Watch Lender-Paid Mortgage Insurance

WASHINGTON —  Thousands of American home buyers and refinancers who sign up for private mortgage insurance yearly could be touched by two forthcoming hot potato decisions from federal regulators.

Both decisions concern a key housing consumer protection issue: Do loan applicants really understand what they’re signing up for--and who’s pocketing hundreds of dollars of their money--when they buy private mortgage insurance with their new loan?

Almost anybody who puts down less than 20% on a conventional (non-FHA or -VA) home loan is asked to pay for mortgage insurance. Its purpose is to protect the lender against the increased risk of losses from defaults or foreclosure on low-down-payment loans.

When you purchase the insurance, you typically have to pay a monthly premium, based on the size and type of loan. For example, on a $150,000 fixed-rate 30-year mortgage you might pay $600 a year--an extra $50 tacked on to your monthly principal and interest payments.

Although some homeowners think they can write off their monthly mortgage insurance premiums on their federal taxes, they are not in fact deductible. Only your mortgage interest is. Three years ago, however, a Chicago-based newcomer to the mortgage insurance business, Amerin Guaranty Corp., came up with financial alchemy--a way to turn nondeductible insurance premiums into deductible interest. It introduced what’s called “lender-paid mortgage insurance” (LPMI). Rather than the borrower paying for the insurance costs, under LPMI the lender treats it as its own expense and charges the consumer a higher mortgage rate.

For example, instead of an 8% mortgage with nondeductible monthly premiums of about one-half of a percentage point, you sign up for an 8 1/2% loan and deduct everything. Amerin’s concept has attracted participation from major mortgage lenders and has forced some competing insurers to offer similar options.

So where’s the problem? In the view of a top Capitol Hill housing expert, LPMI may not be as attractive a deal as consumers think. The chairman of the House subcommittee on housing, Rep. Rick Lazio (R-N.Y.), points out what he believes is a potentially expensive flaw in the concept:

Under lender-paid insurance, the borrowers irrevocably give up their right to ask for termination of the monthly premium charges once their home equity exceeds 20%. That’s because the LPMI insurance premium is built into the mortgage rate and continues for the life of the loan--even if the lender cancels the insurance coverage on its own and continues to pocket the premiums for years.

“The fundamental issue at stake,” said Lazio in a letter to Housing and Urban Development Secretary Henry Cisneros, “is whether the federal government should require full and exhaustive disclosure to borrowers of any loan product that trades a few dollars in upfront mortgage insurance costs for additional thousands in interest payments down the road.”

Lenders and insurers say the basic mechanics of LPMI are adequately disclosed to consumers without detailed federal guidelines. But Lazio is unconvinced. He wants clarification--or tougher federal requirements for disclosure--from HUD, which has regulatory authority for consumer protection on mortgage closings.

A department official says a response to Lazio is in draft, but declined to reveal HUD’s position on LPMI. In the meantime, though, consumers should be aware of the critical feature of LPMI that Lazio’s letter highlights:

If your loan is likely to be for the long term, your lender will be free to cancel your mortgage insurance policy unilaterally but keep collecting your premium dollars as part of your monthly interest payment for the life of the loan. That’s sweet for the lender, but could be costly for you.

Another issue pending before HUD: Should it be legal for mortgage lenders to set up side joint ventures with mortgage insurers to share portions of borrowers’ insurance premiums?

The details of these ventures are complex, but the bottom line is this: The lender who is protected by your insurance winds up with extra profits, derived by creating an insurance subsidiary it jointly controls.

One top industry expert says “there is substantial money to be made here” by lenders if HUD flashes a green light. But a consumer advocate says she thinks the whole concept “stinks.” Gale Cincotta, executive director of the Chicago-based National Training and Information Center, says lenders joint-venturing with insurers will avoid lower-income city neighborhoods that they see as higher risk. And they’ll also be reluctant to cancel other borrowers’ insurance policies when they reach the 20% equity threshold “because it will cut their income stream.”

“There’s an inherent conflict when you’re both the lender and the insurer on a mortgage,” Cincotta said. A HUD official would only say that “we are reviewing” the issue.

Distributed by the Washington Post Writers Group.