Automated mortgage insurance cancellation is a dangerous plan

David Paul Morris/Bloomberg

A recent proposal published here ("The FHFA could save borrowers billions with automated PMI cancellation," Jan. 15) by two former Freddie Mac employees to use automated valuation models, or AVMs, to cancel private mortgage insurance, or MI, prematurely is a short-sighted and risky move that could threaten housing affordability and financial stability in the mortgage finance system. The proposal would create new risk and financial loss exposure for the government sponsored enterprises, or GSEs, which have benefited from taxpayer support in the past, and could make homeownership less affordable for prospective borrowers at exactly the wrong time.

Private mortgage insurance provides critical benefits to homebuyers, lenders, taxpayers and the stability of the mortgage market. In 2023, despite high interest rates and home prices, private MI helped 800,000 low-down-payment borrowers — nearly two-thirds of whom were first-time homebuyers — qualify for home financing. Today, more than $1.4 trillion in GSE-backed mortgages are protected by MI coverage, which has paid nearly $60 billion in claims since the GSEs entered conservatorship.

Importantly, while the proposal comes from two ex-Freddie Mac employees, it does not reflect the official position of their former employer. Still, the authors of the ill-conceived proposal are among the inventors of Freddie Mac's proprietary AVM, and now propose adapting the technology to cancel MI automatically. This would supplant the current, well-functioning framework that was first established under the Homeowners Protection Act and already allows a homeowner to cancel coverage after 20% equity in the mortgage's loan-to-value, or LTV, ratio is established.

There are clear reasons why this proposal should be rejected. For starters, it creates immediate risk exposure to Fannie Mae and Freddie Mac. This proposal would expose the GSEs and taxpayers to new, unnecessary risk by binding the cancellation of MI to estimates of current home prices generated by models, which can have varying degrees of accuracy. Policymakers have consistently emphasized the need to reduce GSE and taxpayer exposure, particularly to home price volatility. Shifting risk that private mortgage insurers cover to the GSEs runs counter to this objective.

The proposal would also make homeownership less affordable for new homebuyers. Polling consistently shows that the biggest obstacle for prospective homebuyers is the down payment, not the cost of MI. MI is a temporary cost with clear rules for cancellation already in place and allows borrowers to achieve homeownership with a down payment as low as 3%. Furthermore, publicly available data shows that MI costs have been declining, particularly relative to other homeownership expenses, such as property taxes and property insurance.

Unlike other lines of insurance where premium rates are adjusted annually, MI premium rates are fixed for the life of the policy. Actuarial principles underlying insurance require that the costs associated with claim payments be spread across the premium collected over the life of the policy. Ultimately, increased risk and capital costs of automatically shortening MI duration would be passed on to prospective borrowers — a counterproductive outcome at a time when housing affordability remains a pressing issue.

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Additionally, reducing private MI coverage would undermine the GSEs' efforts to build the capital necessary to exit conservatorship. Indeed, the Enterprise Regulatory Capital Framework, or ERCF, provides loan-level capital relief to the GSEs for loans with MI coverage and prematurely canceling coverage increases the GSEs' required capital on high LTV loans. Furthermore, it also undermines the integrity of Credit Risk Transfer, or CRT, transactions, since existing securities were initially priced and issued to the market with MI and assumptions based on MI coverage.

Lastly, it runs counter to the intent of the GSEs' congressional charter requirements. Under their statutory charters, Fannie Mae and Freddie Mac are prohibited from acquiring loans originated with less than 20% down unless those mortgages have credit enhancement (e.g., private MI). Canceling coverage before the thresholds established under the Homeowners Protection Act risks prematurely reclassifying high LTV loans — a real possibility given that AVMs have standard deviations — running counter to the intent of the GSEs' congressional charters.

If policymakers genuinely wish to assist low- and moderate-income borrowers with high LTV mortgages, there is a proven, and far simpler, way to put some hard-earned money back into the pockets of the working-class homeowners — reinstating the expired MI premium tax deduction. From 2007 to 2021, an average of 3.4 million homeowners annually claimed this deduction, amounting to $64.7 billion in total benefits. In its final year, homeowners received an average deduction of $2,364.

This tax policy directly benefits working-class homeowners, offsetting homeownership costs without compromising the critical risk protection provided by MI and without decreasing upfront affordability for new homebuyers looking to enter the market. Reinstating the deduction would provide meaningful relief to borrowers without introducing new risks to the GSEs or taxpayers.

Private mortgage insurance plays an essential role in ensuring access to homeownership while utilizing private capital to protect against risks. Proposals to prematurely cancel MI coverage expose the GSEs and taxpayers to unnecessary risk and undermine efforts to improve affordability for new homebuyers. Policymakers should reject this ill-conceived proposal and instead prioritize reinstating the MI premium tax deduction, a proven tool that supports homeowners and preserves the integrity of the housing finance system.