M.I.s and P.I.s
If Bank of America Corp.'s allegations against MGIC Investment Corp. are any guide, mortgage insurers are going the extra mile to find evidence to deny claims.
According to the lender, MGIC sent investigators to track down and interview defaulted borrowers, and it dug up tax returns and bankruptcy filings, all in an effort to prove the borrowers misrepresented their incomes or their intentions to occupy mortgaged properties.
In a complaint filed in the Superior Court of California in San Francisco this month, B of A alleged that MGIC is denying "millions of dollars in valid insurance claims" the lender has submitted for defaulted mortgages. The complaint essentially argues that MGIC has no right to deny coverage because it was intimately familiar with the underwriting standards at Countrywide Financial Corp. (which B of A acquired last year).
At the center of the dispute is the interpretation of the insurance policy's "incontestability provision." B of A argues that, under its policy, MGIC can't rescind coverage unless the insurer can prove the lender was aware of or involved in a misrepresentation. But the lender says MGIC has taken the position that the lender must prove it didn't know about the misrepresentation if it wants to collect on a claim.
If that burden of proof were on the lender, it stands to reason that the insurer would have a lot more to gain by looking for evidence of misrepresentation. That may help explain MGIC's alleged use of investigators.
The complaints allege that much of the evidence MGIC relies on in rejecting claims are "second or third hand accounts of one-sided, self-serving and/or unsubstantiated hearsay," including "post-default statements by borrowers, obtained by MGIC through its investigators, who have an incentive to shift blame by implicating a first party."
The lender claims MGIC also relies on "unauthenticated documents of questionable veracity, such as tax and bankruptcy-related documents, even though MGIC knows these documents may have a downward bias, i.e. borrowers have an incentive to understate income and ability to pay debts."
Complicating matters is the fact that a substantial number of the claims MGIC is rejecting are for mortgages that Countrywide underwrote — allegedly with MGIC's approval — without independently verifying the borrower's income information.
The complaint says MGIC has also denied claims or rescinded coverage claiming the borrower misrepresented the value of the property. The insurer bases these claims on "review appraisals" performed well after the loans were made.
"It is not sufficient simply to show that a second appraiser has a different opinion, particularly when the second appraiser's opinion was developed with the benefit of hindsight," B of A said in the complaint.
The lender claims these review appraisals "cherry-pick" comparables and make adjustments so as to support unreasonably low value opinions.
Shifty Short Sales
Even as the Treasury Department encourages some borrowers to pursue short sales to avoid foreclosure, the Federal Housing Administration seems a bit leery of the practice.
In most cases, borrowers who sell their house for less than the balance of their mortgage are barred from getting a new FHA-insured mortgage for three years. But the agency must be getting a lot of queries, because it issued guidelines last week spelling out the limited circumstances under which FHA lenders can make exceptions to that rule.
It said borrowers are eligible for a new FHA loan if they were current on their mortgage (and other debts) at the time of the short sale and the mortgage holder accepted the proceeds from the sale as payment in full. If the lender is still chasing after the borrower for debt not covered by the short sale's proceeds, she doesn't qualify for FHA financing.
In certain circumstances deemed to be beyond a borrower's control, such as the death of a primary wage earner or long-term uninsured illness, she can get a new FHA loan even if she was in default at the time of the short sale. But that's only if a review of her credit report indicates her credit history was "satisfactory" prior to these circumstances.
FHA will also insure the first mortgage in a "short payoff" — that is, a refinancing where the existing noteholder writes off the amount of debt that, due to a decline in property value or income, cannot be refinanced into the new mortgage. But again, the borrower must be current on loan payments.
Further, borrowers are not eligible for a new FHA loan if they pursue a short sale simply to take advantage of a tanking market and purchase a similar or larger property nearby at a lower price, the agency said.
Of course, that raises the same question as in the B of A-MGIC case: How is a lender to know the borrower's intent?
"Do you think billionaire investor Sam Zell feels any guilt or shame because his buyout of the Tribune Co., which had $12.9 billion in debt, ended in a Chapter 11 filing last December? Rather than worry about whether Americans will take cues from modest homeowners who make a tough decision not to stay current on debt, perhaps we should worry about middle-class Americans taking cues from billionaires and Fortune 500 companies who make the rational decision not to stay current on debt."
— The writer Daniel Gross, in a Dec. 21 Newsweek column.