Correct calculations at a premium

This week&#39s column completes my look at the use of calculations in answering questions in the mortgage advice examinations. Questions on mortgage indemnity guarantees or high percentage lending fees as they are called in the Mortgage Code, are not uncommon.

MIG is a single premium policy that is often arranged by a lender if the LTV ratio exceeds a certain level. This threshold varies from lender to lender but is usually between 75% and 90%.

MIG is regarded as additional security as it protects the lender in the event of a property being taken into possession and being sold for less than the outstanding debt. Although the premium is often paid by the borrower the policy offers no benefit to him except for the fact that without it he would not be able to borrow such a high amount. Some lenders will allow a MIG premium to be added to the mortgage advance, rather than being paid upfront. However, in recent years, more and more lenders have either dispensed with MIG altogether or taken to paying the premiums themselves. This is one of a range of incentives that lenders sometimes make available to attract new business.

If an insurer pays out on an MIG claim made by a lender, the insurer is entitled to exercise its right of subrogation i.e. to sue the borrower for recovery of the amount paid to the lender. For many years MIG claims were almost unheard of. However, when lending policies were relaxed in the 1980s and this was followed by a substantial fall in property values, claims became more commonplace.

This led to discussions between lenders and MIG insurers which resulted in the Association of British Insurers issuing guidelines for the handling of MIG claims. These guidelines allowed insurers to insist that lenders adopt certain mortgage underwriting standards before policies are underwritten. Irrespective of whether a particular lending decision has been based on the accepted criteria, the insurer has a right to impose a 20% excess on any MIG claim made. The following question is taken from a CeMAP two specimen question paper.

If the guidelines produced by the ABI were strictly applied, how much of a mortgage indemnity claim for £30,000 is likely to be paid?

(a) £18,000 (b) £21,000 (c) £24,000 (d) £30,000

The strict application of the ABI guidelines would result in a 20% excess being applied to the claim. Therefore, if a valid claim for £30,000 was made, an excess of £6,000 would be applied. This would result in a payment of £24,000 (option c).

This next question is also taken from a CeMAP two specimen question paper:

Amy is planning to purchase a property priced at £110,000 with the help of a mortgage for £85,000. The lender&#39s valuer has valued the property at £105,000. If the lender requires an MIG if the loan-to-value ratio exceeds 75%, how much of Amy&#39s loan will need to be covered by a MIG?

(a) None (b) £2,500 (c) £4,500 (d) £6,250

The lender will base the MIG calculation on the lower of the purchase price or the valuation. In this example the valuation is lower than the purchase price. This a common situation that is encountered in CeMAP questions of this type. Consequently, Amy is able to borrow up to 75% of the valuation price i.e. £78,750 without a MIG being required. However, she requires a mortgage advance of £85,000. Consequently, the difference between the two figures i.e. £6,250 (£85,000 less £78,750) is the amount of the mortgage advance that will need to be covered by an MIG (option d).

Sometimes a question may go a stage further by asking candidates to calculate the premium payable in respect of an MIG. If the above question also provided the information that the premium payable on the amount covered by the MIG was 7%, it would be a straightforward matter to calculate that the premium payable is £6,250 x 7% = £437.50.

I am grateful to the Institute of Financial Services for granting their permission for me to reproduce the above questions which have been taken from CeMAP specimen question papers.