In our last issue, we showed how borrowers could eliminate their mortgage insurance even with equity of less than 20%. After running that article, Geoffrey Cooper of MGIC, the company that essentially founded the private mortgage insurance industry, responded to our article with some compelling reasons why mortgag insurance may not be as costly as everyone thinks. Twenty five years ago, The Wall Street Journal featured Mortgage Guaranty Insurance Corporation (MGIC) and private mortgage insurance (PMI) in a page one article. At the time, PMI was a 15-year old invention. The article lauded MGIC founder Max Karl for his innovation in creating an easier and lower-cost private alternative to the government guarantee provided by the Federal Housing Administration (FHA). MGIC and Mr. Karl were crowned as white knights that had effectively found a way to slay the housing affordability dragon. What a difference a quarter century makes. Today, private mortgage insurance is cast in the role of the dragon. Consumers are bombarded with articles proclaiming PMI is not needed and is impossible to cancel if you do have it. Mortgage structures, such as the 80-10-10 plan, are heralded as the up-and-coming saviors of housing affordability. The author's purpose in this article is to demonstrate that PMI, which is offered by many companies in addition to MGIC, is a better choice than 80-10-10's for the majority of borrowers seeking to buy homes with down payments of less than 20 percent. Not only does PMI enable families to buy homes with less than 20 percent down payments, but in this current period of low interest rates, it can be useful in helping to reduce the cost of borrowing and increasing financial flexibility. Unnecessary evil or a partner in housing? With PMI, a typical American home buyer can obtain home ownership ten years sooner than if he or she waited and saved for a 20 percent down payment. This is possible because the private mortgage insurer is reducing the mortgage investor's (i.e. lender's) exposure to the higher level of losses characteristic of low down-payment loans. In a sense, the insurer is co-signing the loan, promising to pay the loss to the lender if the borrower can no longer make monthly payments. This makes the MI company the borrower's partner in housing. Still, there is a tendency to paint private MI as an unnecessary evil. However, should one consider what investors might charge to put their capital at risk in high-ratio loans that are not insured. A world without MI would be one in which borrowers making less than 20 percent down payments either opt for higher-cost and non-cancelable FHA mortgage insurance, pay a higher interest rate over the life of their loan with an alternative to private MI such as an 80-10-10, or postpone buying a home indefinitely. In fact, a world without private MI would be a lot like 1956 all over again. Private MI enables people to get into homes with down payments of as little as 3 percent, and has helped more than 17 million families buy a home since it was created in 1957. Today, 13.5% of the nation's $4 trillion in residential mortgage debt carries private MI. That figure continues to grow as more than one million families each year use private MI to buy a home. Private MI: A Better Deal for Consumers 80-10-10 programs are mortgage structures in which the borrower makes a 10 percent down payment, obtains an 80 percent loan-to-value (LTV) ratio first mortgage (thereby avoiding private MI) and then obtains a 10 percent LTV second mortgage to close the gap. These mortgage structures are pitched to borrowers as lower-cost options to private MI. Several MI companies recently have introduced premium rate plans designed to compete directly with 80-10-10's nullifying any pricing advantage that might have existed for most split mortgages offered today. For example, one MI plan results in monthly mortgage payments that are lower than those promised under many split mortgage programs. Even in instances where the monthly payment might be slightly higher than with an 80-10-10, borrowers who finance the cost of private MI will gain that difference back and more when they have their MI canceled and receive a sizable refund check from their MI company. A typical single-premium MI program works as follows: A one-time charge fo private MI can be financed with the first mortgage. Borrowers pay nothing for private MI at closing, and there is no escrow of premiums. There are other considerations as well. Consumers should be aware that with 80-10-10's come a number of potential inconveniences. For example, 80-10-10's limit a borrower's ability to tap home equity for home repairs, college tuition and debt consolidation. Having a second lien already on their home reduces a borrower's financial flexibility. Also, many 80-10-10's include second mortgages that amortize over 30 years but mature in 15 years. This means that when the second mortgage matures, the borrower will be left to refinance in an uncertain interest rate environment or pay in full about 78 percent of the original loan balance. If the second mortgage is an adjustable rate mortgage (ARM), 80-10-10 borrowers may at some point be subject to higher monthly payments than they anticipated at closing. With interest rates near 25 year lows, borrowers who today have first and second mortgages may want to consider refinancing to consolidate their debt into one low-rate, low-down payment first mortgage using private MI. If it makes sense to choose private MI over an 80-10-10 at origination, it clearly makes sense to choose private MI when refinancing. Cancellation: A Reality, Not a Myth One of the clouds hanging over the mortgage insurance industry has been the misconception that private MI can not be canceled. The truth is that unlike FHA insurance, borrowers can have private MI canceled. In fact the average MI policy at is on the books for less than five years. Mortgage investors have very specific criteria that borrowers must meet in order to have their private MI canceled. Typically, they require that home equity is at least 20 percent, that home prices are not falling, and that borrowers have not missed a payment in the past 12 months. Most mortgage servicers today are being very helpful to borrowers who wish to cancel private MI. They are willingly accomodating the requests of borrowers who meet the cancellation criteria. As a result, of the more than 17 million private MI policies written since 1957, more than 12 million have been canceled. Geoffrey F. Cooper is Director of Cor-porate Communications with Mortgage Guaranty Insurance Corporation (MGIC). |
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