Mortgage Insurance Rises Since New Bill’s Passage

Shares of mortgage insurance companies have soared since December 6, the day before word leaked out that Congress was finally ready to let homeowners deduct mortgage-insurance premiums.

On December 9, Congress did approve the deduction. Yet it has so many strings attached, the San Francisco Chronicle reports, it’s not likely to be a boon for home buyers or mortgage insurers.

The federal tax deduction only applies to mortgages taken out since January 1. It expires at the end of this year. Homeowners can’t grab the full tax benefits if they have more than $100,000 in household income and can’t claim it at all if their income exceeds $109,000.

Even if Congress extends the deduction beyond this year, it’s not likely to solve the mortgage insurance industry’s loss of market penetration.

Mortgage insurance pays the lender if a borrower defaults on a loan. Most lenders require borrowers to buy mortgage insurance if they put down less than 20 percent of the purchase price of a home. Borrowers can cancel mortgage insurance when their equity in the home reaches 20 percent.

The cost varies depending on the particulars of the home mortgage loan, but it averages 0.6 to 0.8 percent of the original loan amount per year, says Greg McBride, senior analyst with Bankrate.com.

On a $200,000 home loan, that works out to about $1,400 annually. On that amount, the federal tax deduction would save someone in 25 percent federal tax bracket about $350 a year.

The deduction will make mortgage insurance more competitive with piggyback loans, which have always been tax deductible.

Piggyback loans are home equity loans or lines of credit that let buyers who don’t have 20 percent down avoid mortgage insurance. They borrow 80 percent of the home’s value with a first mortgage, then borrow whatever else they need with second, and in some cases third mortgages.

These are also called 80-20 or 80-10-10 loans. The smaller of the piggyback loan has a higher interest rate than the first mortgage.

In the last five or six years, piggyback loans have taken a big bite out of the mortgage insurance market.

When mortgage rates, even on a second mortgage, were rock bottom, piggybacks were much cheaper than mortgage insurance, even without the tax deduction. Piggybacks also benefited from a relaxation in credit standards.

In the late 1990s, about 18 percent of new loans had mortgage insurance. That share fell to 8 or 8.5 percent at the end of 2005, says Michael Grasher, an analyst with Piper Jaffray & Co.

Since then, the share has crept back up to 9-10 percent, he estimates, mainly because mortgage rates have climbed, making second mortgages, especially variable-rate ones, costlier.

The downturn in residential real estate also has made some lenders less willing or able to make piggyback loans. Many second mortgage loans are sold off to hedge funds and other large investors.

But even with equal tax treatment, in many cases piggybacks “are still more competitive,” Miller adds. “The mortgage insurance product tends to be a little overpriced relative to the risk they are taking. The home equity loans are underpriced compared to the risk they are taking.”

Grasher says most of that increase stems from improving market fundamentals - higher interest rates and tighter bad credit home loan. The rest comes from a belief that the tax deduction will steer more customers toward mortgage insurance. That assumption could prove wrong.

Even with the same tax treatment, the piggyback loan might be cheaper than a loan with mortgage insurance. But when you take on a piggyback mortgage, “you are saddling yourself with two loan payments for 15 (or so) years,” McBride says.

Mortgage insurance can often be canceled sooner. By law, borrowers can ask their lenders to cancel mortgage insurance when the equity in their homes, based on the purchase price, reaches 20 percent.

It can take many years to reach that point by making mortgage loan payments alone because, in the early years, payments are mostly on the interest, not the loan’s principal.

However, most lenders will let borrowers cancel their mortgage insurance if their loans are at least two years old and they get appraisals showing that, thanks to appreciation, their equity now exceeds 20 percent.

Of course, if their home appreciates, borrowers also could get out of their expensive piggyback loan by refinancing, assuming their credit rating is still good and interest rates have not shot up.

More importantly, brokers and mortgage lenders make money on piggyback loans. They don’t make money on mortgage insurance, putting that product at a distinct disadvantage on the sales floor.

If recent trends - higher mortgage rates and stricter lending standards - remain in place, mortgage insurers could continue to gain market share. But if unemployment rises, defaults will rise and profits will get squeezed.