Mortgage Insurers Worried by Piggy-Backs, 'Risky' Loans

Mortgage insurers are concerned that regulators are not acting quickly enough to put the brakes on risky nontraditional loans, particularly payment-option mortgages with "piggy back" second liens.

The Mortgage Insurance Companies of America is urging federal banking regulators to act "quickly" and finalize underwriting guidance on interest-only and payment-option adjustable mortgages.

MICA executive vice president Suzanne Hutchinson warned in a July letter that "recent trends show alarming signs of on-going undue risk-taking that puts both lenders and consumers at risk."

Private mortgage insurers are "deeply concerned about the potential contagion effect of poorly-underwritten or unsuitable mortgages," she said in the July 10 letter.

Federal regulators are not expected to issue final guidance for a few more months. Most mortgage industry trade groups complained strongly that the underwriting guidelines represent an overreaction and urged the regulators to rethink the guidance or withdraw it.

Meanwhile, house price appreciation has slowed dramatically since the proposed guidance was first issued last December.

This slowdown is raising new concerns that homeowners with relatively new POAs could find themselves trapped 12 to 36 months down the road and unable to refinance into another POA or a safer loan.

This scenario is possible for pay-option borrowers who elect to make minimum payments and took out piggyback loans to avoid paying mortgage insurance.

MICA wants the final guidance to make clear that piggyback or simultaneous second loans are "risky in and of themselves" and these risks are heightened when layered on IO and POAs.

The MICA also wants enforcement if lenders ignore the guidance. Ms. Hutchinson noted that banks and thrifts have not cut back on originations of IO and POAs since the proposed guidance was issued eight months ago. This fact "reinforces" the need for clear penalties," she says in the July letter.

The July letter is a follow up to a comment letter filed in March, which was equally emphatic. "We strongly commend the regulatory agencies and urge rapid adoption, together with clear indications to the industry and examiners that its provisions must be implemented or material enforcement actions will result," MICA said in the March comment letter.

So far, delinquencies on POAs are low and borrowers in many of the hottest markets have benefited from price appreciation of 10% to 20% a year.

However, housing prices are stabilizing and might fall in some markets, which means loan-to-value ratios on POAs could rise due to negative amortization.

This scenario is likely if short-term interest rates remain at current levels, housing prices are flat, and borrowers make the minimum payments. Approximately 60% to 70% of POA borrowers make the minimum payment.

Such a borrower with an initial 80% LTV first mortgage could see the LTV raise to 92% in three years, according to Dan Walker, senior vice president at AIG United Guaranty.

With a 15% piggyback, the borrower has a combined LTV of 107% and their monthly payment could double due to a negative amortization cap, which triggers a recasting of the loan to a fully amortizing ARM.

These borrowers could be in "trouble," Mr. Walker said. "We would encourage lenders to have an aggressive solicitation campaign to try to get their customers to refinance into products that are better for consumers over a long-term basis."

The National Association of Realtors reported last week that annual price appreciation on existing single-family homes fell to1.5% in July - down from a 14.6% annual rate in July 2005

United Guaranty and other MIs insure interest-only and POAs but their exposure appears to be is limited. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com