"You hope your buddies will win so you don't have to loan them any money."
Chris LeDoux
Mortgage insurance offers the lender some protection for the loan made to the home owner. That's the simple explanation. The more difficult truth is how, when mortgage values have collapsed as much as they have in recent years can these insurers make good on their commitments?
The losses these lenders insure themselves from can be difficult to calculate if the value of the home has diminished. Many people are paying a premium for insurance that is out-of-whack with the value of the house, even as the loan has remained. Here's how the product works. You buy a home for $150,000 and because you do not put more than 10% down, the lender understands that the risks are higher of default. Traditional loan requirements suggest that the borrower pony up 20% of the home's value. But even in these slower economic times, lenders are willing to finance a home on less. BUt they require some of the risk be offset by insurance.
Unable to make the standard down payment, the lender requires the borrower to pick up the difference in insurance. So the borrower needs to insure the mortgage for the difference (10% down or $15,000 in our example brings the loan value down to $135,000). But the lender requires the insurer to cover more than the missing 10% down. To limit the borrowers chance of default, the lender requires insurance in excess of the remaining mortgage, often 25% of the remaining balance. This leaves the insurance company (in our example) covering $33,750 and giving the lender coverage on the property (with a mortgage of $101,250).
The borrower can rid themselves of this payment, which is added to the mortgage payment (in many cases, with the smaller downpayment, the taxes and insurance are required to be paid for from an escrow account) by proving the house is worth more than the original sales price making the downpayment plus the increased value appear to be larger than the 20% of the loan. Not easy in these times.
The problems isn't so much with the borrower or even the lender. It is with the ability of the insurer to make good on their portion of the process. In other words, the economic problems facing the industry (increased foreclosures, refinances at 125% and even defaulted payments) have put pressure on the reserves (collected by the premiums) these insurers are required to have.
On October 20th, 2011, the Washington Post reported that "Insurance regulators in Arizona have seized the main subsidiary of private mortgage insurer PMI Group Inc., which will begin paying claims at just 50 percent."
This could present problems for the industry moving forward. Agnes T. Crane, writing for Reuters Breakingviews suggested: "bad practices prevalent in the good years bear a good part of the blame. For instance, as lenders loosened their credit standards during the boom, many mortgage insurers felt compelled to give banks a share of their premium income. That left the insurers with a smaller cushion to weather losses from claims during the housing collapse."
None of this good news for borrowers, those looking to refinance or those hoping that the government will step in with favorable terms for troubled mortgages. If you have a loan with private mortgage insurance, keep current. If you are looking to buy a home, expect to pay more. If you are looking to refinance, the costs could escalate as the problem within the industry unfolds.
