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Real Estate Financing: Making Sense of Mortgage Insurance

Fingers start pointing when people talk about the current real estate crisis in our country. The many players in this drama interest me because part of my job is to help individuals deal with the fallout. Helping homeowners negotiate loan modifications or try to short sale their property when facing foreclosure has introduced me to a new behind-the-scenes player: private mortgage insurers.

Here is the short and simple on mortgage insurance. The insurance protects the bank against your failure to pay the loan. Of course, you pay to cover the bank’s behind (those mortgage insurance premiums are bundled up into your monthly payments). Traditionally, mortgage insurance is required for any loan that does not come with a 20% down payment. That way, if you default on the loan, the bank has a cushion. Regardless of what the bank recovers at the foreclosure sale, it also collects from the insurance policy.

For distressed homeowners, mortgage insurance is a plague. It decreases the bank’s incentive to work out alternative payment plans or approve short sales. Why would the bank adjust your payment schedule or interest rate to keep you in your home when it is getting paid by the mortgage insurer for your missed payments? Banks are businesses. They calculate risks and returns and in the end, they look at the bottom line.

So what can you do about it? Well, if you do not currently own a home, pinch your pennies until you can put 20% down on your purchase. Shop around for a good loan and read the fine print. Make sure there is no mortgage insurance requirement. What about the rest of you who own a home that has mortgage insurance? There are several laws that provide protection. The greatest protection comes at the federal level in The Homeowners Protection Act of 1998 (HPA). The HPA requires, in most cases, automatic termination of mortgage insurance once you reach 22 percent equity in the home – based on the original property value. Under this law, you can request cancellation once you hit 20 percent equity. To accomplish the automatic termination or the termination request, you must be current on your payments.

If you have a high risk home loan or other liens on the property, the mortgage company may be able to require the continuation of mortgage insurance past the previously mentioned percentages. Illinois enacted the Mortgage Insurance Limitation and Notification Act (765 ILCS 930/1 et. seq). This law requires the bank to disclose the mortgage insurance cancellation process to the homeowner on a yearly basis. It also prohibits banks from requiring excessive amounts of hazard insurance on the property.    

It should be noted that these legislative protections only apply to single family properties that are used as the principal residence of the borrower. You are not entitled to the same protections on your investment property or summer home. Be informed home owners. Avoid mortgage insurance if you can, and if you cannot, then watch it like a hawk and terminate it as soon as you possible.