Real Estate Boys; It is a pleasure to write to you guys. We enjoy your column and finally think we have a question of merit for your comments. Here goes…we have heard, but are not certain, that when the banks foreclose on a home there is an insurance policy that the bank collects on the premium. Do you Boys have any knowledge of this fact or myth?
— Auntie Mae
Auntie Mae, May we call you Mae? May we come up and see you sometime…oh, sorry. Great question you have for us this week. We are going to try and answer this question, but all you readers must understand that we are just responding with our best guess on this one. We have tried to get straight answers on this topic but just can’t seem to talk with the right person. Here we go with our comments.
In my real estate books, from when I took the exam 30 plus years ago, Freddie and Fannie both had insurance programs to help the banks in case of defaults on loans. Alas, when I read your question I felt I already knew the answer. Thanks to Lloyd I did some research and found what I knew was opposite of what was correct. PMI (private mortgage insurance) is insurance the lender requires you, the buyer, to pay for in your monthly payment. The insurance covers the lender in case you default on your mortgage. The cost of the insurance is about $55 for every $100,000 borrowed. So, a $200,000 loan can run from $1,300 to $1,500 per year. PMI is added to your monthly payment of principle, interest, taxes and homeowners insurance. Don’t confuse the two insurances. PMI is for default and homeowners is for fire, etc. PMI is charged for owners with less than 20 percent equity at the time of purchase. OK, we know what PMI is. Now we’ll try to answer Mae’s question. Lloyd, take it from here please.
Lar, PMI kicks in when a buyer is foreclosed upon and the lender, whoever it may be at the time, receives the house back. Most times in foreclosure the bank purchases the home back for the loan amount, so we’ll use $200,000 as the loan amount. So, the bank now owns the home and has listed the home for sale with a Realtor. The listing agent gets an offer for $125,000 cash from a buyer. The bank, who is the owner, accepts the offer and nets at the close of escrow about $117,500. Remember, the original note is in the amount of $200,000 and they net $117,500. So in theory the bank has lost $82,500 right? And this is where PMI kicks in to the bank that lost money. The PMI insurer only insures a portion of the entire loan amount. It will typically cover 20 to 25 percent of the upper loan amount. Let me explain, Mae. The upper 20 to 25 percent in this scenario is $50,000 the upper 25 percent of $200,000 equals $50,000. So instead of losing $82,500, the lender loses $33,500 or thereabouts. Sure a loss is a loss, but not as bad with the insurance. Larry, I see your hand waving. What do you have to add?
The above is very well written Lloyd and now maybe with a little further explanation on the current housing inventory to tie in this mess. What Lloyd and I have written about in past articles is that the banks now are holding these foreclosed homes. It is our understanding — what we think, or guess — is that the banks don’t have to write these losses off of their books until they actually sell the home. So, rather than take the $33,500 loss, they are holding the foreclosed home, getting the insurance money from Freddie or Fannie and will sell when they feel they can break even or make a few extra bucks later; making a bad situation come out OK for the bank.
Interestingly, back in the early 2000s to 2006 buyers often got around paying the PMI by getting two loans. Yes, two loans. This type of loan was called an 80-10-10 loan. Buyer paid 10 percent down payment and got a bank loan for 80 percent and then a second loan for the other 10 percent, therefore no PMI insurance was required. Another type was called 80-5-15 or 5 percent down and borrowing the other 15 percent. This helped get a lot of banks in trouble from 2006 to the present because there was no PMI insurance then for back-up when the foreclosure crash began. Lenders did lose money. Foreclosures seem to be slowing down to a snail’s pace now and I’m sure banks are pleased about that. The bleeding has finally stopped to both the buyers and the banks.
One last thought on this type of loan. Recall a few weeks ago, we wrote that banks have begun to hit their previous clients if they had been foreclosed on but are now able to buy another home. The banks have not forgotten these buyers still owe the bank money and they are halting the purchase of a new home until the buyers sign another loan document for that old loan they thought they had walked away from five years ago.
— A little about us, Lloyd is a retired farmer of 27 years and a realtor for about 10 years. Lloyd is an active member of the Central Valley Association of Realtors and sits on the CVAR Board of Directors. Lloyd is a long time member of CVAR’s Master Club for his sales production.
Larry has been involved in Turlock real estate for 30 years and has been a broker for almost 27 years. He is also active in CVAR activities and is a past president of CVAR. If you have questions please call Lloyd at 531-4853 or Larry at 484-4216. E-mail questions for future columns to: firstname.lastname@example.org or email@example.com.