By David Katkov

Between slowing appreciation, falling demand, and layoffs in the construction industry, we began to see a change in the housing market by early 2006. The contraction of the subprime lending industry in early 2007 added momentum to the transition, and today we are in a much more challenging market than we were even as recently as a year ago.

The survivors of this challenging market will be the ones who think creatively about solutions to facilitate sustainable homeownership, especially for the growing low down payment market. Mortgage insurance is one such solution, especially for low- and moderate-income borrowers and first-time home purchasers. It's tax deductible, affordable, and cancellable, and it can help expand your business.

The growing low down payment market

Over the past 10 years, nationwide, home prices have appreciated 107 percent, according to the Office of Federal Housing Enterprise Oversight (OFHEO), while during this same period (Moody's Economy.com tells us) incomes have increased just 37 percent. Given these statistics it's not surprising that low down payment loans are becoming an increasingly important part of the mortgage finance landscape. According to a National Association of Realtors® survey, nearly half of all first-time homebuyers from mid-2005 to mid-2006 put no money down; the median down payment was just two percent.

The problem with low down payment loans

Loans with a loan-to-value (LTV) ratio greater than 80 percent are statistically more likely to result in losses. Because of the higher likelihood of default, the government-sponsored enterprises (GSEs) will not purchase a high-LTV loan unless the loan is insured or the selling lender retains a participation interest or accepts full recourse in the event of default. Given these options, lenders typically choose to sell loans to the GSEs with mortgage insurance, which protects the lender against losses associated with borrower default, up to the limits of the policy.

The problem with piggybacks

Mortgage insurance isn't the only option for a high-LTV loan: the borrower may also get a second mortgage, "piggybacked" on top of the first, to cover the difference between the 80 percent first mortgage and the down payment. But interest rates on seconds are often adjustable and float with the prime rate, so piggyback loans are more expensive than they were a year ago and payments can jump significantly if interest rates increase. A more fundamental problem is that due to ratings downgrades on securities backed by second liens, lenders are more reluctant to write seconds than they once were, so this option may not be available.

The solution: mortgage insurance

Mortgage insurance is a simple, safe and smart way for borrowers to purchase a home with a low down payment, and it's a good match for today's market.

Fast: Today, underwriting and obtaining mortgage insurance is typically done electronically and almost instantaneously. Ninety percent of PMI's policies are approved within the same business day and, industry wide, single loans with mortgage insurance often close faster than piggybacks.

Flexible: Mortgage insurance is available in a wide variety of options that can serve a wide array of borrowers, including expanding market products specifically designed to help the industry serve new borrower segments.

Affordable: On a $100,000 house with a 5 percent down payment and a 30-year fixed rate mortgage, standard mortgage insurance would cost 0.78 percent or $61.75 per month - less than a monthly cable TV bill. PMI's online calculator, eCompareSM (www.pmi-us.com) offers an easy way to compare costs.

Cancellable: Mortgage insurance can be cancelled upon a borrower's written request once the loan principal balance reaches 80 percent of the original purchase price. And federal law requires that lenders automatically cancel mortgage insurance once the loan's balance is paid down to 78 percent of the property's original value. Many lenders will allow early cancellation of mortgage insurance based upon a home's appreciation in value.

Tax deductible: Borrowers purchasing or refinancing homes in 2007 who have annual household incomes of $100,000 or less will be able to deduct the full cost of their mortgage insurance on their federal tax returns. Borrowers with incomes between $100,001 and $109,000 can take a partial deduction.* Bankrate.com estimates that a homeowner with a $180,000 mortgage would save $351 in taxes.

The bottom line

While initially the new tax provision is only for a year, given the groundswell of interest in helping low- and moderate-income Americans achieve homeownership without having to resort to potentially higher risk loans, I believe there's a good chance Congress will extend the deduction or even make it permanent. With home prices slowing and originations down, mortgage insurance is an effective solution for today's market.

 

*Based on transactions closed in 2007, and MI premiums paid between January 1 and December 31, 2007 and allocable to 2007. Deductions are phased out in 10% increments for borrowers with adjusted gross incomes between $100,000 and $109,000. PMI cannot provide tax advice. Taxpayers should consult their own tax advisors concerning applicability of this new deduction to their particular circumstances under the Internal Revenue Code and the laws of any other taxing jurisdiction. This information is not intended or written to be used, and it cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties.

David Katkov is the President & Chief Operating Officer, PMI Mortgage Insurance Co.