Thursday, July 24, 2008

What Happened to PMI?

When I bought my first house back in 1995, I couldn't scrape up a full 20% down payment and still afford the city I wanted to be in. So I only put down 10% and paid PMI, like most people did. Even with PMI I was still paying 20-30-% less monthly than it would cost to rent the same house, so I felt comfortable about the decision not to wait and save more towards the down payment.

Fast forward to today and I'm wondering what happened to PMI in the age of the zero-down, negative amortization mortgage. Here's an interesting piece on why it went away:

If you don’t live in a cave, you have probably hears about the current crisis in banking and housing. Many banks and mortgage companies have already failed (Netbank, Indymac, and others), and many more are expected to follow. But if the banks hedged their risks appropriately, the pain of the housing crisis would be mostly limited to the private mortgage insurance companies, such as MGIC Investment Corp (MTG).

Traditional wisdom states that you need a 20 percent down payment to purchase a house. The 20 percent down payment is the method a borrower can use to prove loan worthiness. The large down payment, and a good credit score were the traditional means a bank used to establish credit worthiness for such a large purchase. If a borrower wanted a home loan with less then a 20 percent down payment, they were structured as a piggyback loan. The piggyback loan consisted of two loans, one for 80 percent of the value of the house, and a second loan at a higher interest rate for the difference between the smaller down payment (sometimes nothing at all), and 20 percent. In addition, banks and mortgage lenders issuing piggyback loans required the owner to purchase additional private mortgage insurance. The mortgage insurance premiums paid by the owner was a protective insurance policy designed to hedge the banks risk against default. Companies such as MGIC, who sold the mortgage insurance, would cover the first 20 percent of loss and the banks would cover the rest.

Looking in on the carnage now, I bet most of the folks that are walking away or losing their houses as rates reset could have rented the same place for less than their mortgage payment. That should have been a sign that prices were out of whack. I know we rent our current place for less than the monthly PITI.


Anonymous said...

But you're discounting the status effect of owning a house. Most people won't admit it but one of the biggest reasons to buy a house is the same reason people bought SUVs, get big engagement rings, send their kids to private schools and aspire to attend Ivy League universities. Status. That status of not being a lowly, white trash renter (the prevailing wisdom) is worth the extra $1000 or more a month to own rather than rent. Put another way, driving a Honda Accord will get you lots of places but driving a BMW costing thousands more will get you there and noticed.

You can hang that classism squarely at the feet of the market-cult culture created by 30 years of shallow, vapid, conservative ideology.

I get a quiet thrill when people with houses bitch about how much it costs them to "own". I readily describe myself as a lowly renter and you can almost see the pity in their eyes! Meanwhile, I live in one of the nicest parts of this city for about 1/4 what it would cost me to buy, which I could never afford anyway. They of course think that they'[re going to "win" the game with a buttload of equity when they're old. Nevermind that the $300K fixer upper they bought will cost them almost a million over the life of their loan.

It's all rather amusing. I actually had a woman from work exclaim, her eyes wide, "Aren't you afraid of not having a house when you're old?!" Um, No.

bearlee said...

hahaha anon, I agree, when I look at my house I mortgaged/rented from the bank I cringed when I saw how much I was gonna pay in interest. Though I don't recall the exact numbers I think the $178K house was gonna cost around $390K in just principle and interest. Throw in 30 years of property taxes and insurance and BAM! Add to it the maintainance costs and one really has to wonder why you would buy...sure there are reasons, but in this market?!?!?!

Anonymous said...

Buying a house on the west coast is a SCAM!

I am on my second house now - I sold at the peak of the market and couldn't find anything liveable in the price range I sold for, so I had to step up 100K. I bought because I wanted a stable place to live and the freedom to do what I want with my home.

Now I realize I am free to do what I want, except that I am tied to this house for probably 5 years or so,not being able to sell it for what I bought it for. When I do sell, I will rent from then on. The mortgage deduction and other fringe benefits of being a homeowner dont stack up against the payment, taxes, maintainence, and being tied down.

MiTurn said...

PMI got us into our house. But we bought pre-bubble. When values became inflated, we had our property reassessed, got into a lower fixed-rate and were able to shed the PMI after a year with our "increased equity."

But right now, I wouldn't want to be one of those outfits trying to cover all of their current and pending loses.