Private Mortgage Insurance

[cindy.wellman]

Eric's Aunt Melba was our realtor when we bought our house last year. We see Melba and her husband on a regular basis because we really enjoy their company.

On Sunday we had a discussion with Melba about the private mortgage insurance (PMI) that is sometimes required on home loans. She said it is usually required for borrowers who have less than 20% down to put towards their loan. She did say that sometimes that can be waived if the borrower is able to get an 80/10/10 loan, if the borrower accepts a higher interest rate for the loan and possibly certain other factors.

Melba has been selling homes for 30 years and is a broker, as well as an agent. (so she's been around the block...ha ha) She isn't as involved in the financial side of things, but of course she does have a lot of working knowledge. Her big question to us this weekend was more of a retorical one, but she was curious to know what has happened to all of this PMI money. With the PMI, it is supposed to protect the lender in case the default of the borrower. Has the availability of insurance money dried up due to the explosion of defaults on the loans? Was that money even put into proper channels (investments, etc) anyway? Are the majority of the defaults occuring in the 80/10/10 loans, higher interest rate loans or with people who had 20% or more down which would mean they weren't covered by PMI anyway? After our discussion I wondered where the ARMs fit into all of this too.

I would be interested in hearing any explanations from anyone who might have some information about this. I'm not very knowledgeable in this area, but I would like to understand it a little better. If anyone has any good websites for explanations, that would be great too.

[Ritterskoop]

I also have a question on this topic.

Loan people for years did not loan money to folks who were obvious risks not to pay it back.

What made someone say, out of the blue, "I am willing to risk it?" Did they change their minds about the poor credit risk folks?

I understand greed. I am just curious where it started.

I also understand loaning money to people on the bubble. That can pay off nicely, as in the microfinancing in Pakistan, which helps small businesses and farmers. But this stuff in the U.S. has just been dirty, and I can't figure out where it started.

[cindy.wellman]

I also have a question on this topic.

Loan people for years did not loan money to folks who were obvious risks not to pay it back.

What made someone say, out of the blue, "I am willing to risk it?" Did they change their minds about the poor credit risk folks?

I understand greed. I am just curious where it started.

I also understand loaning money to people on the bubble. That can pay off nicely, as in the microfinancing in Pakistan, which helps small businesses and farmers. But this stuff in the U.S. has just been dirty, and I can't figure out where it started.

Skoop - Nitrah and I posted in separate threads about, "This American Life", which had a broadcast of a show this past June called, "The Giant Pool of Money". It was very informative and it touched a bit on the question you asked above. It was an hour long show. Just now when I went to get the link to the site, I noticed that the same men who did the original show, have a follow up show this week. So, instead of linking directly to the download, here is the link to their front page: This American Life

[TheConfessor]

Good question. Here's a recent article from the Dallas newspaper.

Troubled home loans didn't require insurance

12:00 AM CDT on Friday, September 26, 2008

By JIM LANDERS / The Dallas Morning News
jlanders@dallasnews.com

WASHINGTON – If the problem threatening to take down the economy is bad mortgages, then why isn't mortgage insurance taking care of it?

In the 1980s and 1990s, most homebuyers could not get a mortgage with a down payment less than 20 percent unless they bought private mortgage insurance, or PMI. This insurance covers the lender in case the borrower can't pay. It wasn't cheap (about $150 a month for a $235,000 mortgage). And unlike mortgage interest, you couldn't deduct it on your federal income taxes.

Between 2000 and 2007, lenders offered homebuyers unable to afford a large down payment several ways to get a house without mortgage insurance.

One of the most common was a "piggyback," where the borrower took out two mortgages at once. The first mortgage covered 80 percent of the price. The second mortgage, usually with an adjustable rate, covered another 10, 15 or 20 percent of the price. Down payments ranged from 10 percent to nothing.

With house prices rising, it all looked good. Interest paid on both mortgages was tax-deductible. If the second loan was going to set at a high rate, the borrower could refinance with the rising value of the house.

But when the housing bubble popped, so did piggybacks.

"The loans that are in the most trouble are the loans that circumvented mortgage insurance," said Jeff Lubar, spokesman for the Mortgage Insurance Cos. of America.

Karen Watson, who runs a Dallas mortgage company in Preston Center, said buyers of mortgage securities set the guidelines allowing borrowers to get home loans with no money down and no mortgage insurance. The underwriting and approval process was automated.

Mortgage securities buyers "came in and took on the risk that insurance companies were designed for," she said.

Mortgage insurers got back in the game after persuading Congress to allow homebuyers to deduct their mortgage insurance payments. That law took effect on Jan. 1, 2007, but expires in 2010.

Ms. Watson said she was still offering piggyback mortgages until this spring, when the lenders "changed the guidelines almost ex post facto – 'We're not offering these as of yesterday.' "

Despite the mayhem this month on Wall Street, she said mortgages are still being sold.

"People are getting used to the new guidelines, which are the old guidelines," she said. "We're doing what we used to do."

[Ritterskoop]

Skoop - Nitrah and I posted in separate threads about, "This American Life", which had a broadcast of a show this past June called, "The Giant Pool of Money". It was very informative and it touched a bit on the question you asked above. It was an hour long show. Just now when I went to get the link to the site, I noticed that the same men who did the original show, have a follow up show this week. So, instead of linking directly to the download, here is the link to their front page: This American Life

That was terrific. Thanks.

So the idea is there was all this new money from emerging markets, and people wanted to make more.

I hope the individual people in the chain who made poor choices know what they did. It isn't enough to say "everyone else is doing it." They had a chance to say they were drawing a line and not crossing it.

[Bob Juch]

I want to add that most of the problem loans were not made to people who were a credit risk, but to those who didn't have 20% down. It's the fancy ARMs that are causing the problem. Those with an initial very low payment that balloons up after five years or so are the main culprits.

[gotribego26]

A great deal of the problem comes from quantatiative modeling - as computer power expanded and became more available people developed models for lending. Historically this had been based on human evaluation of income, loan terms and the property being purchased/refinanced. (Kusch knows more about this - we used to call this banking and bankers underwrote loans).

Over the last 25 years the underwriting process was replaced by automated underwriting. The underwriting was based on models developed from prior results. THe recent problem is that the history in the models did not include the price declines we've seen in parts of the country or the amount of adjustable mortgages that were being created. When both of these were outside of the model parameters, things happeend to default rates that had not been anticipated.

Another driver of the problem was securitization. Anoither group of smart guys figured out they could pool 1.000s of mortgages and create bonds that they would sell to investors. In the old days bankers (and S&Ls) wrote loanss and kept them on their books - there was a limit to what they could lend out. With securitization they created a pool of loans, got fresh money and relent it.

BTW, the mortgage insurance companies have suffered in this decline. I'll get some citations later today.

[wintergreen48]

I want to add that most of the problem loans were not made to people who were a credit risk, but to those who didn't have 20% down. It's the fancy ARMs that are causing the problem. Those with an initial very low payment that balloons up after five years or so are the main culprits.

This does get into something that is thoroughly ironic about this (and touches on how greed -----> stupidity).

The whole reason for requiring PMI for people who put <20>[/u] 20% down is that someone with a small investment (i.e., <20>[/u] 20%): the more you have to lose of your own money, the less likely you are to default and so the less likely you are to cause someone else to lose their own money. This principle is supported by a separate credit risk analysis: someone who manages to save up enough money so that he/she can even put down a large down payment is almost by definition more likely to be more financially stable than someone who cannot put down such a large down payment, and further, someone who actually does put down a large down payment is likely to be more debt-averse (and hence, more likely to pay down debt) than someone who actually does not put down a large down payment.

So, although PMI is annoying for borrowers who have to pay it, there are extremely sound economic, social and psychological reasons for requiring it of 'weaker' borrowers.

So what do greedy lenders do? They come up with piggyback loans that make it look like someone is putting down a large down payment (and thus, 'appears' to be a better credit risk), and they waive the PMI requirement, completely ignoring the reality that, in fact, they are making extremely risky loans (loans without a real down payment to speak of) to the people least likely to be able to repay them, AND AT THE SAME TIME they are burdening those very same people with TWO loans at the same time, one of which (the 10-20% ARM that typically resets after a few years) that typically has very onerous (but theoretically profitable for the lender) terms.

All of this had the effect of getting some people to buy houses who simply should not be buying houses (the true bad credit risks), and getting other people to buy houses that were simply too expensive for them (many people bought houses that were affordable at the low teaser rates of interest, but that became unaffordable once the interest rates reset: if those very same people had simply bought 'less house; (i.e., one costing less money), in many cases they would probably have avoided these problems entirely.

[wintergreen48]

I want to add that most of the problem loans were not made to people who were a credit risk, but to those who didn't have 20% down. It's the fancy ARMs that are causing the problem. Those with an initial very low payment that balloons up after five years or so are the main culprits.

Oh, and another thing...

I wonder how many of these cases involve scams against 'good' lenders in which dishonest brokers and dishonest lenders conspire with stupid/greedy/dishonest buyers.

For example, Joe Blow buys a $200,000 house, and with the encouragement of Sleazy Real Estate Company goes to Reputable Bank to borrow $160,000, telling Reputable Bank that the 20% down payment ($40,000) is coming from his personal savings, or a gift from Mom, or something (Reputable Bank, like any good bank, always asks specifically about the Sources of Funds). But in fact, Joe Blow hasn't got a dime to his name, but instead he is borrowing that full $40,000 down payment from Slimy Mortgage Company (actually, he is borrowing $50,000, and will use the extra $10,000 to cover the excessive fees and commissions that Sleazy Real Estate Company and Slimy Mortgage Company are charging).

Reputable Bank relies on Joe Blow's misrepresentations and makes an 80% first mortgage loan, on very conventional terms, with no PMI, having confirmed through its conventional and thorough underwriting process that Joe Blow is fully capable of repaying that $160,000 loan. But not knowing, and not having any reason to know, that Joe Blow will actually be paying much higher debt (that extra $50,000 loan from Slimy Mortgage Company), which Joe Blow probably cannot service in the best of times, and when that second loan balloons or resets at some very high rate, he won't be able to pay at all.

So, time marches on, and Joe Blow defaults on the Reputable Bank loan (which has been paid down to, say $155,000), and Reputable Bank has to foreclose, and finds (1) the house was overappraised in the first place, it was really only worth $185,000 when the loan was made, (2) real estate values have crashed, so that the $200,000 house (which was worth only $185,000 when the loan was first made) is now worth only about $150,000, (3) at the foreclosure sale there are few buyers, and, Reputable Bank itself ends up having to buy the house, for 70% of its real value at the time of the sale (i.e., $105,000), and (4) thus taking a loss (after paying costs of sale) of about $60,000 on a loan that LOOKED perfectly safe and secure when it was first made, that Reputable Bank underwrote on sound principles that have always worked in the past.

Slimy Mortgage Company of course takes a loss of its entire loan, but the crooks who run it have long since looted it and taken off (with all those commissions they collected in the golden days), so that the real bag holders are Reputable Bank, which is entirely innocent and actually did everything right, and the investors who didn't know and probably had no real reason or way to know what what was happening.

[minimetoo26]

I have heard about both of wintergreen's scenarios happening. Some people got in over their heads, and some grifters took advantage of the system.

[kusch]

A great deal of the problem comes from quantatiative modeling - as computer power expanded and became more available people developed models for lending. Historically this had been based on human evaluation of income, loan terms and the property being purchased/refinanced. (Kusch knows more about this - we used to call this banking and bankers underwrote loans).

Our bank is one of few in the country that does NOT use "credit scores" for either making or turning down a loan. We have withstood a few wrist slappings from regulators but so far so good. By "credit scores" I mean assigning points for length of employment, rent or own, income, children, other debt etc. You total xx "points" you get the loan at this rate, you get xx points and you still get loan but higher rate. Being from a "smaller" (to most of you) city, we pretty much know our borrower. Character is a big factor when I make a decision to give a loan. Yes, other factors are also included, but doing a straight "credit score" does not serve the community or borrower, in my view.

If I don't make some bad loans that go bad, (or good loans that go bad) I am not serving the community. Yes, believe it or not I make good loans that stay good.

This whole mess is not about the "stock market" or Wall street, it is about the availabilty of credit. Without credit, you or any business will suffer.

I do not have an answer to what is really going on and how to fix it, but I know the "blame game" from both sides is non-productive.

[Rexer25]

I do not have an answer to what is really going on and how to fix it, but I know the "blame game" from both sides is non-productive.

But blaming others is what America does best. Just wait. Someone will post here shortly and tell you whose fault it is.

[dimmzy]

Some of the problem (I really don't know how much) also may be due to people who thought they could get an ARM and then sell UP a couple of years later when their original purchase increased in value. I am seriously wondering about these college-educated people who are now claiming, "We didn't know the rate was going up!"

Yes, you did. You gambled. You lost.

I had a boss a few years ago with a 6-figure income who bought a McMansion. The day after it closed, she and her husband started proceedings to get a home equity loan to buy furniture.

I expect to see her face on TV any day now complaining how the ARM took advantage of her. Right ...

What about the term "ADJUSTABLE RATE mortgage" don't you understand?

I do think mortgage companie took advantage of people. I always wondered about those home shows on HGTV that showed middle class couples in California buying $750,000 homes. I mean, the guy was a trucker and the wife was a secretary and they had 3 small kids ...

[Bob Juch]

A great deal of the problem comes from quantatiative modeling - as computer power expanded and became more available people developed models for lending. Historically this had been based on human evaluation of income, loan terms and the property being purchased/refinanced. (Kusch knows more about this - we used to call this banking and bankers underwrote loans).

Our bank is one of few in the country that does NOT use "credit scores" for either making or turning down a loan. We have withstood a few wrist slappings from regulators but so far so good. By "credit scores" I mean assigning points for length of employment, rent or own, income, children, other debt etc. You total xx "points" you get the loan at this rate, you get xx points and you still get loan but higher rate. Being from a "smaller" (to most of you) city, we pretty much know our borrower. Character is a big factor when I make a decision to give a loan. Yes, other factors are also included, but doing a straight "credit score" does not serve the community or borrower, in my view.

If I don't make some bad loans that go bad, (or good loans that go bad) I am not serving the community. Yes, believe it or not I make good loans that stay good.

This whole mess is not about the "stock market" or Wall street, it is about the availabilty of credit. Without credit, you or any business will suffer.

I do not have an answer to what is really going on and how to fix it, but I know the "blame game" from both sides is non-productive.

Your credit score does not take into account your income or number of children. Whether or not you rent or own is considered only in that having a mortgage gives you a higher score (which is sort of dumb in that you might have a property totally paid off which doesn't count - I have two).

The main reason credit scores are used instead of making a decision on a case-by-case basis is to avoid claims of discrimination.

[gotribego26]

I want to add that most of the problem loans were not made to people who were a credit risk, but to those who didn't have 20% down. It's the fancy ARMs that are causing the problem. Those with an initial very low payment that balloons up after five years or so are the main culprits.

Another problem that has been under-reported is the problems in Home Equity Lines of Credit. In the purchases of WaMu and the Golden west portfolio at Wachovia they are anticipating 40-50% default rates on these loans. The portfolios are smaller than the ARMs but the loss ratios are higher.

[BigDrawMan]

pmi companies reviewed the loans they insured.
they wouldnt have approved many subprime borrowers

[kayrharris]

It's Rexer's fault.

[Rexer25]

It's Rexer's fault.

Thanks for actualizing my reason for existence.

[Iben Browning]

Did someone say fault!?!?!?

Can I blame Rexer for my prediction being a little off?

[Ritterskoop]

Character is a big factor when I make a decision to give a loan. Yes, other factors are also included, but doing a straight "credit score" does not serve the community or borrower, in my view.

If I don't make some bad loans that go bad, (or good loans that go bad) I am not serving the community. Yes, believe it or not I make good loans that stay good.

If everyone in the business used your model, we would not be in this mess. You stood by your proper model.

I agree with you about the blame game. I was more asking about human nature.