Credit Scores and Credit Reports, by Evan Hendricks

Chapter 15

Mortgage Insurance

You say potato and I say 'po-tah-to,'
You say tomato and I say 'to-mah-to;'
Potato, po-tah-to, tomato, to-mah-to

- George & Ira Gershwin
"Oh, Let's Call The Whole Thing Off!"

In 1998, in a little-noticed action, the Federal Trade Commission staff warned the mortgage insurance industry that it needed to give homebuyers adverse action notices whenever their credit reports caused a mortgage insurer to deny coverage.

The FTC considered the issue after a lawyer representing the Mortgage Insurance Companies of America asked the FTC whether mortgage insurers were exempt from giving adverse action notices under the loophole in the Fair Credit Reporting Act.

"No," was the basic answer of Clarke Brinckerhoff, an FTC staff attorney who specializes in credit reporting. Brinckerhoff summed up the industry's position, and then shot it down.

"You support your belief that a Mortgage Insurer should not be required to provide this notice with (1) a legal argument that the section does not apply where a mortgage insurer declines to insure a consumer residential loan based on the credit report on the applicant, and (2) a policy argument that consumers will be confused or distressed by the notices. We disagree," Brinckerhoff wrote.

"In our view, the plain language of Section 615(a) requires mortgage insurers (MI) to provide notice. First, an MI takes 'adverse action' — in both the common sense and legal definition of that term — when it declines to extend insurance coverage that is a prerequisite for approval of the consumer's residential mortgage loan application... An MI's refusal to insure a consumer loan is certainly a 'denial in connection with the underwriting of insurance,'" he wrote.

"First, the reason the MI is allowed to obtain a report on the loan applicant is because FCRA Sect. 604(a)(3)(C) provides a permissible purpose 'in connection with the underwriting of insurance on the consumer.' Second, the party evaluated by the MI is the consumer. Third, the premium when coverage is granted is paid by the consumer."

"Finally, we are unpersuaded by your policy argument that consumers will be confused by receiving the notices... We believe that the benefit provided by the notice... outweighs any problems that might arise when consumers get the notice."

Brinckerhoff's analysis was logical and straight-forward. However, while it said notice was required when coverage was denied, it was silent on whether notice was required when rates were raised because of information in a credit report. That issue would return another day.

Established Industry, New Controversy

Mortgage insurance grew in popularity during the home-buying boom of the late 1990s. It was used mostly by first-time homebuyers and others who could not make a full 20-percent down payment and therefore need to have their mortgage insured against default. Each year, an estimated one million homebuyers pay for mortgage insurance.

In January 2003, Anthony and Alethea Preston were sitting at the settlement table in Clermont, Florida, about to close on their mortgage. But they were shocked to learn that the deal could not go through unless they agreed to pay a monthly mortgage premium of $762.29. No explanation was given. Their investigation later revealed that the mortgage company, Flagstar Bank, had passed their credit report and/or credit score to Mortgage Guarantee Insurance Corporation (MGIC). MGIC allegedly came up with the $762.29 figure after reviewing the Prestons' credit report.

The Prestons ultimately sued MGIC under the FCRA for not providing an adverse action notice. The Mortgage Insurance Companies of America (MICA), the industry trade association, filed an Amicus brief supporting MGIC's argument that mortgage insurers did not have to comply with the FCRA's adverse action requirement for insurance.

The mortgage insurance industry disagreed that the FCRA required its member companies to give adverse action notices when a consumer's credit report resulted in higher rates. In the kind of highly technical argument that high-paid lawyers are known for, the industry contended that mortgage insurance wasn't really an "insurance transaction." Instead, they argued, it was part of the mortgage-granting process and it was really a "credit transaction." Thus, mortgage insurance fell within the so-called "counter-offer" loophole for creditors. Under that loophole, creditors who raise rates because of credit reports don't have to give adverse action notices when they counter-offer at a higher rate, and the counter-offer is accepted by the consumer. No such loophole existed for insurers. (What's more, even the creditor's loophole was somewhat closed by the 2003 Amendments to the FCRA: any significant increase in an interest rate based upon a credit report would require a "risk-based" pricing notice, regardless of whether or not the consumer accepted the counter-offer.)

On December 19, 2003, U.S. District Judge Wm. Terrell Hodges ruled that under the plain meaning of the FCRA, the Prestons' arrangement with MGIC was an "insurance transaction requiring an adverse action notice. The ruling cleared the way for a trial.²⁴⁴

Moreover, Judge John Steele, also of the Middle District of Florida, rejected arguments by PMI, another major mortgage insurer, that it did not have to give adverse action notices.²⁴⁵ Both cases were pending in March of 2005 when this book went to print.

²⁴⁴ Tony Preston & Althea Preston, et al. v. MGIC: U.S. Dist. Ct. - Middle Dist. Of Florida (Ocala Div.) No. 5:03-cv-111-Oc-10GRJ; December 19, 2003. The Prestons were represented by Terry Smiljanich, of James, Hoyer, Newcomer and Smiljanich, of Tampa, Florida. However, Judge Hodges declined to certify a class action.
²⁴⁵ Clayton Glatt, et al. v. PMI Group, Inc., et al: U.S. Dist. Ct. - Middle Dist. of Florida (Ft. Myers Div.) - No. 2:03-cv-326-FtM-29SPC; January 2, 2004.

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