Troubled home loans didn’t require insurance

WASHINGTON – Oct. 2, 2008 – If the problem threatening to take down the economy is bad mortgages, then why isn’t mortgage insurance taking care of it?

In the 1980s and 1990s, most homebuyers could not get a mortgage with a downpayment less than 20 percent unless they bought private mortgage insurance, or PMI. This insurance covers the lender in case the borrower can’t pay. It wasn’t cheap (about $150 a month for a $235,000 mortgage). And unlike mortgage interest, you couldn’t deduct it on your federal income taxes.

Between 2000 and 2007, lenders offered homebuyers unable to afford a large downpayment several ways to get a house without mortgage insurance.

One of the most common was a “piggyback,” where the borrower took out two mortgages at once. The first mortgage covered 80 percent of the price. The second mortgage, usually with an adjustable rate, covered another 10, 15 or 20 percent of the price. Down payments ranged from 10 percent to nothing.

With house prices rising, it all looked good. Interest paid on both mortgages was tax-deductible. If the second loan was going to set at a high rate, the borrower could refinance with the rising value of the house.

But when the housing bubble popped, so did piggybacks.

“The loans that are in the most trouble are the loans that circumvented mortgage insurance,” said Jeff Lubar, spokesman for the Mortgage Insurance Cos. of America.

Karen Watson, who runs a Dallas mortgage company in Preston Center, said buyers of mortgage securities set the guidelines allowing borrowers to get home loans with no money down and no mortgage insurance. The underwriting and approval process was automated.

Mortgage securities buyers “came in and took on the risk that insurance companies were designed for,” she said.

Mortgage insurers got back in the game after persuading Congress to allow homebuyers to deduct their mortgage insurance payments. That law took effect on Jan. 1, 2007, but expires in 2010.

Watson said she was still offering piggyback mortgages until this spring, when the lenders “changed the guidelines almost ex post facto - ‘We’re not offering these as of yesterday.’”

Despite the mayhem this month on Wall Street, she said mortgages are still being sold.

“People are getting used to the new guidelines, which are the old guidelines,” she said. “We’re doing what we used to do.”