Mortgage insurance is meant to protect the investor: the borrower pays the insurance premium so that if they default on the loan, the investor is protected. The loan servicer (which, in most cases, is the bank) is only an intermediary in the process. However, a recent report in American Banker indicates that some loan servicers’ position in the insurance deal is a bit too close for comfort - and quite possibly, a conflict of interest with the parties the servicer is supposed to represent. In some instances, loan servicers have force-placed insurance on their borrowers that is up to ten times as expensive as regular insurance: disadvantaging both the borrowers and the investors.
Fo the most part, banks (as loan servicers) negotiate mortgage loans with borrowers, and then they sell those loans to third parties: the investors, such as Freddie Mac or Fannie Mae. The investors pool the loans into mortgage-backed securities (MS), which are usually sold as bonds. The purchasers of the bonds earn an interest payment which is tied to the interest payment made by the borrowers on their mortgages.
Borrowers are required to have mortgage insurance, which protects the investors should the borrowers default on their loans. The loan servicers, once they have sold off the mortgage, become minor players in the deal - just intermediaries. And once they have sold those mortgages, their earnings as intermediaries are low: typically about 0.25% of the value of the mortgage. On a $200,000 mortgage, this translates to about $500 per year.
The American Banker report has uncovered many examples of close business relationships between the loan servicers and the mortgage insurers; in some cases, the insurers themselves are actually owned by the banks. The report quotes Diane Thompson, counsel for the National Consumer Law Center, as saying “There’s no arm’s-length transaction here.” She notes that this situation actually creates incentives for servicers to force-place excessive insurance coverage.
This close relationship may include outright ownership, or it may include kick-backs from insurers: payments to loan servicers. In one example given in the article, loan servicer EverBank replaced its client’s $4,000 insurance policy with a $33,000 force-placed one. They paid specialty insurer Assurant for the policy, and Assurant returned a $7,100 “commission” to EverbBank subsidiary EverInsurance - a payment far greater than EverBank would ever have received from servicing the loan.
In other instances, cases were uncovered where the banks had deliberately let an insurance policy lapse so that they could force-place a more expensive policy - stopping the advance of a delinquent borrower’s escrowed private insurance until the policy lapsed, then purchasing a more expensive policy and advancing payments on it.
These policies do not only harm borrowers - who quickly see the equity of their property stripped away as the large part of any payments they are making (or, if they are not, a growing arrears calculation) as funds go towards unreasonably high insurance policies. (American Banker uncovered one example of a $120,000 property with a force-placed insurance policy costing $10,000 per year - a policy that would soon strip away any remaining equity in the property). These policies also harm the investors, who become increasingly unlikely to recover their investment when borrowers' payments are going to insurance policies, and investment equity is rapidly being stripped.
The issue here is conflict of interest. As the American Banker report notes “there ceases to be a clear difference between the entity purchasing insurance and the entity selling it.” This works out even better for the insurer, because it means that the servicer is less likely to pursue claims (to avoid any apparent conflict of interest, and also because payments on the claims could possibly come from its own profits)) - when in fact, the servicer as representative of the investors should actually aggressively pursue any insurance claims arising from its forcibly insured portfolio.
Many banks are still reeling from the discovery of sloppy documentation practices, a discovery which leads to questions about the legalities of many past foreclosure proceedings - including accusations of “robo-signing,” as well as documentation with signing dates or locations that suggest that they may not have been signed in the presence of a notary, as required by law. These further revelations, of potentially "too close for comfort" ties between loan servicers and mortgage insurers - their lack of arms-length distance, and how their association might be to the detriment of both borrowers and investors - will only add to the mass of paperwork (and possible litigation) related to foreclosure proceedings to be expected over the coming months.
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