First, let’s start with the basics: what is PMI? As implied by the name, PMI is literally an insurance policy on your mortgage, which protects the lender in case of default. Typically, PMI is required on mortgages with a loan-to-value of greater than 80% (i.e. when the down-payment is less than 20% of the value of the mortgage). The insurance is calculated as a percentage of the the total mortgage value, and is rolled into the monthly mortgage payment.

PMI is not cheap, and will average about $1,000 per year on a $200,000 mortgage. Generally speaking, insurance premiums for fixed-rate mortgages are lower than for variable-rate mortgages. In addition, long mortgage durations (30 years, as opposed to 15 years), and high loan-to-value mortgages are associated with higher PMI premiums. This is to be expected, since mortgages with these characteristics typically have higher default rates.

One alternative to making monthly PMI payments is to roll a one-time premium into the mortgage. Thanks to current tax rules (mortgage interest is tax-deductible, while PMI premiums are not), it will be cost-effective for the average borrower to do so. Unfortunately, most borrowers are not aware of this possibility, because lenders require special authorization to process it and hence avoid mentioning it to prospective borrowers. Finally, while such a strategy will technically raise the size of your mortgage, some (or even most) of this premium will be rebated to you when it is determined that you no longer need it.

Speaking of which, mortgage insurance is only a temporary outlay. After your loan-to-value ratio exceeds 80%, you will no longer be required to pay for it. This is natural, since if your loan-to-value ratio had been this high when you first obtained the mortgage, you wouldn’t have been required to purchase PMI.  In fact, thanks to a law passed in 1999, lenders must take the initiative to cancel the mortgage insurance agreement when the LTV falls below 78%, based on the initial appraised value of the home. Borrowers are also entitled to early cancellation (though, you must request it), if your equity exceeds 25%, based on a current appraisal of the home.

As I mentioned, private mortgage insurance is quite expensive, and hence not-at-all desirable. This is because the mortgage insurer is selected by the lender – not by the borrower – which doesn’t have as much of an incentive to cut costs. Accordingly, it might be economical to pay a higher interest rate in lieu of PMI, if your lender offers you such an option. The best approach is to simply (save up until you can afford to) make a higher down-payment, such that PMI is no longer necessary.

The program has also been modified slightly from its original form, in which only first-time buyers with a maximum combined income of $150,000, were eligible for the $8,000 tax credit. In its latest iteration, the tax credit will be available to an even wider demographic. First-time homebuyers will still receive a tax credit worth $8,000, but the income restrcitions have been raised to $250,000, which means that all but the wealthiest 2% of Americans are now eligible. In addition, those wishing to make a new home purchase (but are not first-time buyers) are eligible to receive $6,500 for so-called “Trading Up” purposes.

For many homebuyers rushing to close on a home purchase, the extension was no less than a windfall. It appears that many had orignally underestimated the amount of time it can take to close (sometimes several months); now that they have until May 1 to close, there is less of a need to rush. In addition, the tax credit credit can still be claimed in advane, in the form of a loan from the government. In this way, homebuyers looking to make a purchase now, won’t have to wait until filing their taxes to receive a reinbursement. Given that April 15 is right around the corner, however, this is probably less of an issue for those that take advantage of the program in the coming months. As an aside, it’s important to check with an accountant/tax-preparer to confirm your eligibility for receiving the credit, as the IRS has already identifief 20,000 caes of fraudulent/accidental claims by those who were ineligible.

In the short-term, there’s no question tha this tax credit will continue to provide support for the housing market. Many analysts have attributed the apparent stabilization of the housing market solely to this program. Given its expansion to include all but the wealthiest home-buyers and the removal of the requirement that it can only be claimed in association with a first-time home purchase, it will provide have an even greater impact in the months ahead. In fact, “The industry group is forecasting 5.69 million existing home sales in 2010, up from an anticipated 5.01 million this year. About 549,000 new-home sales are projected for next year, up from an estimated 397,000 this year,” a rise of nearly 15% from 2009 levels.

As for the long-term, that’s another story, altogether. ““Housing activity is likely to fall back once the tax credit finally expires, as some sales will have been brought forward from future months,” explains one analyst. Ideally, the economy will pick up during the interim, and cushion the fall after the program ends. In this way, the tax credit can be seen as nothing more than a giant bridge loan for the housing market.

Low-income borrowers have always been at a disadvantage when it comes to obtaining mortgage financing. State and local agencies have thus played a valuable, and even necessary role, in funneling cash to this under-served group of borrowers. As a result of the credit crisis, however, such agencies have had an extraordinarily difficult time obtaining capital, and many are operating at only 20% of normal lending capacity. Historically, they have been able to count on Fannie and Freddie to purchase their mortgages and satisfy their capital needs; since being nationalized in 2008, however, Fannie and Freddie have also had a difficult time meeting their capital needs, with 2009 bond issuance projected to be only 25% of 2007 levels.

30 states have already signed up for the program, and it is expected that more will follow. In order to participate, every agency will have to pay a fee for each mortgage that they originate, which should be offset by the lower interest rates and cheap access to capital. From the government’s standpoint, it is expect that these fees will defray all of the costs associated with the program. While there is no fixed budget, government officials anticipate healthy demand, and hence, healthy costs, perhaps as high as $35 Billion. Plus, the federal government will ultimately be on the hook for any mortgage defaults. As advocates of the program note, however, these state and local agencies have a strong track record. Despite targeting risky borrowers, they typically only issue 30-year fixed-rate loans, and require rigorous documentation of assets and income.

It is unclear how long the program will last, since it is being justified retroactively on the basis of a law passed in 2008. Government officials have been clear in their insistence that this initiative is intended to serve as a stopgap measures, and that these agencies should effect the government to fulfill their capital needs in the future.

From the standpoint of borrowers, this should provide a minor windfall, as loans can be used either for home purchases or for fixing up rental properties. Even before the inception of the credit crisis, such borrowers have largely been locked out of the conventional financing system. Now, they will have a chance to obtain mortgages, at reasonable cost. For more information, and to find an agency in your area, consult the National Low Income Housing Coalition.

By most measures, there has never been a better time to rent. While housing prices and interest rates remain favorable, rental costs are even more attractive, with ratios in many regional housing markets continuing to favor renting. Even in New York City, long perceived to be the nation’s most robust rental markets, is experiencing falling rents. Fundamentals (i.e. oversupply) are combining with rude economics (increasing unemployment, falling wages) to create one of the most attractive environments for renters in recent memory.

Many advocates argue that the government should ride this wave by formally ending at least some of its home ownership subsidies, such as the mortgage interest tax credit, FHA insurance, and guarantees for mortgage securities. Unfortunately, the vested interests which benefit from this system are enormous, and will not sit by idly as home ownership gives way to renting. From lenders to brokers, realtors to investment banks, there are literally trillions of Dollars at stake which are preventing a change in the status quo.

Renters did manage to score a token victory when it was announced last week that Fannie Fae had already initiated a pilot program that would enable to homeowners to remain in their homes for up to a year after foreclosure. This mirrors a similar move by Freddie Mac last March, and is in the same vein as an existing Fannie program which honors existing lease arrangement in rental properties facing foreclosure. Under the new program, the deed reverts back to Fannie after foreclosure, but the homeowner is given the option to rent the former home at market rate, which is typically well below the payment required under the preexisting mortgage. By most accounts, the program has proved to be a success, with a conversion rate of approximately 66% (i.e. 2/3 of homeowners opt for the deed-leaseback instead of eviction).

Of course, this initiative is not really grounded in any kind of altruistic desire to minimize foreclosure, nor does it aim to shift the balance back towards renting. Rather, it’s a simple business decision. Fannie realized that by delaying foreclosure in the practical sense, it could avoid dumping these properties on a market that is already saturated with foreclosed properties and taking a massive write-down from a short-sale. Instead, it can sit on the properties for a year while the housing market (hopefully?) recovers, while collecting a modicum of income from the homeowners-turned-renters.

Cynicism aside, renters should be happy for any break that they can get. With special interests and government incentives continuing to favor home ownership, renters are still fighting an uphill battle.

Towards that end, Fannie will effectively guarantee all-short term debt issued by such lending institutions, provided that funds received from such debt issuance is used to originate new mortgages that meet Fannie’s lending standards. It should be noted that in most cases, Fannie Mae (and/or its counterpart, Freddie Mac) already guarantee the majority of the mortgages issued by such lenders. While this protects the mortgages that the lenders originate, it doesn’t protect the lenders themselves. Thus, this program, will make it easier for small lenders to raise capital to fund mortgage-origination activities by guaranteeing their solvency.

The upshot is that this should not only increase overall mortgage lending activity, but also enable smaller lenders to compete more effectively more with the big boys. Previously, small lenders were hoarding existing capital and having trouble raising new capital, since investors were rightfully worried about the viability of the loans that they were making. For better or worse, this initiative means that they should be able to offer new mortgages at lower rates and less rigid lending standards.

Certainly, this program is not without its critics. The WSJ has suggested tongue-in-cheek that the government should just go ahead and nationalize the entire mortgage lending industry given that it is now directly responsible for ensuring its functioning. “Fannie and Freddie’s guarantees and subsidies helped to create the housing disaster, which has led the Fed directly to purchase mortgage-backed securities and mess up the market for small mortgage lenders, which in turn is leading Fan and Fred to guarantee the debt of those small lenders,” summarized its editorial board.

For those of you contemplating a mortgage, this means that you can obtain one from a small lender, without worrying about whether it will still be in business tomorrow. There’s no longer a substantial advantage associated with taking out a mortgage from a “Big-Box” lender, since smaller lenders can now compete on terms and pricing. In fact, given the bureaucracy of large lenders, it might be smoother to simply work with a regional/community lender, with which it will be easier to work with in the event of a problem.

While it’s impossible to offer a comprehensive explanation for this divergence, most analysts attribute it to the fact that the different mortgages are being utilized by different types of borrowers. “The main users of 15-year loans…are established homeowners refinancing mortgages — people secure enough that they often take on larger monthly payments in order to pay off their loans before they retire…People who take out 30-year loans, by contrast, are generally less well established, with smaller down payments, and require a bigger slice of their incomes to make their payments.” Given the current economic climate, then, it makes sense that lenders are willing to offer a discount to those with an established credit history (i.e. 15-year borrowers), compared to those entering the market for the first time (i.e. 30-year borrowers).

As for those of you trying to decide which duration is most appropriate for you, well, that’s not an easy question to answer. In a nutshell, a 15-year mortgage will save you a tremendous amount of interest (more than half) over the life of the mortgage, but this is offset by a much higher monthly payment. There is also a psychological benefit of being able to pay off the mortgage sooner and not have to worry about spending the rest of one’s life making payments. Summarizes a Freddie Mac rep: “The thinking is that many baby boom mortgagors are taking advantage of the low rates to refi into a mortgage that will enable them to live a relatively care-free retirement life — i.e. free and clear of mortgage debt.”

But with any dilemma, the reality is much more nuanced. For one thing, the monthly payment associated with a 15-year mortgage is significantly higher. Accordingly, one might opt for a 30-year mortgage and simply repay it in accordance with a 15-year amortization schedule. In this way, one retains the flexibility to make the lower (30-year) payment if financial hardship strikes. This “insurance” is inexpensive relative to the overall mortgage, adding $50 a month for a $200,000 mortgage. Skeptics counter that few borrowers are disciplined enough to make the 15-year payment voluntarily and that for those facing financial hardship, making a 30-year mortgage payment will probably be just as problematic as a 15-year payment.

Other proponents of 30-year mortgages point to the extra interest as an advantage, since it is tax-deductible. One clever analyst thought he had figured out a way to save money overall with a 30-year mortgage by exploiting this loophole, but it turns out that the spread between 15-year and 30-year rates has widened to such an extent that “the math no longer works.” Once again, the skeptics rightfully point out that even if you can deduct 30% (assuming a relatively high tax bracket) of your mortgage interest, that still leaves 70% that you are paying to the lender.

Finally, there is also the possibility that interest rates will skyrocket, creating a possible arbitrage opportunity with a 30-year mortgage that wouldn’t exist with a 15-year mortgage. Basically, if you invest the funds that would otherwise have been paid to the lender in a high-yield savings account, you would end up with more money than you would otherwise have had if you simply opted for the 15-year mortgage. But these opportunities are pretty rare, and anyone who argues to the contrary is probably trying to cover up the risk associated with such a strategy.

In short, it’s reasonable to assume that a 15-year mortgage will save you money, compared to a 30-year mortgage. However, the higher monthly payment is an important consideration, and should not be accepted by those with uncertain financial situations. If, on the other hand, your income stream is relatively stable, and you’re eager to escape from under the burden of debt as quickly as possible, the 15-year mortgage is a reasonable choice.

In short, the crisis has entered a new phase. Initially, the majority of foreclosures were driven largely by sub-prime and other risky types of loans. As interest rates rose and housing values plummeted, many of these borrowers suddenly found themselves unable to afford the higher payments and defaulted on their loans. At this stage, foreclosures were largely concentrated in bubble regions of the country, where house prices had appreciated faster than justified by fundamentals. This type of foreclosure has been easy to address, although not as easy to prevent. With the support of lenders, the federal government has sought to modify the mortgages for those struggling with higher debt burden. The underlying principle was pretty straightforward: lower payments should translate into lower default rates.

In the still-emerging second stage, foreclosures have begun to crop up among prime borrowers in relative stable housing markets. This trend is unrelated to risky lending practices, but instead, is a product of the economic downturn and rising unemployment. Job losses have exposed the precariousness of many borrowers’ finances, causing them to begin missing payments almost immediately thereafter. As a result, “About 30% of foreclosures in June involved homes in the top third of local housing values, up from 16% when the foreclosure crisis began three years ago…The bottom one-third of housing markets, by home value, now account for 35% of foreclosures, down from 55% in 2006.”

This brand of foreclosure, while easy to identify, is nearly impossible to treat directly. In many cases, unemployed borrowers can’t afford to make any mortgage payment, which means a loan modification wouldn’t do much to ease the possibility of default. The government is facilitating refinancings for mortgages with negative equity, but for most borrowers, this will only forestall the inevitable. Only when the economy recovers and employers begin hiring again will the crisis subside. While the Mortgage Bankers Association (MBA) is projecting that unemployment will peak at 10% in 2010, many analysts expect that the total number of foreclosures will be roughly the same as in 2009.

Even if new foreclosure filings subside, however, there is still an enormous “shadow inventory” of foreclosed properties that hasn’t yet been brought to market. According to a recent report by Amherst Securities Group, “As many as 7 million pending foreclosures could flood the market in the near future, driving housing prices down. That number represents homes that have already been repossessed by lenders or are in serious danger of defaulting….The 7 million units represent 135 percent worth of an entire year of existing home sales, which are pegged at 5.2 million.” Lenders realize that the housing market is still tenuous to try offload more than a small portion of these properties.
“But some economists expect that a wave of foreclosed properties could hit the market in 2010, dampening home prices again,” as self-imposed moratoriums are canceled.

Many homebuyers smell opportunity, and have waded cautiously into the market. The same goes for speculators, some of which are buying foreclosed properties en masse. Others are buying mortgage notes at deep discounts, as part of a gamble that borrowers will be able to repay them after the crisis eases. “The process works like this: A company or its investors purchase a note, then the homeowners get a knock on their door and are given the news about the change of their loan servicer and offered a modification.” As always, these first-movers could potentially reap large windfalls, Still, given that foreclosures have yet to peak, it might be wise to remain on the sidelines, until all of the dust settles.

In light of these statistics, it’s not surprising that more and more borrowers are simply walking away from their mortgages, despite the fact that many have the financial wherewithal to continue making payments. According to Experian, a credit rating agency, 582,000 such borrowers executed a “strategic foreclosure” in 2008 alone, which is more than twice as high as the 2007 total.

In other words, a growing contingent of borrowers has determined that it’s simply not economical to continue paying their mortgages. (As an aside, this is an excellent indication that homeowners, themselves, don’t have much confidence in the apparent housing recovery that many analysts believe is taking shape). Before, it was assumed that the impact of foreclosure on one’s credit would be enough to discourage strategic default, but the uptick in this trend demonstrates otherwise. Some borrowers evidently think it will be too many years before housing prices will return to the bubble levels. For those that bought properties for speculative purposes, there is a sense that it makes little sense to continue making payments on an investment that has little value.

Despite the clearly negative impact of this phenomenon for lenders, they appear to be doing little to avert it. Some are finally helping borrowers with loan modifications, but this rarely involves a truncation of the principal amount. Thus, borrowers who were underwater before receiving a modification will likely remain underwater after a modification, despite the lower monthly payment.

The government, for its part, hasn’t done much either. Its program aimed at helping underwater borrowers reduce their debt burdens through refinancing has been a miserable failure, reaching only 3% of eligible borrowers, despite the recent elimination of an initial 5% cap on underwater equity. It seems that despite the possibility of a lower interest rates, most borrowers are smart enough to realize that paying money (i.e. closing costs associated with the refinancing) to retain an underwater mortgage doesn’t make financial sense. Ironically, the Mortgage Forgiveness Debt Relief Act of 2007 is facilitating strategic default by allowing borrowers to discharge of debt tax-free. [If not for the law's passage, foreclosure could have potential tax consequences].

Still, there are negative consequences of ignoring government help and deliberately defaulting on a mortgage. For the majority of Americans, foreclosure is still stigmatized. From a financial standpoint, foreclosure (as well as short sales and deeds in lieu of foreclosure) will immediately result in a lower credit rating, diminished ability to borrow, and higher interest rates. Thanks to the Mortgage Forgiveness Debt Relief Act, strategic default no longer carries any tax implications. Of course, they may be costs associated with finding a new residence.

From a legal perspective, one’s liability post-foreclosure depends one’s state of residence. 10 states forbid banks from making claims against personal assets when foreclosing on a mortgage with negative equity. The other states, however, generally allow lenders to sue for the difference. Legal experts have indicated, however, that this is only used in 15% of cases, which means the majority of defaulters get off with hardly a slap on the wrist. Still, if you’re considering this as an option, it would be beneficial to consult a lawyer and/or accountant just to confirm.

Mortgage Calculator: Given the title of your blog, is it fair to say that you believe the housing market hasn’t yet bottomed?

My timing skills are notoriously bad, but I’d say the bottom is about a year away.”Housing Doom” was actually the compelling domain name researched by our anonymous “Admin,” one of several invisible but essential volunteer support staffers without which the blog couldn’t possibly happen.

Mortgage Calculator: You reported recently that “strategic defaults” are on the rise, and comprise a larger portion of overall defaults. Do you think this suggests that even though home prices are stabilizing, foreclosures will continue to increase?

It’s possible.  This is tangled up in the story of “recourse mortgages” that was recently discussed by AEI’s invaluable banking analysts.  A while ago I produced a transcript of one of their seminars where they talked about this in depth.

I’d like to note that the first widely heard voice to “just walk away” was Jim Cramer in late July 2007.  Debi and Admin performed a valuable service by preserving the videos for posterity.

Mortgage Calculator: Given the complete absence of lending standards in FHA standards when making conventional loans, as well as the rising pool of underwater reverse mortgages, it seems this class of loans represents the next “subprime” fiasco. Do you concur?

Doom’s friends over at Implode-O-Meter are covering this topic in depth.  Today, I noticed a wire-service story claiming that subprime was back up to pre-crisis levels, but now almost entirely backed by the government.

Mortgage Calculator: You have reported diligently on the market for Mortgage Backed Securities (MBS), presumably because of its direct connection to mortgage rates. Given the current dynamics of this market, where do
you think rates are headed, considering also the Fed’s plan to slow (and eventually halt) purchases of MBS?

It’s much worse than you know. GSE Agency Debt actually represents the unconsolidated cost of the Vietnam War, and Fannie’s privatization in 1968 was likely the largest off-balance-sheet deal ever done.  During the 2003-07 bubble, the swelling agencies purchases by foreign central banks financed Afghanistan & Iraq, while post-conservatorship the GSEs’ books are being swelled to help pay for the stimulus.  The crack in the beam in this economic House of Usher is the convergence of the “effective guarantee” on agencies to the full-faith-and-credit guarantee on treasuries.  Should Agency Debt ever cease to be junior, OMB will have to double the size of America’s National Debt, with catastrophic consequences.  The fate of the US housing market is trivial in comparison.

Mortgage Calculator: Your posting on “How the Relentless Promotion of Positive Thinking has Undermined America” was interesting, especially since it seems that despite the housing crisis, this “positive thinking” is making a
comeback. That being said, what do you think it will take for people to accept the notion that home prices don’t appreciate much faster than the rate of inflation, over a long-term period of time?

Positive Thinking has been a root value of America since long before that famous remark about happiness posted on 7/4 1776, and its philosophical promotion goes back at least to Emerson.  In a sense, I’ve been studying this issue for more than 5 decades.  That’s somewhat separate from house prices, though.  People will wake up on “house prices always go up” when the government stops propping them up…

Mortgage Calculator: On a related note, do you generally believe that renting is more economical (and more sensible!) than buying, even when the ratio of rent to home prices is more in line with long-term averages?

Local! Local! Local!  I’ve been perfectly happy owning properties on the same street for over 30 years.  Everyone’s situation is different.

Mortgage Calculator: How would you reconcile government and seller incentives and low interest rates with the possibility that home prices could fall further, when advising someone thinking about buying their first home? Would you advise them to buy, wait for a while, or wait forever?

*** WE ARE NOT FINANCIAL ADVISORS *** Please professionally consult an expert on that one.  It is a fact of life that nearly every trained expert in these areas is constrained by professional ethics, etc. from commenting in a public forum, which is why interested amateurs like us have been trying to fill the gap the last few years.  However, our participation only goes as far as sharing our common-sense thoughts and, hopefully, posting links to the works of wiser heads than ours.  And with that thought, I’ll turn it over to your readers and their own thoughts and researches.  May they generously share their findings with you like Doom’s many readers have with us.

Let’s start with the basics: What is meant by the term “assumed mortgage?” In a nutshell, the assumption of a mortgage is just what it sounds like- the transfer of all liabilities associated with a mortgage from one party to another. There are several variations, but it basically refers to a situation in which the buyer of a home assumes the existing mortgage from the seller, in lieu of taking out a new mortgage.

The benefit of such an arrangement is cost savings. Especially if interest rates have risen in the interim (i.e. in the time that has elapsed since the mortgage was initially obtained), the savings can be significant. Even with significant changes in interest rates, there are savings associated with not having to pay closing costs associated with obtaining a new mortgage. A buyer whose credit is less than stellar meanwhile, can avoid negotiating with a bank, and instead negotiate directly with the seller. Typically, any savings are shared between the buyer in the seller, and are simply tacked on to the price of the home.

Historically, mortgage assumption was only ever popular during times of interest rate uncertainty, namely the 1980’s and early 1990’s. At that time, many mortgages were assumed privately. In other words, the transfer was negotiated directly between buyer and seller, without the knowledge of the lender. Such mortgages are often structured as wraparounds, whereby the original mortgage is maintained by the original borrower, who receives payment from a new homeowner at a spread to the original borrower. Nowadays, such assumptions have become the exception, since lenders have caught on and inserted due-on-sale clauses into mortgages, which essentially required them to be repaid in the event of a change of ownership on the underlying property. Failure to notify the lender of a mortgage assumption, in such a case, qualifies as mortgage fraud.

Some lenders have become more amenable to mortgage assumption, such that they are willing to honor a transfer to a new borrower without assessing fresh closing costs. The catch is that in the process, the interest rate is ratcheted up to conform with prevailing rates. [Otherwise, the lender would deprive itself of the income that it could earn from charging a higher rate]. It should be noted that FHA and VA loans are always assumable, although those originated after 1989 require the approval (and payment of certain fees) of the lender.

If private mortgage assumption strikes you as incredibly risky, that’s because it is! While a public (i.e. lender-approved) assumption relieves the original borrower of all liability, private mortgages are off-the-record (and often illegal) and hence must be resolves directly between the two parties involved. Failure by the new borrower to make timely payments would place the original mortgager in the awkward position of playing landlord, perhaps to the point of executing a form of foreclosure. Meanwhile, mortgages that are assumed multiple times still leave the borrower (and his credit rating) on the hook until for as long as the mortgage remains existence, as one borrower learned the hard way.

In today’s ultra-strict lending environment, chances are you won’t ever have to deal with mortgage assumption. Given that rates are projected to begin rising, however, it could conceivably experience a modest surge in popularity. Still, for the average borrower, it’s not something worth considering.