Private Mortgage Insurance Group (PMI), a leading provider of mortgage insurance, swung a loss in 2007 due to an unanticipated increase in overall claims and payouts. This news could spell even more trouble for future borrowers, as increased claims lead to future price increases.
Private Mortgage Insurance Basics
Private Mortgage Insurance (PMI) protects banks against mortgage defaults. Much like your homeowner’s insurance pays you the value of your home if there is some kind of serious disaster, PMI pays banks in full in the event a borrower does not pay.
Insurance companies make money on a price-to-probability ratio. Private mortgage insurance is fairly cheap because most people pay off their home mortgages. While there are very complicated econometric models behind this calculation, essentially as defaults increase their profits decrease. Additionally, if there is a higher future probability of default increases, consumers will begin to see premiums rise.
Remember Hurricane Katrina
There are parallels between the future of the mortgage insurance market and the past events of the flood insurance market. During the period directly after the floods, hurricane insurers suffered huge losses. They responded to these losses with very sharp price increases because they felt the risk of severe hurricanes had increased. Needless to say, this year was a light hurricane season and those insurers have taken home record profits. Additionally, now that they have precedent for their higher pricing structure, don’t expect flood insurance prices to decrease.
The Private Mortgage Insurance will be no different. While it has been slow to adjust to the impending mortgage crisis, the Private Mortgage Insurance Group’s $300-million loss will serve as a wake-up call to the industry.
Private Mortgage Insurance and the Consumer
Consumers should expect to see higher Private Mortgage Insurance in the future. This is an important development because this money essentially goes out the window. It only benefits consumers indirectly because it allows banks to charge lower rates. Additionally, higher PMI rates make it harder for consumers to qualify for loans. Furthermore, those consumers who do qualify will only be able to afford to buy smaller homes.
As consumers the only option to avoid these price increases will be to avoid private mortgage insurance altogether. This could open more consumers up to a second mortgage or force consumers to save longer to make a larger downpayment on their home. Either way, this could have a negative effect on the housing market.