum equity standard; borrowers with loans 5 years or older would have to meet a 20% equity test. To establish current market value, an appraisal typically would be required at the applicant's expense.
Sources at Fannie Mae cautioned that the Engelstad proposals are still in the negotiation stage with mortgage servicers and won't be firmed up until late February.
Moreover, sources said, the proposal with the biggest potential effect on borrowers--the automatic monitoring and termination plan--would not take effect until this summer.
After that, however, eligible homeowners with Fannie Mae-owned loans could well start receiving surprise good news in the mail: notifications that mortgage insurance no longer is required and that their monthly payments will be reduced immediately. Any excess funds held in escrow for private mortgage insurance would be refunded or credited.
Distributed by Washington Post Writers Group.