Mortgage Insurance Primed For a Comeback?
In the mortgage industry, the magic number is 80 percent.
Peter Boutell writes in the Santa Cruz Sentinel how mortgage lenders are comfortable loaning up to 80 percent of the value of a home.
They decided long ago that the 80 percent loan-to-value ratio [LTV] is as high as they wanted to go without being compensated for the increased risk.
A big obstacle to home ownership has always been coming up with the down payment, and it is not surprising that borrowers have pushed lenders to provide them with the ability to buy a home with less than 20 percent.
Lenders agreed that they would loan more than the standard 80 percent of the sales price of the home if they could be assured that they would not lose money in the case of a foreclosure.
Based on that premise, the mortgage insurance industry [sometimes referred to as private mortgage insurance or PMI] was created specifically to help mitigate that risk.
Mortgage insurance has been around for 50 years and is designed to protect the lender from a loss if and when a mortgage lender has to take back the property and sell it in a foreclosure.
In California, when a borrower fails to meet his pay back obligations under the terms of the promissory note, the lender will take back the property and sell it to the highest bidder.
When the mortgage lender has loaned out more than 80 percent of the value of the home, there is an increased likelihood that it may not be able to sell the home for what is owed on it.
When the lender has to sell the home for less than owed on it, a mortgage insurance company will reimburse the mortgage lender for losses incurred in the forced sale.
Mortgage insurance companies work similarly to other insurance companies. They collect a monthly premium from the borrowers and pay out to the lender when there is a loss.
The premium that a borrower must pay for insurance depends on the LTV ratio and type of loan. A 90 percent fixed-rate home loan will require a premium that adds about one half of 1 percent to the borrower’s housing payment.
One complaint about home mortgage insurance is that the IRS has not [until now] considered it a fully deductible expense. The mortgage insurance for a 95 percent LTV adjustable-rate mortgage loan may add as much as a full percent to the borrower’s housing payment.
Some lenders offer a 90-95 percent LTV loan without mortgage insurance. The quid pro quo is that the lender increases the mortgage rate to pay for the added risk. For example, if the best 30-year fixed rate for a 80 percent LTV loan is at 6 percent, the rate for a 90 percent loan may be 7 percent.
To combat the added expense of mortgage insurance, the mortgage industry began providing a second mortgage that would allow borrowers to buy a home with less than 20 percent down without requiring mortgage insurance.
The first mortgage would provide the initial 80 percent loan, while the second mortgage lender would provide the additional 5, 10 or 20 percent. Again, due to the added risk, providers of second mortgage loans charge higher rates and may have stricter underwriting guidelines.
Over the past five or more years, the mortgage insurance industry has all but disappeared as borrowers chose the more popular, and less expensive, second mortgage route.
Congress has recently showed an unusual interest in mortgage insurance and has decided to make mortgage insurance deductible — but be sure you read the fine print. It only applies to mortgages originated this year and will only last for this year and only applies under specific situations.
SOURCE: Santa Cruz Sentinel