Federal loan insurance disputed Two court cases involve reminding consumers they may cancel policies


ANY HOMEOWNER who pays private mortgage insurance premiums every month should take note of two important new court cases involving when -- and how -- consumers can save money by obtaining cancellation of their loan insurance coverage.

In one case, a federal judge in Texas dismissed a class-action suit that charged Fannie Mae -- the giant home loan investor -- with unfair and deceptive practices nationwide in its use of private mortgage insurance. The suit argued that Fannie Mae has a legal duty to inform consumers that they may obtain termination of their loan insurance payments when their equity in their home is 20 percent or greater.

In the second case, homeowners from New York and Alabama BTC filed a class-action suit against Freddie Mac -- the country's second-largest home loan funding source -- charging that it, too, illegally permits collection of private mortgage insurance payments long beyond what its own rules specify as necessary.

Both cases are part of an ongoing battle between lenders and borrowers over loan insurance premiums that can add $50 to $100 to the cost of a monthly mortgage payment. Critics of the insurance say unwary consumers pay millions of dollars a year needlessly to insure their lenders against the remote possibility of loss in the case of default or foreclosure.

In some instances, according to critics such as Utah Republican Rep. James V. Hansen, borrowers pay insurance premiums for 20 years or more, with loan balances just 10 percent of the property value. The risk of loss to a lender in such circumstances is virtually nil, Hansen says.

Private mortgage insurance is designed to provide lenders -- or the ultimate purchasers of local lenders' home loans, such as Fannie Mae and Freddie Mac -- protection against financial loss in the event of a borrower's nonpayment. Both Fannie and Freddie require insurance coverage on all new loans where borrowers put down less than a 20 percent down payment.

Should a borrower default and go to foreclosure, the insurance policy pays the lender's or investor's costs to some pre-specified coverage level. The premiums for this protection almost always are paid directly by the borrower, but the borrower is never the insurance beneficiary. The lender or investor is.

Since the risk of actual loss diminishes sharply once the loan balance is below 80 percent, companies such as Fannie Mae and Freddie Mac allow cancellation of premium payments under certain conditions. But do they -- or their contract mortgage servicers who collect monthly payments from borrowers on their behalf -- have to cancel policies at any point?

In the Texas class-action suit, U.S. District Judge Lynn N. Hughes ruled that Fannie Mae has no legal duty to inform borrowers that once their balances hit the 80 percent-of-value mark, they can request -- and obtain -- termination of mortgage insurance.

Hughes noted that the original loan documents of the plaintiff in the suit required the borrower to "maintain mortgage insurance for the entire life of [the] mortgage." The borrower obtained the loan from a mortgage company that later sold it to Fannie Mae. Servicing of the loan was handled by a third mortgage firm.

The fact that Fannie Mae's internal rules require a servicer -- upon a borrower's request -- to cancel borrower-purchased mortgage insurance whenever the loan balance is 80 percent or less of the original property value, creates no contractual obligation upon Fannie Mae to cancel insurance or alert borrowers to their opportunity to do so, the judge ruled.

The Freddie Mac suit filed in Alabama asked the U.S. District Court to require Freddie Mac and its servicers to notify all borrowers that they have the right to terminate their mortgage insurance "by making a demand to do so when their equity equals or exceeds 20 percent, whether by amortization, market appreciation or a combination thereof."

Without an injunction to halt current practices, said the complaint, nearly all Freddie Mac borrowers will continue to be "unaware of their rights and will continue to pay in the aggregate hundreds of millions of dollars for unnecessary [insurance]."

Pub Date: 12/15/96

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