Can somebody explain to me the role of mortgage insurance in the subprime lending meltdown? I know all those mortgages require mortgage insurance, so what why are mortgage lenders at risk? If a borrower defaults on their loan, does the lender get their principal back from the insurance company? All I can figure is they are losing the future interest on that principal, but it is not like they put in under the mattress; they are going to lend it to someone else and make interest on it anyway, right? So what is the risk to banks? Seems to me like it is the mortgage insurers who will take it in the shorts.
Mortgage insurance covers losses in the event that the lender is unable to foreclose and/or sell the property, and in some cases covers the difference between a sale price and the remaining principal on the loan.
So, the issue of mortgage insurance doesn’t even come into play until after the foreclosure proceedings.
I suspect you might be incorrect about lenders requiring mortgage insurance. When I purchased my current house we took out two loans. One for 80% and one for 15% and we put in 5% cash. There was no mortgage insurance. This was about 8 years ago and I don’t think the banks were getting more stringent with requirements as the years went by.
The 80/10/10 and 80/15/5 arrangements (“piggy back loans”) are one way to avoid having to pay mortgage insurance, because the risk is spread somewhat among the two lenders. If you had taken out a single loan for 95%, you definitely would have had to pay for insurance.
There’s a secondary benefit in that the interest you pay on the second loan is also tax-deductable, whereas the mortgage insurance fees you would have had to pay on a single loan would not be.
Another issue that sometimes gets mentioned in this context is that many of these mortgages were done as 80/20, 80/10/10, or piggyback loans. The first lien mortgage was only 80 percent of the LTV; with a simultaneous second mortgage to cover the difference. The whole idea behind these loans was to avoid PMI. I see **friedo ** already said this.
Understood. But after the foreclosure, what has the bank lost?
The foreclosure process can be quite costly with all the legal fees, so the bank frequently gets stuck with a deficiency.
Are those expenses not covered by the insurance?
Like others have noted, most subprime loans didn’t have PMI.
From this article:
Which is precisely why we’ve got this mess. Instead of using traditional, proven methods of determining financial readiness, it was assumed that breaking down the mortgages into untested investments products would somehow eliminate the risk. :rolleyes:
I thought piggyback loans were those ones you took out when selling a house and purchasing another, using the equity available in the first house to cover your down payment on the second until the first house sale is closed?
In any case, I took an 80/20 to avoid paying the VA funding fee, which isn’t PMI exactly, but does cost (IIRC) 1% of the loan. VA (and FHA?) don’t require PMI and you can finance (again, IIRC) up to 103% of the value.
There’s really no difference between an initial 80/20, or purchasing with 20% down and immediately taking a home equity up to the value of your home. Of course 100% LTV home equities cost an extra 0.25% or more.
Also (IIRC) PMI only covers that 20%. Does that mean if you go into foreclosure (and in this current market), the bank only recovers 60% of the value, you’re only on the hook still for 20%, or the entire 40%? Will the PMI people come after you for restitution? It’s the bank’s insurance, not yours, right?
Wow. Now I have even less sympathy for the banks. Not only were they colossally stupid in lending to people who could not afford to repay the loan, they did not require insurance to cover that risk. I hope they all fail, and leave banking to those who know what they are doing.
That’s a bridge loan.
And that’s the flip side of the subprime mess. Lending up to 100% of the euqity is why we’re seeing a lot of foreclosures involving people who bought their houses years ago but have been using home equity loans to fund expensive renovations, vacations, big screen tvs, etc. Traditionally (and that means really only maybe eight years ago), banks were reluctant to lend 100% precisely because real eastate doesn’t always go up! Having a littel euqity in the house, keeps banks (and borrowers) protected against real estate fluctuations.
Gosh, don’t hope that. Unfortunately, almost all of the major banks got caught up in the subprime mania. How could they not? For a while, it was a major cash cow and their stockholders demanded it. If all the banks failed, we’d be looking at a situation even more dire than the Great Depression. (and I’m already a bit worried on that front)
Too late to edit:
BTW, check out the Mortgage Lender Implode-O-Meter. To date, 186 :eek: lenders have ceased lending operations. Most of these were lenders specializing in subprime loans.