Mortgage Insurance Shocker: Collections After Default

Homeowners who obtain low down payment mortgage loans are often required to pay monthly premiums for mortgage insurance (MI). Mortgage insurance helps protects lenders in case borrowers default by reimbursing some of the lender’s loss. But homeowners who purchase MI may not understand that if they lose their homes to foreclosure, the insurer may come looking to them to reimburse its losses.

“Basically, MI companies cover the lender’s loss during foreclosure. Since they cover this loss, they later are trying to seek reimbursement from the homeowner. The homeowner essentially owes the MI company money rather than the foreclosing lender,” explains Troy Doucet, an attorney with Doucet & Associates, LLC and author of 23 Legal Defenses to Foreclosure.

But Doucet isn’t convinced that this is clearly disclosed to homeowners when they obtain mortgages and agree to pay for MI, and he’s been representing clients challenging claims by mortgage insurance companies. He says private mortgage insurance companies, Fannie Mae and Freddie Mac, and even the federal government (for FHA and VA loans) are going after homeowners for these losses.

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“I’d frame it this way,” he says. “A mortgage insurance company shouldn’t be able to collect against a borrower any more than her auto insurance company could collect against her after paying an auto claim on her behalf.”

“This is a poorly understood area,” agrees R. Wilson Freyermuth, a law professor with the University of Missouri. But he believes it’s “misunderstood by consumers.” They think, “I am paying this and I must be paying it for my own benefit. But private mortgage insurance is really insuring the lender and not the borrower. When the private insurer has to pay off the lender because it suffered a loss, that loss will typically be passed on to the borrower.”

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Subrogation is the basic principal behind these transactions. Subrogation is defined as:

the act of subrogating; specifically : the assumption by a third party (as a second creditor or an insurance company) of another’s legal right to collect a debt or damages. (Mirriam Webster dictionary)

In other words, the right to collect is subrogated to, or assumed by, a third party, often an insurance company.

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Using an auto insurance example, Freyermuth poses a hypothetical scenario:

“Suppose I have a policy with State Farm. You are driving drunk and run into me, and you are uninsured. State Farm pays me off. They become subrogated and can come after you to the same extent that I could have.” Then why don’t auto insurance companies routinely go after their customers when they have to pay claims? He explains: “My (own) insurance company can’t (generally) subrogate a claim back against me.”

In the case of mortgage insurance, the insurance is for the benefit of the mortgage company, not the borrower. That’s why a borrower who pays the mortgage insurance premium may be pursued for payment by the mortgage insurer after a claim is paid.

If It Happens To You

What happens if you’ve lost your home and are now being hounded by a mortgage insurer, Fannie or Freddie, or a governmental agency?

“Before taking any course of action, the best advice I can offer is to contact your lender and then consult a real estate attorney regarding your rights,” says Andrew Schrage, co-owner of Money Crashers Personal Finance. He adds, “If you end up owing money, just be sure that you aren’t paying twice. If your original lender received money by filing a PMI claim and later sells your mortgage, there are situations where you won’t have to pay this amount to the new lender.”

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Getting good legal advice is essential, agrees Doucet, who says, “People jump out of the frying pan and into the fire” when they walk away from or lose their homes. Whether or not the insurer or guarantor can pursue the borrower depends on a number of factors including whether the loan is a recourse or non-recourse loan, as well as whether the statute of limitations for collecting on deficiencies has already passed. If a mortgage insurer is threatening a lawsuit, or has already obtained a judgment against the borrower, it may make sense to talk with a bankruptcy attorney.

As the losses to lenders and insurers pile up, homeowners may find that those mortgage insurance premiums they’ve been paying will be used to collect from them.

Image: Krystian Olszanski, via Flickr.com