What about PMI?
So the ‘Housing rescue’ bill became law yesterday. I’m trying not to write or think about it - I just get frustrated and cynical. But it did get me thinking about something. Why is there so much turmoil surrounding housing foreclosures?
Maybe this just shows my ignorance of home finance in general and PMI in particular, but how come banks and other mortgage lenders are suffering huge losses on this? Isn’t that why they make you buy PMI when you put down <20% on a house? I have to believe that in 90% of ’sub-prime’ mortgages, the buyers didn’t put down 20%, ergo, they had PMI on the house. So if the buyer defaults, the bank gets paid, right?
Yes, I realize in a foreclosure, the lender typically realizes something like 60% of the prior value of the house. Yes, I realize people got creative with 80-10-10 loans and builder-funded downpayment schemes. But still, I’d think PMI would serve to at least mitigate losses on these things.
This makes me think two things -
- Banks are using foreclosures as a cover to write down other, unrelated losses
- PMI is going to be much, much more expensive in the future
I’m somewhat surprised we haven’t heard very much about mortgage insurers going bankrupt. If foreclosures are as bad as we’ve been led to believe (and I’m not sure they are), I would think insurers would be drowning in red ink. Anybody have any thoughts?
July 31st, 2008 at 12:31 pm
I wouldn’t be surprised to see PMI costs rise for consumers in the near future, and it wouldn’t bother me that much. The American mindset has become one where debt is not only acceptable, but assumed as the only way to live. Debt is too cheap and many people have mortgaged their futures beyond a reasonable expectation of ever becoming solvent.
Making credit more slightly more difficult to obtain might tighten up or economy by lowering defaults. Of course, the opposite could happen if it were tightened too much and the economy slowed to a crawl…
I guess it should come down to personal accountability and not legislation. Hopefully greed won’t always win out and some people learn from the current situations in the housing market.
July 31st, 2008 at 1:46 pm
Wow, I never thought of that.
Some possible answers:
1. All loan companies must make it possible to cancel PMI when the loan gets 20% paid off. Homeowners who did this and then took out equity would leave their lender exposed.
2. Some loan companies — Fannie and Freddie in particular — will look at your property’s current market price when deciding whether to let you cancel PMI. Thus, you can cancel without even reducing your loan at all.
I must admit that I’m puzzled… I don’t have a good answer, although these two reasons certainly contribute to the problem.
-Wm
July 31st, 2008 at 10:45 pm
If I’m not mistaken……
The PMI coverage that one is required to have by the lender is determined by the lender, and is based on the lender’s perceived risk exposure… and typically only covers a percentage of the note. It is designed to protect the lender from capital losses incurred due to foreclosure (including any shortfall in the sale of the foreclosed property and in some cases the expenses of the foreclosure itself).
It should also be noted that even if the PMI insurer pays off the lender for some or all of the note, there are two ramifications to the borrower. Whatever amount of the note that is paid off by the PMI insurance, effectively becomes INCOME (and is thus taxable) to the borrower, and the PMI insurer and/or the lender can still get a court judgement against the borrower for the unpaid amount.
Also, there have already been and/or are changes to the PMI rate structures and coverages in place… the premiums are dependant on %equity of the note, coverage percentage, and FICO score of the borrower and are often quoted in terms of the loan amount.
PMI insurers are changing their tunes as well and even not selling coverage for some of the super-risky loans. In the cases where they do, the premiums have doubled or even tripled.
As for how hurting the PMI insurers are…
- Something like 1% of mortgages are in foreclosure and something like 6% are in trouble…
- PMI rates are in the range of .5-1.5% of the loan amount (pick the middle ground.. 1%)
- PMI insurers only pay off a percentage of the loan amount (say up to 25%)
- PMI insurers only pay when there is a loss to the lender (how often??)
So PMI insurers are exposed to only a small percentage of the total outstanding mortgage debt and probably collect enough to cover their exposure fairly well. They also have sufficient advanced warning to adjust their premiums before getting hit with the claims, and they do have some recourse via judgements to collect from the borrower on the claims that they have paid (though those judgements likely usually go unpaid).
At least that’s my understanding of the topic.
August 1st, 2008 at 6:17 am
@ Wm - Wow. Great insight. I hadn’t considered the possibility of your first point and I was unaware of the second.
@ EJD - You obviously know more about the topic than me. Thanks for your comments.
August 7th, 2008 at 12:08 pm
Just saw this today (8/7) on Fox Business website…
“BOSTON — Shares of mortgage insurer PMI Group Inc. were down 18% Thursday morning after the company reported a $246.3 million second-quarter loss. The company said the loss was driven by its exposure to the troubled U.S. mortgage market, adding it was closing its operations in Canada. PMI shares have lost half their value over the past three months on worsening conditions in the mortgage and housing markets.”
http://www.foxbusiness.com/story/markets/industries/finance/pmi-shares-fall-mortgage-insurer-swings-loss/
August 11th, 2008 at 7:11 am
Thanks Drew. That’s good information.