Secondary Marketing Executive, March 2011
by Don Kracl
In concept, the basic function of private mortgage insurance (PMI) is to provide borrowers with the ability to purchase a property without the typical 20% down-payment requirement. Historically, this served to increase the pool of potential buyers, which, in turn, increased the demand for housing. As common sense—or, at least, federal policy—insisted, a happy and responsible homeowner is a good citizen. Unfortunately, our recent troubles can be traced to the federal government’s efforts to artificially increase the level of homeownership.
But the current problems were actually a long time coming. With the creation of the government sponsored enterprises (GSEs), underwriting programs for all insurance companies—both private and federal—became more relaxed. In the late 1970s maximum loan-to-value ratios (LTVs) were at 90%, while the principal, interest, taxes and insurance ratio was at 25% and the total debt ratio was 33%. Although the government agencies were not as strict on the guidelines—and they actually had a different method of calculating them—they contributed to the goal of making homeownership more accessible to the masses.
Although the PMI companies had relaxed their guidelines to mirror the demands of the marketplace, it was not enough. So along came the 80/20 programs and their variants, which were all designed to circumvent the additional layer and cost of PMI programs. Similarly, the Alt-A and subprime programs turned up. The demand for the less-than-prime lending solutions brought about ways to provide PMI for those programs.
Higher premiums are charged for various risk factors. The problem arises when the growth in a risk category exceeds the premium revenue and reserves. This causes a “perfect storm,” in which premium revenue and reserves are both insufficient. We all know how that ended up.
In a case of too little/too late, the industry reined in the excesses of this mess by increasing premium rates. Today, mortgage banking is much more conservative with its underwriting criteria and the programs available for mortgage insurance. Logic would suggest that PMI is more expensive and restrictive, especially compared to what is being offered by the Federal Housing Administration (FHA). However, things might not be as they seem.
For starters, the FHA has become the de facto subprime mortgage insurer. The PMI companies have been too beat up and have absorbed too many losses to continue working with these borrowers. However, for many people looking for a loan over $271,050 – remember that the government-sponsored enterprise (GSE) conventional maximums are $417,000 - the FHA may not be the right solution.
For example, you can go with a lower FICO score with the FHA program - even as low as 500 with 10% down; today’s “normal” FICO minimum is 580. But will your investor accept the loan, or are you putting yourself at risk of a buyback? In most instances, the minimum FICO for PMI is 660 - but, again, are you putting yourself at risk for buying back with a FICO that low?
With the FHA’s new insurance premiums, your borrower will be paying 1% up front and 0.90% (annual rate) on his or her monthly payment if the LTV is greater than 95%. With an LTV of 95 % or less, the upfront payment is the same, but the monthly payment drops to 0.85%.
If your borrower needs to do a cash-out, the FHA will accept an LTV of up to 85%. But not all PMI companies will accept cash-out refinances. For a rate/term refinance, PMI will limit you to 95%, but the FHA will accept up to 97.75—so there’s a slight advantage to FHA in this case.
Another factor to consider is the impact of the credit markets towards conventional financing versus government financing. Due to the favorable view given the government loans, you can expect a lower base rate for the government loans. However, you will be paying a higher mortgage insurance factor - thus, you get a little in rate and give a little in mortgage insurance. Generally, you’ll find that a 95% or greater LTV will yield your borrower a slightly lower payment and about the same payment from around 90% to 95% LTV.
Let’s examine the loan scenario presented in the accompanying chart. This is for a loan amount in Nebraska for $250,000, with a FICO score of 700 at a 95% LTV.
*Upfront Mortgage Insurance included in loan amount
In this particular case, the loan amount in the FHA case will increase the mortgage insurance premium, but the conventional program with PMI still has a lower total payment. However, you'll get a slightly better rate with the FHA program.
Now let’s take a look at the same scenario with a different LTV for each mortgage insurance case. Similar outcomes ring true.
With the 90% LTV scenario, the FHA program results in a lower interest rate but slightly higher mortgage insurance premium payment (MIP). The same is true in the 85% LTV case, where the rate in the conventional program is lower but has a higher MIP amount.
On the other hand, even though a PMI company and/or the FHA will accept certain loan scenarios, investors can be even more restrictive when it comes to approving loans. For example, in a declining market, a loan might be eligible under a PMI company, but some investors will reject it.
So how can originators proceed? There is clearly a need to access rates, credit overlays and guidelines from all major PMI companies to help determine the best available options. Automated by decisioning can speed the process by sending quotes to multiple prospects within seconds of the loan inquiry’s being submitted.
With today’s new regulations in place, borrower transparency is also crucial. Creating good-faith estimates and cost estimation worksheets with all settlement charges within a pricing engine solution can keep mortgage originators in compliance.
While PMI may come with additional layers of underwriting guidelines and concerns, originators should not be in a hurry to dismiss it in favor of the FHA program. In lending, there is no such thing as a one-size-fits-all solution.
With the right focus and the determination to do what is best for the borrower, mortgage insurance does not have to bring a series of headaches to the origination team.