Troubled home loans didn’t require mortgage insurance

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By Jim Landers

Published: October 18, 2008

WASHINGTON — 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 home buyers could not get a mortgage with a down payment 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 home buyers unable to afford a large down payment 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.

Karen Watson, who runs a Dallas mortgage company, 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 home buyers to deduct their mortgage insurance payments. That law took effect 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.”

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