Next bank scandal? Forced-place insurance
Imagine how you'd feel if your mortgage lender bought a new homeowners insurance policy for your home -- then billed you $33,000.
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 their security. So your lender ensures that you have 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, including your retirement account's 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 homeowners 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 Sultan 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?
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.
Sultan maintains she never received any notice of the forced-place policy purchased on her behalf, nor did she need it -- she had never let her insurance lapse. But even if she didn't have insurance and ignored warnings from her mortgage servicer or 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 Sultan's suit refused to comment, citing pending litigation.
While Sultan isn't in foreclosure, that's the situation where you'll most often encounter forced-place insurance these days. When homeowners stop making mortgage payments, they often stop making insurance payments, which means the mortgage servicer buys forced-place insurance.
Then there are those who might be close to foreclosure. One expense they may attempt to temporarily forgo in order to make ends meet is insurance. If they're in a home like Sultan's, they could 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.
Who wins? The mortgage servicer does. While the mortgage service company may have originated the 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, 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? Not only the homeowner, but the mortgage owner, who is at risk of not being fully repaid. When a house is sold at a foreclosure auction, the mortgage holder will get whatever money is left after expenses -- which could include the inflated cost of forced-place insurance.
Many people might say, "So what?" because they assume that the big banks 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, 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.
Who does own the trillions of dollars in mortgage-backed securities generated by Wall Street? 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 argue that the banks' lax lending standards caused the housing crisis to begin with -- one that required a multibillion-dollar taxpayer bailout. Now many of the same banks, in their role as loan servicers, are making a killing with self-serving insurance transactions.
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 pick up on it.
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.
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