H.R. 607

Homeowners Insurance Protection Act

March 18, 1997

Margot Saunders

Mr. Chairman and Members of the Committee, the National Consumer Law Center thanks the committee for inviting us to testify today regarding the implications of passage of H.R. 607 for low-income consumers.

The National Consumer Law Center is a nonprofit organization specializing in consumer credit issues. We work with thousands of attorneys around the country, representing low-income and elderly homeowners, who request our assistance with the analysis of credit transactions to determine appropriate claims and defenses their clients might have¹. As a result of our daily contact with these practicing attorneys we are very familiar with the consumer credit issues facing low-income borrowers in most states in the union. We have worked for years, in a variety of forums to facilitate our low-income clients to obtain and maintain homeownership. For example, in addition to our work with legal services attorneys and private attorneys on cases and projects to reduce mortgage costs; we have a number of contracts with mortgage servicers to avoid foreclosures²; and we have endeavored to explain the impact of various federal legislative proposals on our low-income clients to members of Congress for the past several years. We are interested in private mortgage insurance ("PMI") because it is generally an additional cost for our low-income clients when they purchase or refinance a house.

We commend Mr. Hansen and the other sponsors of H.R. 607 for taking the initiative on behalf of consumers to reduce the cost of private mortgage insurance. H.R. 607 is a very good start toward the effort of reducing homeownership costs.

This testimony has three parts.

• Part One has some general information in Private Mortgage Insurance, and the ways in which it impacts on consumers’ mortgages, and on low-income borrowing in particular.
• Part Two provides an analysis of H.R. 607; what this bill does and does not do for consumers.
• Part Three sets out basic principles that we recommend be included in a bill designed to reduce unnecessary PMI costs for consumers.

Part One - General information on Private Mortgage Insurance, and its impacts on low-income homeowners.

PMI insurance is an important tool to enable low-income and minority borrowers to obtain homeownership, but it is not the primary tool in the marketplace. Without a doubt, FHA is "the primary bearer of credit risk for home purchase loans to lower-income and black or Hispanic borrowers and in lower-income and minority neighborhoods."³ As the Federal Reserve recently pointed out, conventional mortgage lenders only provided approximately one-fourth of loans to low -income and black or Hispanic borrowers. The message from this information is that PMI insurance is an important vehicle to enhancing homeownership, but it is not the dominant provider of low-income homeownership opportunities⁴. Therefore, the regulations considered for PMI insurance should be written with this consideration⁵.

There has been a lot of discussion about the propriety of establishing a federally proscribed 80 to 20% loan to value ratio ("LTV") for PMI. The mortgage industry has indicated that 80% LTV may be too high as a federal standard, and that they want flexibility to require PMI on loans with a lower LTV ration. However, according to the Federal Reserve Board, in 1995 among Fannie Mae and Freddie Mac mortgages there were 0 loans with PMI insurance which had an original loan to value ratio of 80 % or less.

Further, much of the analysis on the proper point for automatic termination of PMI insurance has been based on loans which have original ratios of 90% or 95%. The industry has provided amortization schedules to staff showing that loan to value ratios don’t drop fall to 80% or below for some higher interest rate loans until after the mid-point on a 30 year loan⁶.

This argument is somewhat disingenuous, because the Federal Reserve Board has found that the privately insured mortgages —those held by Fannie Mae and Freddie Mac— are more concentrated in the 80% to 90% range⁷. Loan to value ratios of 80% or less are met much sooner for loans with original LTVs of less than 90%. For example, in a 30 year loan at an 8% interest rate, which has an original LTV ratio of 85%, the equity in the home equals 80% of the loan in the 5^th year (using the original price of the home as the measure). Following is a table which illustrates this at various interest rates:

85% LTV at Origination

As a significant number of PMI loans in the marketplace are originated with a LTV ratio of less than 90%, and the borrowers’ equity meets or exceeds the 80% LTV point in first third of the loan term, or less, automatic termination clauses should be required based on these realities. Requiring automatic termination only halfway through the loan term is a rather extravagant degree of extra premiums allowed to servicers.

Part Two - Analysis of H.R. 607 — what this bill does and does not do for consumers.

The intent of this bill is good: to reduce the amount of unnecessary PMI premiums paid by borrowers. However, as the bill was originally drafted, only a few borrowers would be able to actually benefit from its provisions. (We are aware that new drafts of language on H.R. 607 have been continually proposed during the last few days, many provisions of which differ significantly from those in H.R. 607. As it hard to discuss a constantly moving target, we thought it best to address our remarks to the original version of H.R. 607. In Part Three of this testimony, we provide reactions to other suggestions which have been made.)

The original version of H.R. 607 does not create any new rights to cancel PMI insurance. Instead, the bill requires a lot of new disclosures about the borrower’s possible right to cancel. The effect of requiring disclosures of a right which may not exist would be only to tantalize and frustrate those borrowers who choose to act on the disclosures — only to find that they have no right to cancel their PMI insurance. Such a consequence cannot be what was intended by the sponsors.

Further, the conditions for cancellation are not limited in any way, other than the fact that they must be disclosed. A lender —or servicer — could disclose, for example, that one of the conditions for cancellation be something like: "The lender must be satisfied that its general underwriting requirements will not be compromised by allowing the private mortgage insurance to be canceled on your home." In such a case the disclosure, and any rights which might flow from it, becomes meaningless. Because the lender would have retained the right to refuse cancellation based upon a subjective reason, unknown and unchallengeable by the borrower.

Part Three - Basic principles for a bill designed to reduce unnecessary PMI costs for consumers.

1. Disclosure is nice, but the benefit to the consumer is really embodied in the right to cancel the PMI. Disclosures do not create rights - except to obtain the disclosures. Information about actual rights that exist is important. But if H.R. 607 is meant to be a bill which actually provides benefits to consumers, it should actually create rights for consumers. Indeed, the mortgage industry benefits from clarity of obligations as well.

2. Automatic termination of PMI is the key to protecting consumers from unnecessary PMI premiums. More consumers will benefit - and the mortgage industry will avoid unnecessary costs and litigation - from a crystal clear requirement of termination of PMI at a certain point in the loan term. Obviously, the earlier this point, the more consumers benefit. However, legislators should bear in mind that whatever disclosures, and early rights to terminate PMI, are otherwise created, the majority of PMI borrowers will continue to pay PMI premiums until the automatic termination provision requires cancellation.

Most borrowers will not take advantage of a possible right to cancel PMI premiums, if they first must bear the cost of an appraisal. The costs of an appraisal can vary widely even within a single community. And many borrowers may be wary of incurring the costs of an appraisal when they are not certain that it will have the desired result of causing the PMI premium to be canceled.

The "hurdle" of having to come up with the money to fund the appraisal to prove the value of the house will significantly — and unfairly — impact on low-income households. Studies have shown that many households do not have access to "investment capital," and cannot afford to make expense saving impovements, even if they know that these expenditures will result in immediate savings. Studies and cases from the efforts in the energy area to curtail costs by reducing energy need provide examples of this problem. When an energy conservation program can show that a household can save $500 in electricity bills over the next two years, if the household does not have the initial $400 to invest in an energy efficient refrigerator, no refrigerator will be purchased, and no savings will be realized⁸.

3. Cancellation of PMI insurance should occur automatically at or very near 80% LTV. One must look at the actual purpose of PMI: to provide some insurance to lenders from a) credit risky borrowers, and b) inadequacy of collateral on the loan⁹. Once the borrower has been paying on a loan for enough years to reduce the LTV ratio to less than 80%, the lender is in the same position with this borrower as it would have been at the inception of the loan had the borrower put 20% down. Additionally, the lender has this borrower’s payment record to ensure that there is no unreasonable credit risk.

Therefore, it is rational to require automatic cancellation of PMI premiums at the point during the loan term when the borrower reaches a LTV ratio at which this lender would have been willing to make the loan without PMI coverage.

As the industry standard for requiring PMI coverage is 80%, that seems to be a reasonable trigger to require its cancellation as well. The industry has spent a lot of energy talking about the need for flexibility, and how it will hurt low-income borrowers in particular if PMI must be canceled at the arbitrary point of 80% LTV in every loan. But there are no loans (or so few that they have not been documented by the Federal Reserve Board) that are currently being made in which PMI insurance is required for a loan with an LTV ratio of less than 80%. However, if industry is insistent on its need for flexibility in the future (which could only mean that in the future PMI insurance might be required for loans where 25% or more would have to be paid on the home by the borrower) than the trigger should be at least the lender’s: that LTV ratio at which this lender would have been willing to make this loan to this borrower with no PMI required.

4. Automatic cancellation at a later time would be better than discretion and confusion. As lenders will understandably want some cushion against the 80% LTV ratio when there has been an uneven payment history indicating a risk of default, some additional premiums on all loans would not be inappropriate as a trade-off for the automatic cancellation on all loans. In other words, it would be better to require the cancellation of all PMI premiums — so long as payments on the loan are current — when the LTV ratio has gone 2 or 3% beyond the 80% LTV initially required, rather than have a right which can be rebutted by the lender under a variety of circumstances. So, if the original loan documents indicate that the lender has required PMI because of an 80% LTV, than the PMI should have to be automatically canceled when the borrower’s LTV reached 78%. This automatic right would be subject only to the requirement that the payments on the loan are current.

Again, clarity of obligation and certainty of when the premiums have to be canceled is of considerable benefit to borrowers and the industry alike. Confusion of when the right kicks in, disputes over the validity of one appraisal versus another, and concerns about payment history are all avoided with this proposal.

5. Automatic cancellation at halfway through the loan term provides an absurd amount of extra, and unnecessary premiums for PMI to be paid. If H.R. 607 is intended to be a consumer protection bill, it should not read as a major gift to loan servicers and PMI providers. As most borrowers will rely on the automatic cancellation provisions to see actual savings from canceled PMI premiums, the automatic cancellation provision will become the industry standard. If the automatic cancellation occurs halfway through the loan term, as has been proposed by some, borrowers in most PMI loans will end up paying unnecessary PMI premiums for 9 years or more. (See chart on page 3). If Congress is unwilling to require automatic cancellation at 80%, or some point reasonably close, at the least, automatic cancellation should occur one third of the way through the loan term.

6. With a strong automatic cancellation provision which relates to the original value, an additional right to cancel when the borrower’s equity meets the trigger based on current value should also be included. As many homes do increase substantially in value, and the lender’s risk is therefore significantly reduced, borrowers should also have the right to prove that their loan to value ratio has been met by showing the current value of the home.

7. Any requirement for an appraisal to be provided by the borrower should be met with a recent tax appraisal. Often property tax appraisals undervalue the home. Rarely do they overvalue homes. Clearly tax appraisers have an interest in fairly evaluating the real worth of the home (too low will reduce the property tax revenue to the local government; too high will ignite the wrath of taxpayers.) Therefore, if a recent tax appraisal indicates that the value of the home meets the required LTV ratio, that should be sufficient to meet the appraisal requirements for early cancellation.

8. Lenders should be allowed to reject early cancellation of PMI coverage only for a recent payment history which indicates a real risk of default. A number of proposals for H.R. 607 have been considered which would allow early cancellation subject to the lender’s refusal because of the borrower’s payment history. Borrowers’ payment histories should only be relevant in this regard a) during a reasonably recent period of time, and b) to the extent that they actually show risk of default.

9. All rights created, whether to automatic cancellation or to early termination, should be required to be set out in the contract between the lender and the borrower. Some recent proposals have also been considered which would provide that the borrower’s right to cancel PMI insurance would be set out in the annual statement of such rights provided to the borrower by the servicer. This effectively provides no rights to the borrower, and as the original version of H.R. 607, it will only serve to tantalize and frustrate borrowers. The rights must be specified in the contract to be understandable and enforceable.

10. The Act establishing the rights of borrowers to cancellation of PMI premiums should be enforced by the Federal Reserve Board, not by the Department of Housing and Urban Development. HUD is a department with a myriad of diverse responsibilities, and an uneven record of meeting those responsibilities. The Federal Reserve Board has shown that it can implement the complex web of financial credit laws including the Truth in Lending Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, etc., in a way which is understandable and meaningful to the credit industry and consumers¹⁰.

11. The PMI Cancellation Law should be self-enforcing with adequate damages for failure to comply, statutory damages and attorneys fees. As unpopular as lawyers are these days, they still serve a valuable purpose: they enforce the laws. Violation of any requirement of the PMI cancellation law should lead to liability, including actual damages, a reasonable statutory penalty in the discretion of the court, and attorneys fees. Allowing attorneys fees for individual actions will provide a method of redress for individual consumers, without which they will have no effective way of obtaining relief for violations of the new law.

In sum, we propose the following principles:

Automatic cancellation of PMI insurance at the point during the loan term when the borrower reaches a LTV ration at which the lender would have been willing to make the loan without PMI coverage.

Borrowers should be allowed to cancel PMI insurance earlier when the borrower’s equity meets the trigger based on the home’s current value.

Requirements for an appraisal of the current value of the home should be satisfied by a recent tax appraisal.

Lenders should be allowed to reject early cancellation of PMI coverage only for a recent payment history which indicates a real risk of default.

All rights created, whether to automatic cancellation or to early termination, should be required to be set out in the contract between the lender and the borrower.

The Act establishing the rights of borrowers to cancellation of PMI premiums should be enforced by the Federal Reserve Board.

The PMI Cancellation Law should be self-enforcing with adequate damages for failure to comply, statutory damages and attorneys fees.

Thank you for requesting our input on behalf of our clients on this important piece of legislation.

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¹ The National Consumer Law Center, Inc. (NCLC) is a nonprofit Massachusetts corporation founded in 1969 at Boston College School of Law and dedicated to the interests of low-income consumers. NCLC provides legal and technical consulting and assistance on consumer law issues to legal services, government and private attorneys across the country. The Cost of Credit (NCLC 1995), (plus the 1996 Supplement), Truth in Lending (3^rd Ed. 1995), (plus the 1996 Supplement) , and Unfair and Deceptive Acts and Practices (NCLC 1991), (as well as the 1996 Supplement) are several of our twelve practice treatises published by NCLC, and our newsletter, NCLC Reports Consumer Credit & Usury Ed., describe the law and conditions currently applicable to home lending.