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Plan to Slash PMI Costs Is Thwarted, at Least for Now

November 01, 1998|KENNETH R. HARNEY | SPECIAL TO THE TIMES

WASHINGTON — Congress' fractious rush to adjournment recently obscured intense behind-the-scenes fighting over an issue that could cut monthly mortgage costs for millions of home buyers who pay for private mortgage insurance.

The controversy, certain to attract lots of attention in 1999, concerns a surprise move by one of the largest mortgage finance sources--Freddie Mac--to dispense with traditional mortgage insurance policies on some or all of the low-down-payment mortgages it buys from local lenders.

Freddie Mac believes that by using alternative forms of loss protection on its mortgages, it can save borrowers hundreds of millions of dollars a year that they now spend on traditional mortgage insurance.

Most home buyers who can't come up with a 20% down payment are charged for mortgage insurance. The insurance protects the lender--or the ultimate purchaser of the loan, such as Freddie Mac--from losses caused by borrower defaults or foreclosures. Typical premiums of $40 to $75 get tacked on to borrowers' monthly mortgage escrow payments.

Mortgage insurance is big business: Roughly 5 million homeowners pay premiums annually on $546 billion worth of home real estate.

Cost of Insurance Is Too High

But Freddie Mac believes the borrowers' cost of mortgage insurance is too high.

If the big two mortgage investors--Freddie Mac and Fannie Mae--were allowed to use alternative forms of default risk coverage on the 15 million insured loans they own, according to internal Freddie Mac estimates, more than 4 million households would save $1.4 billion in premium payments every year.

Even by what Freddie Mac considers conservative projections, the average Freddie Mac home buyer now paying mortgage insurance would save $324 a year using the alternative loss-protection plan Freddie would like to initiate.

Who are these home buyers? According to Freddie Mac estimates, 60% of them are moderate-income first-time purchasers. More than 670,000 of them are minority households, including nearly 185,000 African American and 200,000 Latino families.

Peter Zorn, Freddie Mac's director of financial strategy and policy analysis, said traditional mortgage insurance is overpriced and is particularly costly to lower-income minorities and other households "who [we'd] like to provide some benefits and savings."

Freddie Mac's solution: Replace at least some insurance coverage with variations of "self-insurance" under which lenders would create loss-reserve escrow accounts funded by borrower payments. The loss reserves would be tapped only when defaults or foreclosures required a payout.

Borrowers would still be paying for loss protection. But Zorn says that the cost of the protection--without the organizational and regulatory overhead expenses passed on by insurance companies in their premium charges--"would be substantially less."

Zorn added that although the mortgage insurance industry describes itself as highly competitive, just eight companies dominate the field nationwide, and they show relatively little price variation in premiums within each state because of regulatory "price posting" requirements. Freddie Mac "can do it more efficiently" and charge borrowers much less, Zorn said.

With that in mind, Freddie Mac executives sought--and obtained in the closing moments of debate on a housing appropriations bill--a congressional go-ahead to use alternative loss-protection mechanisms.

But lobbyists for the mortgage insurance industry saw a threat to their business--and substantial profits--if one of the biggest users of insurance was allowed to dispense with it. They persuaded congressional leaders to rescind the approval to Freddie Mac, at least until hearings can be held in the new Congress.

Avoiding Possible Costs of Taypayers

A spokeswoman for the Mortgage Insurance Cos. of America, the trade group for the industry, said Freddie Mac's congressional charter specifically directs the corporation to use "third party" insurance to avoid possible costs to the taxpayers.

In a worst-case scenario, said Ellen Schweppe of the insurance trade group, Freddie Mac could suffer a $65-billion loss over a five-year period if it used self-insurance instead of traditional mortgage insurance.

She said the industry "hasn't seen the details" of what Freddie Mac has in mind and can't comment on what it might save.

However, Freddie Mac's regulatory agency, the Office of Federal Housing Enterprise Oversight, has seen the details and, in a letter to Senate Banking Committee Chairman Alfonse D'Amato (R-N.Y.), has said the program would not "adversely affect the safety and soundness" of Freddie Mac.

The bottom line here? Many consumers are no fans of private mortgage insurance, having watched the industry collect premiums from borrowers for years beyond economic necessity.

That situation was corrected by federal reform legislation only a few months ago with requirements for mandatory disclosure of borrower cancellation rights and automatic termination of coverage when borrowers' equity holdings reach preset levels.

Given the opportunity to save money for loss protection through alternative means, a lot of consumers would probably jump at it.

*

Distributed by the Washington Post Writers Group.

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