With the market heating up, and borrowers putting less money down, we’re starting to see a lot of questions about private mortgage insurance. Here is a refresher on what it is and what it does:
FannieMae and FreddieMac require mortgage insurance any time the borrower has less than 20% equity in the property being financed. FHA and VA also require upfront and monthly mortgage insurance since these programs, by their nature, require less than 20% down from the borrower. The mortgage insurance is to protect the lender, Fannie Mae, Freddie Mac, FHA, and VA. Here is generally how it works:
If a borrower stops paying or otherwise default on their mortgage, the lender will foreclose the property. In Florida, that means that they will sell the property at auction. If a third party bidder purchases the property for more than what you owe the lender, then the lender is paid off in full, and the borrower gets the surplus proceeds from the sale.
However, in most cases, the lender is owed more than the property is worth at the foreclosure auction. In those events, the lender usually is the “successful bidder” at the foreclosure sale and gets the property back. At that point, the lender will take possession of the property and try to sell it on the open market. If they can sell it for more than they are owed, then great. All’s well. However, if we go through another real estate crash, they usually can’t get that much for it, and end up selling it at a loss.
At that point, they’ll go back to court and ask the judge to order that the lender receive a “deficiency judgment” against the borrower. The deficiency judgment will be in an amount roughly for the difference between the amount the borrower owes the lender minus the value of the property foreclosed. So, if the property is worth $200,000.00 at the date of the foreclosure, but the borrower owes the lender $230,000.00, then the judge would give the lender a deficiency judgment of $30,000.00 against the borrower and the borrower’s assets.
The lender will then try to collect that additional deficiency judgment from the borrower. If the borrower is bankrupt or otherwise simply can’t pay the judgment, then the lender goes to the mortgage insurer and makes a claim for the uncollectible deficiency judgment. The insurer then, we hope, has the reserves necessary to pay the claim to the lender to make the lender whole on the borrower’s loan so they can continue lending mortgage funds to new borrowers. As part of paying the claim, the lender will also assign the deficiency judgment to the mortgage insurance company who may make further attempts to collect the funds from the defaulted borrower to replenish the insurer’s reserves.
This is not credit life or credit disability insurance that protects borrowers (or their heirs) in the event of death or disability. Lenders typically cannot require that borrowers carry that type of insurance; but they can require mortgage insurance whenever the borrower brings less than 20% of the purchase price to closing or otherwise has less than 20% equity in the mortgaged property.