Private Mortgage Insurance
Canner, Glenn B., Passmore, Wayne, Federal Reserve Bulletin
Before extending a mortgage, lenders typically require borrowers to make a sizable down payment to reduce both the risk of default on the loan and the amount they stand to lose if a foreclosure is necessary. Moreover, borrowers often pay significant closing costs. Together, the down payment and closing costs can be substantial relative to the borrower's savings, particularly for first-time homebuyers and households with lower incomes.
Mortgage lenders usually require a down payment of at least 20 percent of the appraised value of a home. But they will accept smaller down payments if repayment of the mortgage is backed by a type of insurance, paid for by the borrower, known as mortgage guarantee insurance. Mortgage insurance for low-down-payment loans is available from the federal government, primarily through programs administered by the Federal Housing Administration and the Department of Veterans Affairs, and from the private sector.
Insurance on a mortgage comes into play when the homeowner defaults on the loan and the proceeds from the subsequent sale of the mortgaged property fail to cover the remaining debt plus the costs associated with the sale. In such a case, the mortgage insurer reimburses the lender for the shortfall, generally in full if the insurance is governmental but only up to certain limits if the insurance is private. Because insurers bear at least part of the risk of loss on home loans, they must carefully review the qualifications of prospective borrowers and the value of the collateral provided by the property being purchased.
Early forms of mortgage insurance arose in the private sector around the turn of the century and developed until the onset of the Depression. The private mortgage insurance industry then collapsed, and its function was assumed by the federal government, which was the only source of mortgage insurance from the mid-1930s through the late 1950s. Today, mortgages backed by government insurance continue to play a significant role in the home finance market, but mortgage insurance offered by the private mortgage insurance industry is also widely used by homebuyers and those refinancing their existing mortgages. Private mortgage insurance backed nearly 1.2 million single-family home loans extended in 1993, representing about 45 percent of all the insured mortgages granted that year (table 1).
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This article reviews some of the history of the mortgage insurance industry, outlines the way the mortgage insurance business is conducted, examines the financial implications for a borrower choosing between governmental and private mortgage insurance, and discusses the disposition of recent applications submitted to private mortgage insurers. Little information has been available heretofore about the disposition of applications. This year, however, the private mortgage insurance industry released data on the disposition of the cases that private insurers acted on during the fourth quarter of 1993 and on the characteristics of the households in those cases (see box, "Data Disclosed by the Private Mortgage Insurance Industry"). The article summarizes the new information and draws some comparisons with data on applications for government insurance and with mortgage applications generally.
PRIVATE MORTGAGE INSURANCE: A HISTORICAL PERSPECTIVE
The private mortgage insurance (PMI) industry can trace its origin to the early years of this century and the activities of title insurance companies in New York State.(1) The state legislature authorized the issuance of mortgage guarantee insurance in 1904, but the law permitted insurers to guarantee the payments only on mortgages owned by the institution that originated the loan. In 1911, New York amended the law to permit mortgage insurers to purchase and resell mortgages. To enhance their ability to sell mortgages to investors, insurers guaranteed the property title as well as the loan. …