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Foreclosure investigation creeps into homeowners insurance market

The foreclosure crisis hit Florida pretty hard, and the state has seen its fair share of news stories about banks' sloppy documentation practices and robo-signing scandals. Regulators, consumer advocates and consumers themselves have taken mortgage companies to task for predatory lending, too. One state is pursuing banks for yet another questionable practice, this one involving homeowners insurance.

Two kinds of insurance figure in the purchase of a home. First, the homeowners policy protects the purchaser's investment in the house, the land and any personal property there.

The second kind of insurance, mortgage insurance, protects the lender's investment. If the homeowner defaults on the loan, and the home is subsequently sold at a loss, the insurance company will reimburse the lender a certain percentage of the loss. It's important to remember, though, that mortgage insurance is not mandatory if a homeowner's equity hits a defined threshold.

To illustrate, let's say Bob buys a $150,000 home with a $7,500 down payment. The lender's investment in Bob and his home is $142,500. If Bob defaults right away, and the home is sold at auction for $120,000, the lender's loss is $22,500.

Now, say the mortgage insurance policy covers 20 percent of any loss. The insurance company would cover $4,500 of the loss. The bank isn't left holding the whole bag.

Either the lender or the homebuyer can pay the premium. Most often, the premium is wrapped into the loan, and the homebuyer pays it as part of the monthly mortgage payment. When realtors and lenders talk about PITI, they mean principal, interest, taxes and (mortgage) insurance.

Lenders also prefer -- and some insist -- that homeowners maintain homeowners insurance coverage, too. The policy may only cover the homeowner's property, but, by doing so, it protects the lender. The homeowners policy will repair and rebuild the house, of course, but it will also offer financial protection to the homeowner so he can continue to make his mortgage payments.

This is where we turn to the force-placed policy -- in our next post.

Source: New York Times, "Big Banks Face Inquiry Over Home Insurance," Louise Story, Jan. 10, 2012

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