loans. Exhibit IV-4 shows how significantly this changed in the 1970s. Total FHA-VA mortgage debt outstanding increased about $60 billion, or 61 percent, between 1970 and 1978. Private mortgage insurance in force, however, increased nearly $75 billion. By the end of 1978, privately insured loans accounted for nearly 35 percent of all insured or guaranteed residential mortgage debt outstanding. The popularity of privately insured conventional loans over those offered through Federal Government Programs is demonstrated further in Exhibit IV-5. In every year since 1972, private mortgage insurance has accounted for more than half of the net additions to insured or guaranteed mortgage debt oustanding. The last three years in particular have seen a tremendous expansion in the residential mortgage market. This trend, however, may not necessarily continue into the 1980s. If mortgage money is relatively tight, many conventional lenders will follow the practice of rationing mortgage money first to those borrowers able to make the largest down payments. As a result, conventional privately insured loans may provide a smaller proportion of combined insured and guaranteed loans. FEATURES OF THE INSURANCE PRODUCT AND DELIVERY PROCESS The mortgage insurance product is, in theory, very similar to the FHA 203 single-family mortgage insurance program. The private mortgage insurance industry, however, has developed a product that is both more flexible and more comprehensive. It includes: (1) the delivery of the traditional insurance product that assumes the transfer of certain, well-defined risks; and (2) the delivery of certain ancillary services designed to fulfill a broad range of needs of lender customers. The following analysis reviews the type of coverage typically selected by lenders and describes the type and amount of risk that is transferred from lender to insurer as a result of the insurance coverage. The availability of private mortgage insurance has had a substantial im pact upon both the lender's willingness to make conventional, high loan-tovalue ratio loans, and upon the saleability of those loans to secondary market investors. In addition to the basic insurance provisions, a broad range of ancillary services contribute to the saleability of these loans and to maintaining a smooth, liquid resale market for them. Those services are also described in some detail within this chapter. Private mortgage insurance became an increasingly important element in allowing home buyers to qualify for permanent mortgage financing during the decade of the 1970s, and as such, this insurance service plays an important role in the real estate settlement process. To better understand the process involved in delivering this service, this section will trace both: (1) the insurance approval process from the time of loan application to the time at which the insurer sends a Commitment Certificate to the lender; and (2) the claims process from the point of mortgagor delinquency through the options available for complete claims settlement between the insurer and the lender. EXHIBIT IV-4 GOVERNMENT INSURANCE OR GUARANTEE VS. PRIVATE INSURANCE The Mortgage Insurance Product Private mortgage insurance is a financial service provided to mortgage lenders who require such insurance when making a conventional mortgage loan to a home buyer unable (or unwilling) to make a traditional 20 to 25 percent down payment. In providing this service, the mortgage insurer agrees to absorb a set portion of the loss that would result from a borrower's default on his mortgage obligation. This insurance encourages the lender to make high LTVR loans by allowing him to transfer to a third party some of the risk inherent in such mortgage lending. Forms Of Coverage The lender typically determines the amount of insurance or coverage that is necessary, but this decision is often influenced by both regulations (of, for instance, the Federal Home Loan Bank Board) and by the needs of secondary market investors (including the Mortgage Corporation, the Federal National Mortgage Association, and private financial institutions). Such insurance coverage is usually defined as a percentage of the loan amount for which the insurer will assume a risk of loss. The two most popular insurance plans are the 95/25 plan, and the 90/20 plan. Loans accompanied by a down payment ranging from 5 percent up to (but not including) a full 10 percent, typically require coverage under the first plan, which provides coverage for the top 25 percent of the oustanding loan amount. For instance, if a borrower made the minimum 5 percent down payment, coverage under this plan would reduce the lender's risk from 95 percent of the purchase price or appraised value of the property, down to 71.25 percent of its value (the remaining 75 percent of the 95 percent loan amount). This would be roughly equivalent to the security that would have been provided by a 28.75 percent down payment. The 90/20 plan provides coverage for loans accompanied by a down payment of from 10 percent up to 20 percent. In this case, the insurance provides coverage for the top 20 percent of the outstanding loan amount. In the case of the minimum 10 percent down payment, the lender's risk would be reduced from 90 percent down to 72 percent (i.e., 80 percent of the 90 percent loan amount). As a result, the amount of risk borne by the insurer, may be defined in terms of two simple variables: (1) the percentage of the purchase price that the borrower is able to pay; and (2) the percentage of the resulting loan amount that the insurer is willing to cover. Each defines an amount of risk that will be absorbed by the insurer, and each different combination might warrant a different premium charge. These combinations can be graphically presented by a simple matrix (see Exhibit IV-6) measuring loan risk (expressed as a loan-to-value ratio) across one axis and the amount of coverage provided by the insurer along the other. |