Managing Mortgage Insurance for Construction Loans

Episode 20 | The Construction Lending Podcast

Join us as mortgage insurance expert Kevin Hearden from MGIC breaks down the intricacies of MI in construction loans. We delve into activating and canceling MI, special considerations for the construction phase, and strategies for managing MI throughout the loan lifecycle. This is an essential guide to understanding the world of mortgage insurance for construction loans.

Episode Recap

Navigating the Nuances of Construction Loans and Mortgage Insurance
In the complex world of mortgage insurance (MI) for construction loans, we have the expert guidance of Kevin Hearden from MGIC. With 25 years of experience in the lending industry and 8 years as the director of product development at MGIC, Kevin unpacks the process of filing a claim, the nuances of foreclosure in construction lending, and how MI can safeguard lenders against borrower defaults.

We’ll explore the options available to lenders when a default occurs, such as taking ownership of the property or pursuing alternatives outlined by their policy. Kevin highlights the broad range of expenses covered by MI, beyond just the unpaid principal balance, including delinquent interest and attorney’s fees. In our discussion, we’ll also touch on the operational aspects of activating MI in construction loans, the differences between guidelines by Fannie Mae and Freddie Mac, and strategic considerations for lenders in managing mortgage insurance.

Mortgage Insurance: A Safety Net for Lenders
Mortgage insurance plays a pivotal role by protecting lenders against defaults in conventional loans with less than a 20% down payment. MI allows for lower down payments, making homeownership more accessible. As Kevin Hearden explains, MI specifically covers borrower defaults and does not address issues like builder non-performance, making the understanding of its scope essential for all parties involved.

The Claims Process in Default Situations
When defaults occur during construction, the foreclosure process begins, which Kevin outlines with clarity. He emphasizes that while foreclosure during construction is rare, lenders have several options at their disposal. These include taking ownership of the home, filing an insurance claim, or exploring other alternatives as provided under the policy.

Beyond the Loan Balance: What MI Covers
One of the significant benefits of MI, as discussed in the podcast, lies in its coverage extending beyond the unpaid principal balance. It can include delinquent interest, property taxes, attorney’s fees, and even property maintenance expenses, which are crucial during extended default scenarios.

Activation and Cancellation of Mortgage Insurance
MI can be activated at the closing of a standard mortgage or within a 12-month period specific to construction loans. Opting to activate MI upfront can circumvent certain requirements that might come into play after 180 days. However, some lenders might delay this activation due to competitive reasons, technological challenges, or a simple lack of comprehensive understanding of how MI functions during the construction phase.

When to Cancel: A Strategic Decision
Cancellation of mortgage insurance is another strategic area that lenders must maneuver carefully. Governed by the Homeowners Protection Act, MI typically cancels at a 78% loan-to-value ratio based on the original amortization schedule. However, lenders can choose to cancel it earlier under certain conditions, considering factors like property value appreciation, loan holding terms, and secondary market considerations.

The Construction Phase: Special Considerations
The podcast discussion shines a light on interest and contingency reserves in construction loans. While interest reserves generally do not count towards the loan-to-value ratio and cannot be funded through the loan for insurance eligibility, contingency reserves like cost overrun reserves are typically permissible. Lenders may have proprietary programs accommodating interest reserves, but these would not qualify for mortgage insurance structures.

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