oversight

Homeownership: Cancellation and Termination Provisions of the Homeowners Protection Act of 1998

Published by the Government Accountability Office on 1999-12-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

B-2841.53

December lo,1999

The Honorable Phil Gramm
Chairman
The Honorable Paul S. &u-banes
Ranking Minority Member
Committee on Banking, Housing,
 and Urban Affairs
United States Senate

The Honorable James A. Leach
Chairman
The Honorable John J. LaF’alce
Ranking Minority Member
Committee on Banking and
 I?inanciai Services
House of Representatives

Subject: Homeownershiu: Cancellation and Termmation Provisions of the Homeowners
         Protection Act of 1998

The Homeowners Protection Act of 1998’ contains provisions for terminating the private
mortgage insurance that homeowners are required to obtain when they have made a small
down payment on a home mortgage loan. Private mortgage insurance protects the lender if
the homeowner defaults on the loan. Specitically, for certain residential mortgage loans
closed on or after July 29,1999, the act provides that the borrower may cancel this insurance
when the principal balance of the mortgage reaches 80 percent of the original value of the
property securing the loan. If the borrower does not cancel the insurance, the lender must do
so when the mortgage balance reaches 78 percent of the original value of the property
securing the loan. However, these cancellation and termination provisions do not apply if the
loan has what the act calls “high risks” associated with it-a term that the act does not
explicitly define. The act directs the Comptroller General of the United States to report to
the Congress, no later than 2 years after the date of the act’s enactment, on the number and
characteristics of the residential mortgage loans that are considered high risk and are
therefore excluded from the routine cancellation and termination provisions. This letter
describes our efforts to respond to this requirement.

The Homeowners                 Protection   Act of 1998

Mortgage insurance is generally required when a borrower makes a low down payment on a
mortgage loan. Studies show that a borrower with less than 20 percent invested in a house is
more likely to default on a mortgage than a borrower who has made a larger down payment.

P.L 108216,   July 29, 1998.



                                                     GAO/RCED-OO-50B   Homeowners   Protection   Act of 1998
Under the act, if the borrower has a good payment history, he or she may cancel his or her
private mortgage insurance when the principal balance of the mortgage reaches 80 percent of
the original value of the property securing the loan. If the borrower does not cancel the
insurance, the lender must do so when the mortgage balance reaches 78 percent of the
original value of the property securing the loan provided the borrower is current on the
 mortgage payments. Moreover, private mortgage insurance cannot be required beyond the
 midpoint of the mortgage if the borrower is current on the mortgage payments.

The act qualifies this requirement by stating that the provisions for canceling and terminating
private mortgage insurance do not apply if the mortgage has “high risks” associated with it.
The act does not define this term but stipulates that conforming loans (limited to $240,000),’
may be designated as high risk in accordance with guidelines established by the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage
Corporation (Freddie Mac).3 For mortgage loans of more than $240,000 (nonconforming
loans), the lender can define what constitutes high risk. Finally, for loans defined by lenders
as high risk, the act requires that private mortgage insurance be terminated when the
principal balance of the mortgage reaches 77 percent of the original value of the property
securing the loan. The act does not indicate whether private mortgage insurance can be
required beyond this point if the borrower has a poor payment history.

Implementation          of the Act’s Requirements              May Be Limited

Fannie Mae and Freddie Mac have not defined “high risk.” Instead, they have decided to treat
all conforming mortgages the same way and not apply the act’s high-risk provisions for
canceling or terminating private mortgage insurance to specific mortgages. For conforming
mortgages, therefore, the act’s exception for high-risk loans has had no effect. With respect
to nonconforming loans, two trade associations-the Mortgage Bankers Association of
America and America’s Community Bankers-have published a guide on implementing the
act’s cancellation and termination provisions. These organizations have chosen, as Fannie
Mae and Freddie Mac have done, not to define high-risk mortgages in this guide.

We believe that a mortgage lender would gain little by invoking the high-risk provisions for a
mortgage of more than $240,000 because these provisions do not explicitly stipulate that the
borrower have a good payment history or be current on the loan. According to the Mortgage
Bankers Association and America’s Community Bankers, the benefit a lender might derive by
terminating the private mortgage insurance on a lender-designated high-risk loan at 77
percent-compared with 78 percent for a non-high-risk loan-may be outweighed by the
apparent lack of a requirement in the act for the borrower to be current on his or her
mortgage payments. As a result, we believe there is a disincentive for lenders to invoke the
high-risk exception.

We believe that attempting to determine the number and characteristics of high-risk
mortgages would not, in all likelihood, produce information helpful to congressional
decisionmakers for two reasons. First, Fannie Mae and Freddie Mac have decided to treat all
mortgages the same way and not apply the act’s high-risk provisions for canceling or
terminating private mortgage insurance to specific mortgages. Second, the number of
lenders who would define some mortgage loans of more than $240,000 as high risk would, in
our view, likely be small because of the disincentive in the act for lenders to define such

‘Currently, Fannie Mae and Freddie Mac buy mortgages up to a loan limit of $240,000. On January 1,2000, the conforming loan
hmit will increase to $252,700.

 “Fannie Mae and Freddie Mac were chartered by the Congress to increase the supply of money that mortgage lenders can make
 available to home buyers and multifamily investors.



 2                                                       GAO/RCED-OO-50R        Homeowners       Protection    Act of 1998
    loam as high risk. If it becomes apparent that Fannie Mae and Freddie Mac are planning to
    change their position or that private lenders have decided to invoke the high-risk exception,
    we would certainly revisit the issue. We hope this information is responsive to your needs.



    If you have any questions, please contact me at (202) 512-7631. Key contributors to this
    report were Robert Procaccini and Frank J. Minore.



o&teg+-
   d/Director, Housing and Community
      Development Issues




      (385839)


                                                 GAO/RCED-OO-50R   Homeowners   Protection   Act of 1998
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