A new law to terminate mortgage insurance may act as a slight brake on future prepayments of mortgage-backed securities. The law, which goes into effect next month, also requires that lender-servicers keep borrowers posted on the status of their mortgage insurance.
For mortgages originated after July 29, the newly enacted law requires automatic termination of private mortgage insurance when the loan-to-value ratio drops to 78% in most cases.
"The law is mildly good for prepayments, but the effect would be very difficulty to quantify," said Bruce Kramer, a managing director at Bear, Stearns & Co.
The prepayment maven said any slowing effect would center more on cusp coupon mortgages, those borrowers holding loans with mortgage rates that are less than 40 basis points more than the prevailing mortgage rate in the marketplace.
Under current law, when the savings from refinancing is small - 40 basis points or less - the added savings achieved from dropping mortgage insurance at the same time, once it's allowed, can play a deciding factor in a borrower's decision to refinance. For example, a couple might find it economically advantageous to refinance for a 20 basis-point cut in the note rate of their mortgage if they could also at the same time stop making mortgage-insurance payments.
But with the new law, Kramer said, this "unseen" economic advantage of simultaneously shedding mortgage-insurance payments would not be a factor in the refinancing decision. And by removing this unseen advantage that comes from shedding mortgage insurance, the new law will probably have a slightly dampening effect on cusp prepayments, Kramer said.
Kramer said that borrowers who had a substantial economic incentive to refinance (50 or more basis points) probably do not consider the impact of mortgage-insurance payments, since the reduction in mortgage rate would be compelling on its own merits. He expects that the new law will have little or no impact on borrowers with a large incentive to refinance.
Further, the law, the Home Owner's Protection Act, provides for annual notifications for both new and existing mortgages. A yearly written statement must tell the borrower under what circumstances private mortgage insurance can be canceled. - ES