Posted on Saturday, January 15, 2011
A recent study examining the role of private mortgage insurance reveals the instrument serves a vital role in helping to establish stability within the housing market.
The study, conducted by Promontory Financial Group, provides a review of how private mortgage insurance policies protect mortgage lenders and investors against the risk of defaulted mortgages by taking on a part of that risk.
Private mortgage insurers are required by law to retain 50 percent of policy premiums for 10 years. According to the report, the law mandating the reserves of policy premiums stems from a need to be prepared in the event of massive defaults.
During the Great Depression many private mortgage insurers that did not have enough reserves foundered.
“The contingency reserves required of private mortgage insurers offer a time-tested and effective mechanism to increase the availability of loss-absorbing private capital in the housing finance system at times when it is needed most,” said Eugene A. Ludwig, founder and CEO of D.C.-based Promontory, and former U.S. Comptroller of the Currency.
The study lists reasons lenders may seek private mortgage insurance, including stipulations from Fannie Mae and Freddie Mac that prohibit them from purchasing a mortgage above an 80 percent loan-to-value ratio unless the lender provides one of several itemized credit enhancements (for example, private mortgage insurance). Lenders may also seek the insurance as a way to manage risk for loans held on balance sheets.
In comparison to other forms of mortgage credit risk mitigation, “PMI [private mortgage insurance] increases the total amount of private capital available for lending to borrowers unable to afford (or unwilling to provide) a 20 percent down payment,” according to the report.
It continued, “Likewise, pool-level PMI on securitizations containing lower-LTV mortgages encourages lending and investment in these instruments as well. PMI thus promotes homeownership by individuals who would not otherwise be able to afford it, an objective of U.S. housing finance policy since the New Deal.”
By: Joy Leopold, DS NEWS