In a recent post on mortgage insurance (“MI”), I addressed what I saw as a problem, but didn’t yet fully understand the depth of it, so just issued a cautionary warning to Realtors® and sellers that they should find out, in advance, if MI was obtained on the underlying loan. The reason for this warning was due to reports I was receiving that MI companies were requiring the payment of money or a promissory note from sellers, in order to give consent to a short sale. Why consent was even necessary from the MI company has mystified me.
After reading some MI master policies for these carriers, and doing a little research on the Web, together with a well-placed threat to one MI carrier, I think I’m getting closer to understanding what’s going on. Here’s a summary of what I know so far:
- When borrowers were unable to make a 20% downpayment, lenders required mortgage insurance (“MI”) because of the increased risk of default for the more highly leveraged loan. During the easy credit years, the fact that borrowers could not afford a 20% downpayment was never an impediment to getting a loan. Lenders would gladly make an 80% loan with a 20% loan on top of that. This was called a “piggy-back” loan. Sometimes the loans came from two different lenders, since the rate/terms on the second loan (the 20%) were better through the other lender. The selling point was that this way, the borrower did not have to pay the monthly MI premium, which could be difficult to cancel once the borrower’s equity reached 20% or more.
- As far as I know, most MI policies provide for the payment of a claim only when the property has been foreclosed and the lender goes back into title. [Or, perhaps when the property is sold at foreclosure for less than the loan amount. – PCQ]
- Although a short sale averts foreclosure, by definition it usually means the promissory note is not being paid in full. Therefore, if the lender wants to file a “pre-foreclosure” claim with the MI carrier, some arrangement needs to be made with that company to waive the requirement that the lender must recover the property back in foreclosure. Otherwise, if no such arrangement is made, the lender may not make an MI claim, since no “foreclosure” actually occurred, as required by the policy.
- What lenders and MI carriers are apparently now doing is this: After the lender agrees to the short sale, they advise the carrier and ask for permission to waive the foreclosure requirement so that a claim may be submitted anyway.
- The quid pro quo given by the lender is that the MI carrier gets the final say in granting consent to the short sale.
- Although they may deny doing so, it appears that some MI companies try to shake down borrowers (i.e. the seller in the short sale) for money – even though the bank has already approved the short sale. In some cases the MI company demands a promissory note, and in others, the payment of cash.
- It appears that MI companies go to great lengths to insulate themselves from direct contact with the homeowner who is trying to short sell their home. The lender, e.g. B of A, or some other Big Bank, is the point of contact, and they relay to the seller what the MI company will and will not do.
- The existence of MI can pose several problems in short sale transactions. Here are some:
- The MI companies do not normally get involved until late in the process. Remember, this approval occurs only after the seller has provided all necessary documentation (e.g. hardship letter, financial statements, bona fide offer, etc.). After obtaining the BPO and reviewing the pro-forma HUD-1, the bank makes a determination that it is satisfied with the net sale proceeds it is to receive. If this is so, how and why can a total stranger to the transaction, suddenly pop up, and demand money from the seller?
- If the MI carrier paid a claim to the lender following an actual foreclosure, it would have no right [in my opinion] to subrogate [i.e. “step into the bank’s shoes”] against the borrower for the deficiency. However, Oregon law prohibits a bank from pursuing such a claim following the foreclosure of a primary residence. The MI carrier can have no greater rights by subrogation than its insured (the foreclosing bank). In other words, since the bank has no claim, its MI carrier has none.
- So what appears to be happening is that the MI company is reducing its claims payments to lenders, by shaking down distressed borrower-sellers. This is being done with the knowledge and consent of the lender who has already agreed to the short sale. [Remember, if the MI company kills the sale by withholding consent because the seller refuses the extortion demand, the bank doesn’t really care. They will just complete the foreclosure and then file their claim under the MI policy. While it is true that foreclosure brings the property back to the lender, which they really don’t want – neither do they want to waive their rights to file a claim for the MI coverage. – PCQ]
- If this arrangement sounds bad, think about this (true) scenario: Seller does not need MI, since their downpayment is satisfactory. MI is not made a part of the closing. But later, the lender (or another bank in the securitization process) buys a MI policy on the loan – or more likely on the pool of loans. This is a form of “credit enhancement” that lenders use during the securitization process to improve the ratings of the tranches. But when the seller tries to short sell their home, and the lender has approved, at the 11th hour the MI carrier demands that the seller pay $15,000 cash or they will not consent to the short sale. This demand is not based upon any legal right that the MI company has against the seller – and the MI company will be the first to admit this. [I suspect this may have to do with being treated as a “creditor” under the federal and state debt collection laws. – PCQ]
Conclusion. I am increasingly convinced that this MI shakedown is patently illegal. Yet it goes on with impunity. The banks don’t seem to care, since they get paid either way. But if successful, the MI companies save thousands of dollars, since they are able to reduce the amount of payout on lender claims following the short sale. If this is really an issue between the lender and their insurer, why don’t the two of them negotiate the amount of the claim between themselves and leave the borrower-seller out of the picture?
For sellers and Realtors®, it is important for them to know, as soon as possible, whether there is either borrower or lender placed insurance on the loan. If so, that issue should be addressed up front, since the lender’s approval may mean little without the MI company’s consent. If requested, will the MI company reduce or eliminate its demand and permit the short sale closing to occur with an extortion payment? If the proper “buttons” are pushed, I believe the banks and/or their MI companies may “blink” and permit the short sale, because they know that the reason they are engaging in this activity is only because they can – not because they have a legal right to do so.