Responding to a challenge from Fannie Mae, Mortgage Guaranty Insurance Corp. of Milwaukee this week rolled out two low-cost products to insure loans with very low down payments.

The announcement came just weeks after Fannie said it would reduce insurance requirements for such loans to 1994 levels.

Fannie also said it would let borrowers further lower their coverage-and hence their premiums-in return for an up-front fee or a higher interest rate. If they chose this option, Fannie Mae itself would buy additional coverage.

Consumers who chose a higher note rate would, in effect, trade a nondeductible insurance expense for deductible mortgage interest.

The option-dubbed "lowest-cost MI"-has caused some consternation in the mortgage industry, however. Some lenders fear it would require them to rejigger their systems, and that it could change their relationship with the insurers.

MGIC says its products could lower costs for borrowers, as Fannie Mae wishes, without any disruptions. "We can do it in a manner that is more operationally efficient for lenders," said Curt S. Culver, the new chief executive officer of MGIC. "It fits more into how they do their business."

Under one of the two new options offered by MGIC, the borrower could roll part of the premium into the loan balance and pay a lower-than-normal monthly premium. Fannie Mae's plan does not allow the borrower to finance the premium as part of the loan balance.

The other option lets borrowers pay an even lower monthly premium by adding the difference into the interest rate. This option, MGIC said, would let the lender continue to adjust interest rates in eighths of a percentage point.

Under Fannie Mae's proposal, part of the premium could be included in the note rate: The rate on a 7% loan would increase to 7.08% or 7.15%, depending on the size of the down payment. Lenders whose systems adjust in eighths would have to increase the rate further to 7.125% or 7.25% in order to sell the loans in the secondary market, a spokesman for MGIC said.

A Fannie Mae spokesman said that the government-sponsored enterprise was unfamiliar with MGIC's plan, but that Fannie Mae applauds any initiatives by mortgage insurers to reduce costs to consumers.

Both of MGIC options would keep overall coverage at the 1994 levels, so the potential for lenders to make money through captive reinsurance will not be diminished, the MGIC spokesman added.

Fannie's "lowest-cost MI" option uses a structure similar to the "Flexible 97" loan it created last year. That program allows borrowers who put only 3% down to pay a lower premium in return for a delivery fee or higher interest rate. There, too, Fannie purchases additional coverage for those loans from MGIC and Commonwealth Mortgage Assurance Corp.

The new program applies the same principle to borrowers who put 5% or 10% down. But MGIC will not be providing the additional coverage, Mr. Culver said.

By purchasing that extra layer of coverage itself, Fannie would make the lender a less important customer to the insurer, said Mark Constant, analyst at Merrill Lynch & Co.

Mr. Culver, 46, was recently promoted to CEO from chief operating officer. Chairman William Lacy, 54, relinquished the chief executive title and will focus more on finding new business opportunities for MGIC.

MGIC is the top mortgage insurer, with 23.4% market share. Mr. Culver says he wants to increase that. But he is focused on lowering expenses, particularly for contract underwriting expenses.

At the end of last year, MGIC's ratio of expenses to revenues was 18%, down considerably from 30% in 1991 but virtually unchanged from 1997.

"As we get lesser coverages we need to be more efficient in how we do things to return the same levels of profitability," Mr. Culver said.

Reflecting the realities of the need for cost savings in an increasingly competitive industry, CMAC announced plans to merge with Amerin Guaranty late last year. Mr. Culver said he expects consolidation of mortgage insurers to continue.

He wouldn't comment on whether MGIC intends to buy or merge with another company, but said the shrinking playing field benefits those companies left in the game.

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