With New Limits, New Reasons To Question Mortgage Costs

A seemingly arcane policy change by mortgage investor Freddie Mac sheds new light on issues of much broader concern for consumers: Do you really understand where the money flows -- all the nooks and crannies -- when you take out a mortgage and pay thousands of dollars in fees at settlement?

Is anyone required to explain to you what's really going on with your home loan, how it works and whether it could morph into something very different? And could any of this soon be improved?

Freddie Mac's policy change, announced Feb. 14, affected a dark corner of the mortgage business: splits of mortgage insurance premiums between lenders and insurers. What? My lender is getting a cut of the premium, you ask, just as builders and real estate brokers are pocketing chunks of my title insurance premiums behind my back?

You bet. It is called "captive reinsurance," and it has put 4 billion to 5 billion of consumers' mortgage insurance dollars onto lenders' books in recent years, according to some industry estimates. A captive-reinsurance arrangement allows a lender to receive significant pieces of the premiums paid by borrowers who cannot afford to make down payments of 20 percent or more. The percentage of the premium that is shared varies, but often it is about 40 percent. The funds flow into a trust structure but are treated by lenders as income.

The arrangement puts the lender in the position of a backup guarantor should delinquencies and foreclosures on low-down-payment loans trigger claims beyond specified limits. But with losses minuscule during the first half of this decade, lenders clamored for -- and got -- splits of consumers' premiums that appeared unlikely ever to be paid back for insurance claims.

Similar captive-reinsurance programs proliferated in the title insurance business. For example, home builders who agreed to send their title business to particular insurers walked away with hefty splits that padded their bottom lines. But claims and losses in title insurance tend to be extremely low -- 4 or 5 percent of total premium dollars collected. That in turn gave builders and other participants extra cash with almost no exposure to losses.

The risk was so low in some cases that the Department of Housing and Urban Development saw captive-reinsurance deals as shams, little more than conduits for illegal referral-fee payments by insurers to builders who sent them streams of new title policies from buyers who hadn't a clue about what was going on.

Last year HUD settled with six large builders -- Pulte Homes, KB Home, Beazer Homes USA, Ryland Group, Meritage Homes and Technical Olympic USA -- for participating in captive-reinsurance schemes that allegedly involved no real risk. All the builders denied wrongdoing.

Freddie Mac's policy switch focused on the maximum premium split it would permit lenders to take when they participate in captive-reinsurance arrangements with mortgage insurers. Instead of the prevailing 40 percent, Freddie Mac set 25 percent as the limit, effective this June.

Why? Because Freddie Mac wants private insurers -- which backstop the billions of dollars of low-down-payment, high-risk mortgages it buys -- to have enough money readily available to handle rapidly rising claims. Plus, the company said, it wants to help mortgage insurers "rebuild" their capital bases in a climate of increasing losses.

Freddie Mac's move won't have an immediate impact on consumers, but the existence of premium-splitting side deals between mortgage lenders and insurers probably would be news to most home buyers and loan applicants. Though lenders say they disclose the arrangements, they often are boilerplate language in the paper blitz heaped upon consumers in settlements and provide no detail. HUD has not challenged captive-mortgage-reinsurance arrangements on legal grounds.

What's the larger context here, and are there any developments on the horizon to make mortgage transactions any more transparent or understandable? Some limited help appears to be coming.

Next month HUD is expected to announce a new approach to making mortgages and their inner workings and associated fees more intelligible. The plan is expected to require more effective disclosures and a standardized step-by-step "script" designed to ensure that loan applicants nationwide understand the mechanics, expenses and risks connected with their mortgages.

Whether the disclosures will force lenders, title companies and builders to come clean on where every customer's money is flowing is another story. But at the very least, the arrival of improved mandatory disclosures should encourage borrowers themselves to ask hard questions about every cost item, every fee: Who's getting this? Are there flow-back splits involved?

Is someone-- the lender, the broker, the settlement agent -- getting something out of my money beyond the settlement-sheet numbers?

Kenneth R. Harney's e-mail address isKenHarney@earthlink.net.