Fix a flood insurance shortfall

Must borrower boost coverage after lender’s mistake?

Mortgages are complicated instruments subject to a myriad of rules and regulations from the many private parties and government entities that are involved. With so much complexity, mistakes are inevitable.

Q: Last December I did a refinance, which required a flood insurance policy on my home. Everything was fine when, out of the blue, I receive a letter from the bank that purchased the loan stating that I needed to increase the coverage on my flood insurance policy within 30 days or the bank would buy the additional coverage for me. Can the bank do this when the policy I bought met the requirements of the lender I dealt with?

A: This letter is typical of many that I receive about mistakes committed by lenders. First, the mistake arose out of the complexity of a process involving multiple players. The lender was required, as a condition of granting a mortgage, that the borrower purchase flood insurance, because the property was located in an area designated a Special Flood Hazard Area by the Federal Emergency Management Agency (FEMA).

The required coverage, which the originating lender did not get right, is set forth in the Flood Disaster Protection Act.

Another common feature of the letters I receive from borrowers about mistakes is a presumption on their part that because the mistake was not theirs, they should not be required to bear any of the cost of fixing it. That is not the case.

While there are exceptions, in general the law does not allow a borrower to profit (or avoid loss) from a lender’s mistake.

A third common feature is that ownership of the mortgage changed hands before the mistake was discovered. This shouldn’t matter, except that it seems to strengthen the borrower’s presumption that the cost of a fix is someone else’s problem by identifying who that someone is (the originating lender, for example). If the mortgage had changed hands more than once, as is often the case, resolution could become even more complicated.

I advised the borrower in this case to take the path of least resistance, which was to buy the additional coverage and avoid further hassles. I warned her that if the current lender purchased the additional coverage, it could cost her two or three times as much. I also pointed out that the originating lender had no self-serving reason to have her buy inadequate coverage. On the contrary, it exposed that lender to a possible buyback demand from the purchasing lender.

Taking an ex off the hook

Q: You break up with the one you have been living with, and part of the break-up agreement is that you get your ex removed from the loan so that she is no longer liable. Is there any way to do that, aside from refinancing?

A: The only way is to induce the lender to take her name off. That isn’t easy because, from a lender perspective, taking her name off the note weakens it.

What is in it for the lender?

If you have a $1 million deposit or trust account at the bank that holds the mortgage, they would probably do it for you, but that is very uncommon. Most loans are serviced by firms that don’t own them, and these firms don’t have discretion to make changes in the note unless the changes are in the interest of the owner.

The one point of leverage that you may have is that you will refinance if you can’t get her name off the note, which means that the owner would lose the loan. In such case, the servicer might agree if you can demonstrate that you have the assured capacity to make the payments on your own. Documenting that you have in fact been making the payments on your own for a year or more would probably do the trick.

Use a reverse mortgage to repair a home?

Q: I heard a financial expert on the “Today Show” say that using a reverse mortgage to fix up a house was a terrible idea. Do you agree?

A: No, I read the statement and it makes no sense.

Reverse mortgages are for elderly homeowners who need income and are not concerned with the size of their estate. How the additional income will be used, so long as it is the considered judgment of seniors in full command of their faculties, is totally irrelevant. If, rather than leaving the equity in their homes to heirs, they prefer to fix them up, or take a trip around the world, or raise orchids, it is their call to make. Second-guessing the call is presumptuous, to say the least.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.