RISK BASED LENDING - MORTGAGE INSURANCE

Private Mortgage Insurance (PMI).

For borrowers who have less than twenty percent equity or down payment, PMI companies have long played the role of guarantors by providing insurance to the lenders. This has allowed many borrowers to get loans without shelling out hefty sums. With foreclosures at an all time high, PMI companies have had to pay more to lenders than usual. PMI is an insurance policy that pays out when the borrower defaults on his mortgage and the lender has to take back the property.

Let's take a situation where the property sells for $200,000, the borrower makes a 5% down payment or $10,000. The PMI company will insure 15% or $30,000. If the borrower defaults, the lender will receive $30,000 from the PMI company and the property from the borrower through foreclosure, of course the borrower has pledged the entire property and gets nothing.

The lender will the try to sell the property in order to recoup his investment. There are some serious implications here: if the lender sells the property for more than 80% of its original value, he will make money. The other implication is that the lender has room to maneuver which explains why buying REO (Real Estate Owned) are good opportunities for buyers looking for bargains.

Risk Based Lending.

PMI companies have begun assigning risk levels to properties and areas. They have found out that certain borrowers such as investors, those who buy properties to either rent or re-sell, tend to be foreclosed more often than those individuals who purchase principal residences. They have also noticed that foreclosures are higher in certain zip codes, cities, and states. PMI companies now charge higher fees to borrowers based on the perceived risks. As a result, mortgage insurance coverage is being denied to borrowers and without enough equity, lenders simply refuse to make the loan.

Follow the trail.

You need mortgage insurance because you do not have twenty percent equity or down payment. You cannot get mortgage insurance because your property is located in a high foreclosure zip code or you are an investor. Now you cannot get a mortgage because of the above, your refinancing or purchase is canceled and the property stays on the market or in worst case scenario joins the thousands already there. Finally, too many properties and few qualified borrowers drive the prices down. You can play this chain of events over and over until God knows when.

The policy of bandages.

Overlooking the obvious, i.e. loss of equity, a series of solutions have have been enacted with little success. Those solutions are based on mortgage terms and interest rates: five years interest rates freeze, six consecutive rates cuts, counseling, loan limits increases and foreclosure extension.

All these policies are simply delaying the inevitable: as long as property values decline, people will not either buy or continue to pay mortgages that are higher than the value of the collateral. Adding risk based criteria to the equation is certainly not the ingredient that will solve the mortgage crisis.
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