Photo (cc) by 111 Emergency
If you don’t buy insurance on your house, your mortgage company can legally do it for you. This makes sense, because your home is the collateral for your home loan – without insurance, an accident or natural disaster could wipe out the investment. So your lender insures you’ve got insurance, and if you don’t, they buy it and bill you for the premiums.
It’s called forced-place insurance, and it’s been around for a long time. But some are now accusing lenders of using these policies to generate excessive profits at the expense of hapless homeowners. And thanks to the huge volume of foreclosures and the massive amount of securitized mortgages, these inflated policies could also be impacting Wall Street investments, which in turn might trickle down to Main Street mutual funds.
To better understand the issue and its potential effect on both homeowners and investors, meet a homeowner who was billed $33,000 for one year’s worth of forced-place homeowner’s insurance – insurance that could have been purchased for $4,000. Check out the following news story, then meet me on the other side for more.
After watching that story, you may wonder how a homeowner like Hilda could possibly pay even $4,000 for homeowners insurance: the answer is that she lives in Florida – due to the threat of hurricanes, Florida has notoriously high insurance rates.
How can they justify the high cost of forced-place insurance?
According to mortgage servicing and insurance companies, there are reasons forced-place insurance costs more than a typical homeowners policy: for example, the insurance has to be placed immediately, the mortgage servicer doesn’t have the benefit of normal underwriting guidelines, and the insurance company can’t physically inspect the house. They also point out that homeowners are typically notified, often several times, that expensive forced-place insurance is imminent if they don’t act to renew their coverage.
Hilda Sultan claims she never received any notice whatsoever of the forced-place policy purchased on her behalf, nor did she need it – she had never let her insurance lapse. But even if Hilda didn’t have insurance, ignored warnings from her mortgage servicer and otherwise neglected her responsibilities, is that justification for the mortgage servicer to put her on the hook for $33,000 for $4,000 worth of insurance, then earn $7,000 in commissions for itself by doing it? I was looking forward to asking that question in this case, but as I mentioned in the video, the attorney on the other side of Hilda’s suit refused to comment, citing pending litigation.
The snowball effect: why this might matter to you
While Hilda Sultan isn’t in foreclosure, that’s the situation when you’ll most often encounter forced-place insurance these days. When a homeowner stops making mortgage payments, they stop making insurance payments, which means the mortgage servicer buys forced-place insurance. So virtually every foreclosure has this type of high-priced coverage.
Then there are those who might be close to foreclosure. Many Americans aren’t in foreclosure yet, but are struggling to make their mortgage payments. One expense they may attempt to temporarily forgo in order to make ends meet is insurance. Consider what might happen if they keep paying their mortgage but stop paying their premiums: if they’re in a home like Hilda’s, they’ll soon find themselves underwater by an additional $33,000: money that’s essentially added to their mortgage balance. That alone could create a situation where their house is no longer worth saving, which could theoretically create more foreclosures, which in turn drive down the value of neighboring houses – including maybe yours.
Now consider who wins: the mortgage servicer. While the mortgage service company may have originated the mortgage loan, more often than not, they no longer own it. They just collect the monthly payments and pass them along to the new mortgage owner. If a house is ultimately sold at a foreclosure auction, unlike the mortgage owner, all the servicer has lost is the money they made for servicing the loan – often less than $100 a year. So the servicer has no incentive to help a homeowner avoid foreclosure, for the simplest of reasons: with the mortgage current, they’re making $100 a year in servicing fees but with the home in foreclosure, they might make $7,000 a year in insurance commissions.
And who loses? In a foreclosure, the mortgage owner. If a homeowner defaults on a mortgage, the ultimate losers are the owners of that mortgage, because they’re the ones who are at risk of not being fully repaid. The house securing the mortgage will ultimately be sold at a foreclosure auction, and the proceeds will go to the mortgage holder. But they’ll only get whatever money is left after expenses – expenses that include the cost of forced-place insurance.
So virtually every foreclosure will include the cost of forced-place insurance, and the ones who ultimately end up paying the grossly inflated cost of forced-place insurance are the mortgage holders. Many people might say, “So what?” because they logically assume that it’s the big banks that are the mortgage holders. After all, aren’t they the ones who lent out the money in the first place?
While it’s true that big banks and other lenders did originate millions of mortgage loans, shortly after these loans were created, many were bundled with other mortgages and sold on Wall Street in the form of a mortgage-backed securities. In other words, the lenders cashed out. They still service the loans – and perhaps collect commissions for forced-placed insurance – but they no longer own them.
So who does own the trillions of dollars in mortgage-backed securities generated by Wall Street? Pretty much everyone. Individual and institutional investors all over the world own American mortgage-backed securities. And among those institutional investors are many bond mutual funds, including perhaps those in your 401k at work.
Bottom line? In many cases, it’s investors on both Wall Street and Main Street who pay the bill for insanely-priced forced-place insurance.
As you might imagine, some of these investors don’t like this idea very much. After all, many might argue that the banks’ lax lending standards caused the housing crisis to begin with – one that required a multi-billion dollar taxpayer bailout. Now many of the same banks, in their role as loan servicers, are making a killing in insurance transactions that are self-serving.
While forced-place insurance may not garner the kind of media attention you’ve recently seen about other questionable bank practices like robo-signing foreclosure documents, you’re probably going to see more about it as other media outlets discover what we’ve already uncovered.
Now that you know the story, what do you think? Another bank rip-off or an acceptable path to profits? Share your thoughts by leaving a comment below.