• Definition and Purpose
• Background and Evolution
• Key Cases to Watch
• Links to Publications
• Related Documents

Definition and Purpose

Mortgage default insurance (MI) is a specialized form of credit insurance or guarantee that protects mortgage lenders and investors, as beneficiaries, against loss by reason of borrower default on individual mortgage loans—most often loans secured by individual housing units. MI is not to be confused with mortgage life insurance, mortgage disability insurance, and mortgage payment protection insurance, which protect borrowers, as beneficiaries, by repaying some or all of their mortgage obligations in the event of borrower death, disability, or other defined loss of income such as unemployment. MI is also distinct from, though closely related to, “financial guaranty insurance,” which protects investors against losses from defaults on mortgage-backed securities (MBS) and bonds whose underlying collateral typically includes individual mortgage loans.

The benefits of MI, depending on an individual country’s needs and circumstances, can include:

• Increasing access to homeownership financing for borrowers of limited means

• Expanding lenders’ housing finance opportunity by reducing credit risks

• Helping to grow mortgage secondary and capital markets by attracting risk-averse investors

• Stimulating economic activity through increased housing construction

• Strengthening mortgage lending standards, standardization, and housing finance sector stability
  

Background and Evolution

Mortgage insurance and guarantee programs exist in more than 30 countries on all continents. Nearly two-thirds of all MI programs globally are government-sponsored, although program sponsorship and structure vary greatly and include privately capitalized firms, non-profit/NGOs, and a growing variety of public-private partnership arrangements. Most programs today are relatively small, with limited operating experience that has yet to include survival through a period of significant economic stress and falling home values.

Mortgage insurance began over 100 years ago in the United States as an adjunct to title insurance and was used to stimulate private investor interest in purchasing “guaranteed mortgages” from mortgage companies. All such guarantee programs failed with the advent of the Great Depression in the early 1930s due to inadequate reserves, ineffective regulation, conflicts of interest, and bad property appraisal practices.

Government-sponsored MI began in the United States in 1934 with the creation of the Federal Housing Administration and the Mutual Mortgage Insurance Fund. The primary purpose was economic and financial stimulus, via new housing construction. This unsubsidized FHA program has operated successfully for over 75 years.

The 1950s and 1960s saw government-sponsored MI programs initiated internationally, including in Canada, Australia, the Netherlands, the Philippines, the Dominican Republic and Guatemala. During these two decades, private-sector MI providers also began operating in the United States, Canada, Australia, and the UK.

In the late 1980s, established MI programs in some developed markets—both public and private—encountered severe economic stress, resulting in risk and financial management and regulatory reforms. Beginning in the late 1990s many new public and private MI programs were established in Europe, Africa, the Mideast, Latin America and Asia, in support of both primary lending and emerging securitization markets. The recent credit crisis is testing the staying-power of some countries’ MI programs.

Conditions and Coverage
 
Key success factors for a country-based MI program include:

• Functional legal and regulatory system for title registration, contract enforcement, financial institutions.

• Functional primary mortgage market, including loan underwriting, loan administration, transaction costs, property valuation
  

• Available information and data, including property sales prices, borrower credit, mortgage performance

• Government economic policies conducive to economic and financial sector stability, personal savings
  

• individual loan document review

• electronic document or data transfer, with automated approval based upon predetermined criteria

• underwriting approval authority delegated to the lender by contract, with periodic reporting and audit
  

• government-sponsored programs reinsured by private MI providers (e.g., Hong Kong, United States)

• private MI programs reinsured by a public MI provider (e.g., Canada)

• public sponsorship with joint public-private governance structure (e.g., the Netherlands)

• public and private financial support for special purpose NGO (e.g., South Africa) 

• “timely payment” or “cash flow” guarantees on loans in default, payable to MBS holders (e.g., the United States’ “Ginnie Mae” program)
  

• “mortgage payment protection” (MPP) insurance covers borrower’s monthly mortgage payments in the event of loss of income/employment (e.g., in Mexico, the UK, other European countries)
  

• “gap insurance” protects lenders against default-related losses during the interim period between loan closing and proper title and mortgage registration (e.g., in Poland)
  

• “mortgage life insurance” pays off the mortgage debt in the event of death of primary breadwinner. Such coverage is required by lenders in many developing markets.

Key Cases to Watch

Canada
The Canadian MI system has been increasingly recognized for its “best practices,” which include:

• statutory requirement for banks to use MI coverage on all high LTV loans

• government backing of private MI providers in the event of insolvency

• bank regulator use of MI underwriting limits to help prevent irresponsible lending
  

Links to Publications

European Mortgage Federation, Study of the Efficiency of Mortgage Collateral in the European Union, Brussels 2008