American International Group Inc's mortgage-insurance subsidiary plans to launch a product next month that will independently review and store loan paperwork for a fee, the latest attempt to cut down on the battles between banks and insurers over bad mortgage loans.

Banks that agree to use United Guaranty Corp's CoverEdge will pay a 10 to 15 percent fee in exchange for a full review of mortgage documents, both before and after loan closing. The fee will likely be passed on to borrowers as part of closing costs.

United Guaranty will independently verify borrowers' credit scores, payment histories and income, as well as home appraisal values and other details that are viewed as predictors of loan performance. The insurer will also act as a repository for the paperwork, which can be accessed when claims arise.

This would be a second set of eyes and ears on the loans to ensure everything is 100 percent correct, Eric Martinez, chief executive of United Guaranty, said in an interview.

One of the biggest problems we have today in the mortgage community is, we don't know if a loan is good or bad until it goes to claim or goes delinquent, he said. This is designed to stop the bad loans from entering the system in the first place.

Fannie Mae has agreed to purchase loans that have been vetted by the CoverEdge program, while Freddie Mac is reviewing the product, United Guaranty said. Their approval is key to widespread use of CoverEdge, since banks sell most of their loans to the mortgage-finance companies.

Real Estate Mortgage Network, a lender based in River Edge, New Jersey, has agreed to test the program in a pilot period through March before a national roll-out in the spring.

Banks and mortgage brokers already perform such reviews when underwriting loans, but their practices became sloppy during the mortgage-lending boom. The resulting paperwork errors, missing documents and, in some cases, alleged fraud, have created an industry-wide battle among banks, bondholders, insurers and government agencies over who should foot the bill.

U.S. banks including Bank of America Corp , JPMorgan Chase & Co , Wells Fargo & Co and Citigroup Inc have spent $35.5 billion since mid-2010 on repurchasing mortgage-backed securities (MBS) from investors who said loans breached representations and warranties in contracts, according to Inside Mortgage Finance.

United Guaranty became the biggest underwriter of new mortgage insurance last quarter. It now has a 25 percent share of the market, according to Guy Cecala, CEO and publisher of Inside Mortgage Finance.

While its performance has improved, the business still reported a $66 million pre-tax loss for the first nine months of 2011, with $3 billion in reserves for future claims.

Rescissions and denials of claim have been a huge issue for lenders, Cecala said, which could make CoverEdge attractive to banks. But the key challenge will be keeping prices down for borrowers, especially if United Guaranty's competitors do not adopt similar documentation services.

I think there will be demand for it in the market, said Cecala. But is it a game changer that will lift United Guaranty way over its competitors? No.

(Reporting By Lauren Tara LaCapra, editing by Dave Zimmerman)

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