A question about PMI?

Question

Had this debate at work today regarding the subprime mortgages. It seems that a good number of the people that took out these mortgages would have put down less than 20% for their home. As a result of having to put down less than 20%, wouldn't the people taking out the mortgages have to pay PMI. Wouldn't PMI allow the lender to recover any costs that were not able to be gotten from foreclosure? While we can see a reduction in profits, we have difficulty in understanding why these high rate loans would result in a company going under due to the PMI.

Just thinking about this. Were these subprime lenders over-extended in some other way?

Answer 1

PMI is required on Fannie Mae, Freddie Mac loans over 80% LTV. FHA its required for 5 years minimum regardless of your LTV.

Most SubPrime mortgages dont require PMI. I would say 95% of SubPrime mortgages dont have PMI. The reason is very simple. No insurance company will insure them. Thats why its subprime. There is no mortgage insurance backing the Subprime market.

Thats why there is such a mess. There is nobody to fall back on besides themselves. The loss isnt shared over all the lenders and all the people paying PMI. Its a direct loss.

PMI is just like Auto Insurance. Most lenders collect it from millions of people to pay for the ones they lose money on. You pay PMI for other peoples risk. Its not that way in Subprime. The 80% of the people that arent going to foreclose on their subprime loan, arent paying insurance for the people that do. There for the risk is not spread amount all the borrowers. Unlike the Conventional financing you are talking about.

Conventional loans 120 people pay 100 a month. 5 person foreclose the bank loses 200K on the deal. 95 people are paying 12,000 a month to cover the banks loses. They made their money back.

Subprime 100 people take out the loan, 100 people are paying $0 per month in PMI. 10 people forclose. The bank loses 500K on the deals. They have 90 people paying $0 per month to help pay for the loses.

Thats the difference. I made up the above scenarios, but just to show you the point. There simple is no PMI.

Hope this helps.

I agree to an extent with JC, but 90% of these loans were not piggy back. Thats the problem. On a piggy back loan the second mortgage is taking all the risk. The first mortgage is only lending 80%. This is not the case in what is going on. Otherwise the 2nd mortgages would be going out of business, not the 1st mortgage companies. The loans we are talking about are 1st mortgage companies, that gave out Subprime loans for a 95-100% LTV. NO MORTGAGE INSURANCE REQUIRED. There was no stand alone second that took the hit. The 1st mortgage company took it all. CJ is right about payback, to sell these loans to Hedge Funds they personally guaranteed against Default, not a PMI company. They ran out of money.

Answer 2

Most of the products in the subprime world were structured to avoid PMI. Things like piggyback loans were designed to get one loan with low enough LTV to avoid PMI and a second loan which would ordinarily not carry PMI.

The PMI companies charge higher rates for lesser quality loans. The end result is a consumer with a high chance of default - those who were getting subprime loans - would have had to pay the equivalent of another mortgage payment in monthly premiums. This is because the PMI companies recognized the risk and charged accordingly. Because the PMI was so expensive, those borrowers went the piggyback route.

And those loans were not sold to Fannie Mae and Freddie Mac, so the PMI requirement did not cover them. The subprime loans were sold to private investors - hedge funds, mutual funds - who purchased the loans without the PMI.

The insurance companies that did dabble in those markets are now suffering the consequences. The ones that did not will emerge unscathed. (Go to Yahoo business and look up RDN and you'll see what I mean.)

To answer the other question... Most investors will require the lender to purchase the loan back if there is an early payment default. So as the subprime loans started to go back very quickly, the investors wanted to be paid. Lenders kept money in reserve for this, but the losses exceeded the reserves in most cases. The lender, once the reserves were gone, had a choice: either replenish the reserves or go out of business. Most could not replenish the reserves - there was no more money - and were forced into bankruptcy to cover the next losses.

The problem many lenders are experiencing now is not having cash to close loans. Even some previously healthy lenders have gone under in the past week because of this. The lender would make loans, bundle them, sell them, and take the proceeds to make new loans. They would then take that money, make more loans, bundle them and sell them. And the cycle would go on and on. Except in the past couple weeks, the investors that bought the loans stopped buying. So there was no new money being pumped into the system. But in many cases, the lender had already made the next round of loans. They were overextended. It was the equivalent of living paycheck to paycheck. The paycheck stopped and there was no money saved for an emergency.

ADDITIONAL
To explain something another person stated in an answer...most PMI decisions are delegated to the lender. That is, the PMI company will automatically insure a loan if the lender has underwitten the loan and found it to fall within the PMI company's standards. All the lender has to do is order a certificate showing the property is insured before the loan closes. If, however, after the loan closes, the PMI company finds that the loan really did not qualify, but that the lender was mistaken, there can be a recission of the insurance, and the PMI company does not have to pay. While that is true, there are not many loans where that is happening. It is extremely rare. So it is not a contributing factor to what is happening in the market right now with the subprime loans.

Answer 3

Good evening and very good question. Subprime lenders rarely charge/require PMI, Private Mortgage Insurance. Subprime lenders generally charge a considerably higher interest rate than conforming lenders and this is how they were able to get away without needing their borrowers to pay for PMI. They made extra money through higher interest rates to absorb the costs of defaulted loans. Subprime lending, along with other types of lending as well, definitely got way to "loose" with their lending guidelines and were lending on some pretty outrageous stuff. Now with the foreclosure rates being so high, there are many lenders who are feeling to big of a pinch for lending money to basically "anyone with a heartbeat." Thus, these subprime lenders are taking so much of a beating that many of them can no longer afford to stay in business. Conforming lenders require PMI for anything with less than 20% equity and the PMI will cover for some of the lenders losses on those loans. However, in the conforming and the subprime sides of business there were so may lenders that were offering 80/20 combo loans for 1st and 2nd mortgages that consumers were able to get around PMI for a little bit lower overall monthly payment than they would have paying PMI. This is having a serious and rippling affect on the 2nd mortgage industry as well and many of these companies are folding quickly. Many other lenders who offer 2nd mortgages are haulting accepting 2nd mortgage applications and PMI is almost becoming a requirement now for anything over 80% LTV. Therefore, to sum it up in a nutshell, these high rate subprime loans had their security already built in to the loans themselves and they do not require PMI and since they lent money to almost anyone, it is finally catching up with them.

Answer 4

Eventhough the PMI may exist a lot of insurance companies are not paying the claim because of "illegal" or misrepresentation to the lendee by the mortage company. There is usually strict language in a private mortage insurance contract that basically assumes the lender is acting like a saint when making a loan. If they don't then they will be in breach of contract of the insurance policy and thus not have to fund the loss. As you can imagine there were many shady deals done to get someone a loan that never should have been lent the money in the first place. Fake W2's, stated income loans, etc.

Answer 5

Aren't a lot of these loans 80% first mortgage and 20% second mortgage to get around PMI?

Answer 6

Most of the sub-prime loans were not backed by PMI. They were 80/20 loans, interest only, inflated appraisals, etc.