Two rival mortgage insurance providers have abandoned plans to merge given the current, turbulent climate of the home loan markets.
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Slowly but surely, mortgage borrowers seem to be discovering that their mortgage insurance premiums will be deductible for the 2007 tax year.
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PMI Group Inc., a provider of residential mortgage insurance, said Monday that it expects to record a full-year loss at its U.S. mortgage insurance unit as the number and value of claims rose sharply in the first quarter.
Buyers are sometimes torn about how much money to put down a house. Drop too much and you’re in danger of lacking any sort of financial cushion in case of emergency.
Not enough, and you need to either take out a private mortgage insurance (PMI) policy; or, borrow with a piggyback mortgage - consistsing, for example, of one 30-year fixed-rate mortgage that covers 80% of the cost of the home and a second 15-year fixed-rate balloon loan to cover 15% of the down payment.
This time next year, some of the homeowners who pay insurance on their home mortgage will have an extra deduction on their federal income tax returns.
A new law stipulates that certain borrowers who take out a home purchase loan or engaged in a mortgage refinance in 2007 are eligible to write off all or a portion of their mortgage insurance premiums for the year.
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
According to Money Magazine, owners in today’s housing market are faced with a slew of concerns. Here are a few of the questions many borrowers ponder on a weekly basis:
The housing boom has lifted home values 51 percent over the past six years. For most of us that means that if our house was destroyed, mortgage insurance would pick up only a portion of the cost to rebuild.
For the underinsured, the average shortfall is 21 percent, according to one firm that tracks building prices. Even if you bought a guaranteed replacement or an extended replacement policy, you could still face too-low coverage caps.
To see how much PMI coverage you need, have a contractor estimate the cost of rebuilding. And don’t forget to check your contents coverage, which is often inadequate.
Water is your home’s biggest enemy, and your regular policy won’t cover all types of damage. If you live in a floodplain, you need flood insurance, as well. You’ll pay $1,000 a year on average if you live in an area that’s susceptible.
Over the next few years, about eight million adjustable-rate mortgages will reset. If yours is among them, you need to decide whether to refinance now or later. Check the fine print on your mortgage to see how bad it can get in the first reset and over the life of the loan.
While it may seem like a no-brainer to go through with mortgage refinancing now, you may not need to rush because rates aren’t expected to climb sharply this year. What’s more, you could pay closing costs of 2 percent to 3 percent of the loan if you take this course of action now.
Another nagging concern may be that you’re spending money on your house for no good reason. If you bought after July 1998 with less than 20 percent down payment and had to get private mortgage insurance, your lender must automatically cancel your PMI once you’ve paid off 22 percent of the loan.
But price appreciation may help you hit the target earlier.
This annoying fee can run $16 to $50 a month for every $100,000 of debt. However, before you pay $300 or so for an appraiser to prove that your home’s greater value has pushed your home equity higher, understand what it will take to waive PMI.
Mortgage terms vary.
MGIC Investment Corp., the largest U.S. provider of mortgage insurance, has announced it will buy the third-biggest, Radian Group Inc., for $4.9 billion in stock.
The firm homes that by making the purchase, it will reduce computer and salary expenses and improve its margins in this suddenly stagnant mortgage market.
Milwaukee-based MGIC will exchange 0.9658 share of its stock for each share of Radian, paying no premium to Radian’s $61.28 closing share price on February 2, the Boston Globe reports.
The new company, which will be in control of about a third of the country’s mortgage insurance market, plans to cut almost a quarter of its combined costs to boost profit as demand for protection against home loan defaults wanes.
MGIC also will get a foothold in bond insurance - a market that PMI, the number two mortgage insurer in the U.S., first entered back in 2003.
In the United States, mortgage insurers have been hurt in large part by the advent of the second mortgage, in which a borrower actually takes out two mortgages - also known as piggyback loans.
A second mortgage effectively eliminates the need for insurance on mortgages with a low down payment. MGIC and Radian are expecting to cut about $128 million in expenses by 2009 and are targeting opportunities to grow overseas, where some markets are nascent.
“The shape of the market has changed dramatically and it’s unclear as to how it’s going to continue to change,” Radian CEO Sanford Ibrahim said.
The new company, to be called MGIC Radian Financial Group Inc., will have about $290 billion of home mortgage loan insurance in force, the companies said.
Through the first nine months of 2006, MGIC insured $42.5 billion of home mortgages, accounting for 22 percent of a total $195 billion insured. PMI had 19 percent, followed by Radian’s 17 percent.
In the same period in 2005, $197 billion in mortgages were insured.
“Market share is going to be naturally repositioned” because mortgage lenders won’t want to do too much business with one insurer, said Geoffrey Dunn, an analyst at Keefe, Bruyette & Woods Inc. in Hartford, Conn.
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.
Despite conflicts over whether or not the new mortgage insurance tax deductions are a good deal, many owners are considering their options anew.
“It’s certainly a benefit for PMI (private mortgage insurance) if it’s tax-deductible,” said Ron Briscoe, vice president of Bank of Illinois in Normal. “It puts it on a more level playing field.”
Typically, lenders consider people who make a down payment of less than 20% to be riskier borrowers. To cover that risk, individuals often have to get mortgage insurance or a piggyback loan.
Mortgage insurance overview: Mortgage insurance covers the cost for the lender in case of a foreclosure. Borrowers who choose a piggyback loan don’t need insurance, but they have two home loans - one for 80% of the home’s value and a second mortgage at a higher interest rate to cover the rest of the loan amount.
Piggyback mortgages often are referred to as an 80-10-10 or an 80-15-5 depending on the loan amounts and down payments. An 80-15-5, for example, means a borrower is getting an 80% home loan, a 15% piggyback loan and making a 5% down payment.
Piggybacks have had an advantage over loans with mortgage insurance because combined payments are a little less and interest on both loans was tax-deductible.
Now the new law is turning the financial industry across the nation and in the Central Illinois housing market upside down and giving everyone a little more to consider.
“We’ve always figured different scenarios,” said Dave Usiak, a loan officer with 1st Advantage Mortgage, formerly Mortgage Services Illinois, in Bloomington. “Now you’ve got this extra variable in here with people - are they going to save more money because of the tax deduction?”
Assuming a borrower has good credit and is in the 25% tax bracket, a homeowner with an $180,000 mortgage would save about $351 in taxes a year, according to an analysis by Bankrate, Inc., a financial rate data research group.
The deduction may reduce a lot of the need for piggybacks, Briscoe said. Still, “it’s not just do this or do that,” Briscoe said. “It depends on their situation.”
Borrowers have to consider how long they’ll stay in their homes, whether they’ll prepay or make extra home loan payments and their comfort level, he said.
Borrowers are stuck with a piggyback loan until it’s paid off, but they can cancel mortgage insurance once they’ve reached 20 percent of their home’s value. How long that takes depends on the size of the loan and the down payment; the bigger the loan, the more insurance someone will get, said Tyler Ross, a loan officer at Farmer City State Bank in Farmer City.
Home shoppers are faced with a tough choice, and banks will see more people opting for private mortgage insurance, Ross said. He’d probably recommend insurance if someone puts down 15%; he’d encourage piggybacks if borrowers have less than 10% for a down payment. Overall, he’s still recommending piggyback loans.
“I think it’s cheaper to do the piggyback loan,” Ross said. “You’re saving your money right now, up front.”
Conditions, such as income requirements, are attached to the mortgage insurance tax-deduction. Right now, the program also is only available this year, though many believe Congress will extend it, Usiak said.
Still, some people might not want to take the risk that they won’t be able to deduct interest next year, said Randy Jannusch, partner and certified public accountant with Dunbar, Breitweiser and Co., LLP, in Bloomington.
“If these things work out to be fairly close and the tax deduction is the determining factor … I’d go with the sure thing. I’d go with the piggyback loan. We know that would be tax deductible.”
The tax write-off: Mortgage insurance will be tax-deductible for some people who buy a house in 2007. But before mortgage shoppers jump on board, they need to be aware of a few stipulations:
- The tax deduction applies only to mortgages that are closed in 2007. Homeowners could go through with mortgage refinancing in 2007 and also deduct the interest.
- Homeowners are eligible for a full deduction if their income is $100,000 or less. Up to $110,000, deductions are available on a tiered basis.
- It’s not guaranteed that mortgage insurance will be tax-deductible in 2008. Congress would have to renew the deduction to make it applicable for the 2008 tax year and beyond.
- Taxpayers must itemize deductions on their tax returns and not just take the standard deductions.