The private mortgage insurance industry is in an uproar.
For twenty-five years or so, PMI has been touted as making home ownership affordable for home buyers who couldn’t manage to scrape together enough cash for a 20 percent down payment.
By insuring the top 20 percent of the loan, private mortgage insurance allowed lenders to take a chance on home buyers who had as little as 3 percent to put down in cash on a home. These loan programs have proven wildly successful. What lenders have seen in recent years is that while low-down payment home buyers are more likely to default on their mortgages, the truth is that vast majority as much as 96 to 99 percent of home buyers never default on their loans.
However, private mortgage insurers started to get a bad name in the past ten years by charging more and more for their products. Moreover, consumers who built up the equity in their homes found it extremely difficult to get private mortgage insurance eliminated from their loans.
In the creative spirit of financing, and to answer consumers wishes for low-down payment loans without PMI, lenders recently came up with an alternative: The 80/10/10. You take out a first mortgage for 80 percent of the sales price, a second mortgage (or home equity loan) for the next 10 percent of the sales price and put down 10 percent in cash.
The 80/10/10 loans have caught on so quickly that the private mortgage insurance industry has been caught off guard. It has reacted decisively, deciding to try to scare consumers away from 80/10/10 loans back into the arms of PMI-backed loans. Recent missives from Mortgage Insurance Companies of America, the Washington, D.C.-based non-profit lobbying arm for private mortgage insurers, talk about the so-called “truths” and “myths” of 80/10/10 and refer to things “my lender never told me” including “severely impaired consumer credit” once you use an 80/10/10 loan.
From the tone of these letters, you’d think private mortgage insurers were about to lose the last bunker. But is it really all over for this industry? With more than 2 million first-time buyers in the market each year, putting down an average of 15 percent on their homes, the business is theirs to lose. Geoff Cooper, director of corporate communications for Mortgage Guarantee Insurance Corp. (MGIC), based in Milwaukee, WI., admits that the private mortgage insurance industry has given itself a black eye.
“We’ve been atrocious in getting the message out to the consumers. It’s been our belief, as an industry, that our primary liaison is the lender and the lender delivers our product to the consumer. We haven’t wanted to get out there and paste our name in front of the consumer because the consumer can’t buy our product from us,” Cooper said.
“But since we’ve been on the Internet, I get email every day asking me to explain what we do, what our rates are, and why we charge what we do. They can’t buy from us, but now they know who we are,” he added.
But he says that PMI is still very much needed. “There are people who won’t be able to put together the 20 percent in cash for the down payment, or who won’t qualify for the 80/10/10, and we can help these people,” Cooper said.
Cooper says the industry has changed tremendously in the last ten years. Ten years ago, you had a PMI policy you paid for upfront in cash. You paid a year’s premium in advance and then started paying with your first month’s mortgage payment. When you paid off the loan, you’d get that first year’s premium back.
Of course, asking consumers for more cash just when they could barely scrape together their down payment wasn’t such a great idea. So in 1994, the industry introduced monthly premiums.
“You make no payment at closing and you pay with your mortgage. So essentially, you pay in March to have insured your loan in February,” Cooper explained. There’s no refund due because you no longer have to pay the initial year’s premium upfront.
MGIC recently introduced their latest PMI product: financed premiums. Here’s how it works. If you buy a home for $150,000, and put down 10 percent, your loan amount will be $135,000. Private mortgage insurance will cost you approximately $3100 over the expected life of the loan (which Cooper says is typically five years). You can finance the premium, so that your loan amount is $138,100. You may then finance the entire amount at a first mortgage rate, which in today’s market might be 7 percent.
According to Cooper’s example, your monthly mortgage payment would be about $919. Over 5 years, you’d pay $55,140 in principal and interest.
If you took an 80/10/10 loan for the same property, the numbers would be slightly different. You’d still put down $15,000, or 10 percent. You’d take out a first mortgage for $120,000 (80 percent of the loan) at the 7 percent rate, and a second mortgage for $15,000 at 8.5 percent (the approximate going rate for home equity loans).
Your monthly payment would be nearly $914, or $54,840 over the first five years. The out of pocket difference between the two loans would be about $300. Cooper says, however, that if the loan is paid off, or PMI is removed, by the fifth year (which Cooper says is the average life of an insured loan), you’ll receive a check equal to 40 percent of your financed PMI premium. In this example, that would be about $1,300. So you’d save approximately $1,000 by using a loan with PMI over an 80/10/10 loan.
But there’s more to this choice than what it costs you in cash out of pocket. Cooper admits that financing the PMI premium will delay building equity in your home. Add to the 80/10/10 column another $2,500 in equity just in the first five years of the loan, and the pendulum starts to swing the other way. Keep your loan a few more years, and your PMI refund dwindles while your equity builds faster with the 80/10/10 loan.
So how do you know which way to go? Ask yourself what’s most important. If you want the cheapest out of pocket loan, go with the financed PMI premium. If you want to build equity, you’ll do it faster with an 80/10/10 loan. Make sure you understand what type of home equity loan you’re getting with the 80/10/10, Cooper warns. It might be a 15-year balloon with a 30-year amortization, requiring you to make a lump sum payment. Or, it might have an adjustable interest rate.
“Right now, interest rates are low, so an 80/10/10 looks like a great deal. But when interest rates rise, and they will, it may not be as good a deal as PMI,” Cooper explains. “PMI isn’t interest rate sensitive.”