I’ve written several blog posts about the mortgage insurance (“MI”) problem. Two of the several posts are found here and here.
In many cases, MI is not purchased by the borrower, but by the lender – without the borrower’s knowledge and after the loan has already been made. This type of MI is technically referred to as “credit enhancement”, and is bought by the originating lender, say Countrywide [now Bank of America] as the loan is being bundled with millions of dollars of similar mortgages, and sold to investors through a process called “securitization.” Since MI insures the ultimate owner of the loan, i.e. the investor, this enhancement makes it more attractive in the pool of securitized loans being sold. And by placing MI on the mortgages bundled and sold, the ratings agencies, such as S&P and Moodys, give the bonds better investment ratings.
The problem in some short sales is that the servicing banks and MI carriers have an agreement: If the servicer approves a short sale where MI was placed on the seller’s loan – even though the seller never knew about it – the insurance carrier has a right to demand that the borrower/seller pay them money as reimbursement for a portion of the proceeds they will have to pay the investor whose loan is being short sold for less than its full value.
The MI carrier will not speak directly to the borrower – they only communicate through the lender – acting as a sort of a puppeteer. The irony of this 11th hour short sale shake-down scam is that if the transaction fails and the lender ends up foreclosing, the MI carrier has to pay the owner of the paper [i.e. the investor] for the monetary loss but cannot recover anything from the defaulting borrower.
What makes MI’s involvement so frustrating is that the amount of money demanded from the borrower as a condition to final short sale approval, is seemingly pulled out of thin air. The carrier does not disclose, verify, or validate where its numbers have come from – only to say that “This is the amount we want to apply to our loss.” [For me, it is hard to call this a “loss” since MI is in the business of insuring against loss by calculating risk and charging premiums to do so. In other words, how can the payment on a calculated loss be regarded by the MI carrier as its own loss? ~ PCQ]
So the process is really a game of liar’s poker; in order for MI approval to the short sale, either the insurance carrier or the borrower must believe the other will kill the sale if an agreement cannot be reached.
Although the legality of this MI/servicer collusion is questionable in my mind, the 11th hour nature of MI’s demand for payment, i.e. right before closing, makes legal sabre-rattling difficult, since the borrower/seller rarely has the luxury of time to hire legal counsel.
I see no real solution to the problem at present. And what’s worse, in those cases where the mortgage insurance was placed on the loan by the lender, the borrower has no hint that the issue will arise until MI rears its ugly head late in the short sale transaction. At that point, when the borrower/seller and buyer believe that there will soon be a closing, MI’s demands begin to look like a shakedown. And the servicer is complicit in this ruse, since it knows at the outset whether there is MI on the loan, and nevertheless leads everyone down the path without telling them what to expect shortly before closing.
Today, however, there is a compelling reason to get short sales closed in 2013: We don’t know if the Mortgage Forgiveness Debt Relief Act (“the Act”) will be extended into 2014. [Congress didn’t even announce the 2013 extension until early January of this year.] If it isn’t extended, and a borrower’s short sale fails on account of MI intransigence, a 2013 foreclosure will likely not be completed until 2014. If the Act is not extended, it would mean that the 1099-C issued to the borrower as a result of a 2014 foreclosure would result in an assessment of income tax – both state and federal – on the debt the borrower never repaid.