Why is Private Mortgage Insurance so bad for homeowners?

Factual Questions
1

This relates to the United States.

It seems that many sources that talk about mortgages talk about how consumers are required by mortgage lenders to take out PMI (Private Mortgage Insurance), and the article attempts to let people know that it can be canceled if you have been making satisfactory progress on your mortgage and you have sufficient equity. In other words, it is spoken of as something bad for the consumer and a money sink.

My understanding is that if foreclosure happens, the lender seizes the home and sells it at auction. If the proceeds of the sale don’t pay off the mortgage, the PMI pays out and the lender gets the difference between the sale price and the mortgage balance.

Now, if you default on a car loan and the bank repossesses and sells and the car sells for less than the loan balance, the lender can turn around and sue you for a “deficiency judgment”. Does this happen with mortgages? If it does, I can see PMI as insurance against being forced to pay a deficiency judgment on the home you already lost. If a mortgage lender would otherwise have to eat the loss (like a pawnshop proprietor who gives you a $200 loan on a guitar which you fail to pay off and the broker puts the guitar up for sale, but the pawnbroker can’t find anyone willing to pay more than $150 for the guitar and takes a loss), I can see how PMI can be seen as a losing proposition for the homeowner, and that the reason people take out PMI coverage in the first place is that the lender will deny the loan otherwise.

It also feels like there could be a bit of a moral hazard - if you don’t mind losing your home, you can intentionally default and force a PMI payout - what if your uncle was the lender and you decided to default on your home in order to give him a windfall?

What is the straight dope?

2

Not a 100% sure on the mechanics of PMI, but I do know that any deficiency balance due on the mortgage after the foreclosure sale is still owed by the home buyer. It is as collectable as any other unsecured debt, like a credit card.

3

So then I could phrase my question as if PMI protects you the homeowner from having to deal with any deficiency after the foreclosure, why is that bad? I would think that if I was just foreclosed on in a bad housing market where I was underwater already, being proceeded against for a $50k deficiency would not be nice…

4

I think it’s because you’re paying on an insurance policy that you hope will never pay off. No one goes into a home purchase thinking they’re going to default, so it looks like money just thrown down a hole.

5

This.

Keep in mind, you, as the home owner, are paying an insurance premium on a policy that directly benefits the lender. As a home owner, you derive no direct benefit on the insurance.

The standard “rule” is once you have reduced your mortgage to 80 percent, you can have PMI canceled. HPA requires automatic termination at 78 percent. There are additional restrictions and notifications your lender is required to abide, but unless you take steps to watch them, there is no guarantee they will follow the law.

6

I don’t think the concept itself is bad - it’s a product that a lender is requiring you to purchase to offset your reduced collateral position in the asset you’re borrowing for.

I think the problems with it (and this is verging on WAG territory from something I may have heard in passing) is that the premiums are generally very expensive relative to the coverage you’re buying and you don’t really have much in the way of ability to shop around for it - you’re a captive market and they may be fleecing you for it.

Not like people who don’t put 20% down have any business in home ownership, mind you.

7

**Rumor_Watkins **hints at a good insight. The risk pool for PMI is people who have less than 20% down on a house. That’s not a risk pool you want to be in if you have a choice, because your risk is probably lower. If you could get someone to underwrite your personal risk, it might be a good idea for the reason the OP mentions. To what extent do PMI rates consider your personal credit rating? Even holding credit rating constant, though, people with less than 20% down on a house are probably a worse risk.

On the other hand, over recent history, home values have increased so steadily that the idea of this as a risk worth insuring yourself against has got to be fairly new.

8

Another part of the “common wisdom” against PMI:
Until the recent house pricing meltdown, it was generally assumed that unless you totally trashed your new home, inflation would allow you to sell your home for more then you bought it for. So even if you defaulted on your loan, you wouldn’t be upside down on your mortgage.

If your home is worth more then you owe on your mortgage, then PMI isn’t going to be worth anything to you.

9

Incorrect. This is entirely dependent on state law.

Some states allow for the lender to attempt to collect on deficiencies, some do not.
Some allow to collect on 2nd mortgages which were also used for purchase funds (piggyback loans), and some do not.
Most allow for collection of deficiencies on 2nd mortgages that were not used for purchase.

10

Question:

would this PMI cover the mortgage if the borrower died?

11

From what I’ve heard, “PMI protects the lender, not you. In essence, you are paying the premiums on an insurance policy that protects the lender.” Is this correct?

12

In absolute terms, PMI got much more expensive as housing prices ballooned: I’m in a market where 125K still gets you a decent house, and so my PMI is really negligible (like under $25/month). I would imagine it’s different if you borrowed 500K or more. In cases like that, extraordinary measures to avoid it/minimize it are more worth the bother.

13

Yes and no. It protects against a shortfall when the house is foreclosed. The immediate burden of any shortfall falls on the lender, so in that sense you are paying for PMI to protect the lender. But in the absence of PMI the lender can come after you for the shortall*. So in that sense, you are paying for PMI to buy protection for yourself against the lender when he comses after you for the shortfall.

If you consider the case of car insurance, some of what you are paying for is to protect the other guy & some of it is to protect yourself. So the idea that insurance protecting somebody else is somehow weird or *per se *evidence of a rip-off is bad thinking.

The idea mentioned above by **Rumor_Watkins **& **Harriet the Spry **that PMI was (until recently) unrealistically priced and rigged against the consumer has been valid all along & continues to be so. I wonder how many PMI providers will go under when much of their policy portfolio needs to pay off. Can you say “AIG all over again.”?

*As explained above by whatami, in some states the lender cannot come after you for the shortfall. In those states, PMI is purely for the protection of the lender since the second half of my scenario above can’t happen.

14

Canada has a similar concept, CMHC (Canadian Mortgage and Housing Corp.) insurance, although recently private companies have tried to get into the game.

It is required for the banks (or whomever) because the risk is bank instability (sound familiar)? If a bank’s major assets backing their loans are real estate, and the loan is 80% or more of the assessed value, then the risk is that a bank could be caught short if (when would that happen?) a lot of loans needed to foreclose at once in a bad market.

If the bank only has to sell the foreclosure for 80% of assessed value, odds are they will get all their money.

If you own more than 20% equity in your home, odds are you will try to sell it and get some of your money, rather than trash the place to get even with the bank. This is why “no down payment” is likely to raise the insurance rate tremendously.

In Canada, the full mortgage insurance premium is payable at the time the house changes hands and mortgage is registered; no refunds I’m aware of; if you remortgage for more, you only pay the difference in premiums.

It doesn’t matter to the house seller; they get paid in full by the bank when the mortgage is taken out. I don’t know if in the USA a private individual can insure a mortgage, but I think the Canadian CMHC insurance only applies to financial insititutions. If you are thinking of pulling a “sweetheart deal” rip-off, I’m sure the insurance company has heard of that before and probably knows how to deal with it. Sometimes that consists of raising others’ rates rather than dealing with fraud head-on.

Like the USA, the right to collect on the outstanding balance varies in Canada from province to province. The bank doesn’t care once they get the insurance; then it’s the insurer’s problem. That’s why the insurance; chasing people who’ve just defaulted on a mortgage for the outstanding tens of thousands of dollars is probably not a paying proposition unless they win the lottery. Some may be deliberate cheats, but I suspect the vast majority got to those circumstances because they have no money anyway -job loss, sickness, etc.

15

Basically, the lender is saying, “You are putting down less than 20%, therefore I run enough risk that if you default, I lose money since you don’t have enough equity to cover fluctuations in value and the cost of me foreclosing on you. If you want to borrow money, you need to reduce my risk and pay PMI, or I don’t lend you my money and take on your risk.”

In the case of PMI, this is what we want from lenders: Them sticking to practices that reduce their overall risk and ensures a healthy lending environment, wherein they don’t risk their entire business (and thousands of employees) by absorbing too much risk.

With today’s very low interest rates, an increase in home value is usually NOT working to help the borrower get equity, but at least when you make monthly payments on a 4.9% loan, an actual chunk of the principal** is** being reduced, getting you equity. If interest rates were higher (and more normal) and property values were climbing well, then you would get equity from values rising, and you would get squat from your monthly payment would not work towards gaining you much equity if you borrowed at 8%.

16

Wow, I’ve learned a lot from this thread, that I did not know, had never considered in the past.

I thought mortgage insurance was to keep the bank from having to foreclose on, and evict, widows and children. So if you, or your spouse, die the house is paid off and no one, who doesn’t want to, has to move or sell. I never even considered insurance against foreclosure or knew it existed! I have heard of insurance that will pay your mortgage if you become ill or disabled, but that seems like something different again.

My insurance man told me mortgage insurance through the bank was a huge rip off, he explained it like this; If you owe $100,000 on your house and take out an insurance policy through the bank for that amount, making monthly payments regularly. Say it’s 10 - 15 yrs before you die, you’ve now paid down the amount of the mortgage to say, $60,000. When the insurance company pays out, at your death, the bank uses $60,000 to pay off the outstanding balance and pockets a tidy $40,000 as profit from a policy you made the payments on, all those years. Whereas if you have a private mortgage insurance policy for $100,000, when you die $60,000 pays off your outstanding mortgage and $40,000 goes into your pocket/heirs rather than to the bank. It makes sense to me.

But I hadn’t even considered foreclosure as insurable.

17

elbows, you’re thinking of mortgage life (or disability) insurance. That may or may not be a good idea, but in general it makes more sense to consider your overall life and disability insurance needs, plus any life or disability insurance you already have through your employer, and just get a separate life/disability policy independent of your mortgage if you need more. Credit life insurance is rarely the best deal you’re going to get on life insurance.

18

PMI is used when the borrower has a high risk of defaulting or the amount of down payment is less than 20%.

There was a reason why banks use to require you to pay 20% down. If they had to seize the house, it guaranteed that they could get their money back. If you want a $100,000 house, you got a $80,000 loan. This way, the lender could seize your property, do necessary repairs, and then sell it without taking a loss on the loan.

PMI is for the lender and not for the borrower. Yes, in some states, a borrower could go after someone who lost their house through foreclosure and still owes money. But, what would the bank collect in that case? You’re probably talking about someone with no assets, so even in states that permit the lender to go after the borrower for additional funds in a foreclosure, it doesn’t make sense for the bank to even try.

(Some states do prohibit the mortgage lender from going after the borrower because there was a fear that the lender will sell the seized property cheaply and then go after the borrower.)

The problem with PMI is that it allows the lender to make loans they probably shouldn’t be making. Subprime loan? No problem, we’ll have you get PMI. No down payment? We’ll do a deal if you get PMI! It also increases the cost on the borrower on a loan the borrower probably cannot afford anyway.

By the way, many PMI companies did go under, and in many cases, the banks themselves ran their own PMI. After all, historically PMI has been a very safe investment for the insurer. Foreclosure rates were under 2% and even in those cases, the sale of the property raised enough money, so the PMI company didn’t have to pay out. Banks saw this as another profit center and got into the business themselves.

So, banks lent money to risky people knowing that PMI will protect them, and then ran their own PMI firm to protect their own loans. Mortgage brokers got commission on both transactions, and the bank got even more money. What could possibly go wrong?

19

It’s not bad, provided that there’s still a deficiency to need protection from.

In other words, it is a good thing at the beginning of the mortgage. (One could argue about whther it is overpriced or reasonably priced, but it is still a good thing to have.) But it is a bad thing at the end of the mortgage (i.e., after enough equity has been built so that there’s no possible shortfall), because it is just totally wasted money.

20

It’s called Lenders’ Mortgage Insurance (LMI) here, to clarify that very point.