In a Short Sale, How does Private Mortgage Insurance work?

In today’s economy many homeowners are facing the prospect of losing their homes through foreclosure. There are various options they can try to take advantage of to avoid the foreclosure. One is obviously to sell the home. The difficulty arises when the value of the home has declined below the outstanding mortgage and any liens or encumbrances. Selling a property for less than the amount of the outstanding mortgage against it is called a short sale.

There are quite a number of individuals and groups around the country that have readily available capital to purchase homes by the short sale method. The lender will have to agree to the sale so the buyer can obtain a satisfaction of the mortgage or lien. While some short sales are simply a matter of negotiation, others have nuances that are important to understand and address. Regardless of the extent of their experience in closing short sales, many realtors, investors, and investment groups do not fully understand how to handle short sales involving homes that have Purchase Mortgage Insurance (PMI) associated with the loan.

PMI is a type of insurance required by lenders when the homeowner purchased the property without sufficient funds to create enough equity to satisfy the lender. Generally lenders require PMI unless the home’s value exceeds 80 percent of the mortgage. To avoid PMI, a number of homeowners leveraged their equity and obtained a second loan, often called a piggyback loan or home equity loan, to avoid PMI. PMI is added to the mortgage payment each month.

PMI has a number of positive aspects.

It allows people to purchase properties with less cash down payment while at the same time protecting lenders from the higher risk of default and loss. Indeed, many buyers only put down 3 to 5 percent of the outstanding purchase price to buy the property. Their hope if that the property will appreciate during their ownership while at the same time they are paying down the mortgage loan. In some cases, once the value of the home exceeds 80 percent of the outstanding loan, many lenders will cancel the PMI. Whether or not they do depends on the policy of the lending institution, direct payment history with the lender and overall credit history and score.

In the event you are attempting to purchase a house through a short sale transaction, the lending institution may or may not contact and send the matter for review to the company holding the PMI insurance. The reason is that each financial institution usually maintains a pre approval letter or agreement with the PMI Company as to how much of a loss can be taken on any transaction. These are analogous to the authorization percentages for FNMA and FDMC loans. To the extent the short sale will result in a loss under the pre-approved ratios, the lender can negotiate and approve the sale on its own. If, however, the lender believes it needs input from the PMI company or the loss will exceed the authority given the lender, then the lender will send the PMI company the entire file to review for their participation.

Most PMI companies do not maintain particular percentage losses they will accept. They generally handle this on a loan by loan basis taking into consideration the overall property value, loan amount and seller’s circumstances. The PMI Company will then either approve or disapprove the short sale and cover the percentage of the loss it insured for the borrower to the lender. Ultimately, keep in mind that if your short sale transaction involves PMI, that company has the ultimate decision for approval or not either through its pre approved loss ratio or a case by case analysis.

You should also be aware that the general industry standard is that the ratios for PMI coverage are between 10 and 35 percent of the loan payoff.

The five major PMI companies are all publicly traded companies and are as follows:

1. MGIC aka Mortgage Guaranty Insurance Corporation

2. Radian

3. Genworth Financial

4. AIG’s United Guaranty

5. PMI

For anyone who needs to get a promissory note knocked down – negotiate directly with the PMI company. They will use any tactic possible.

Actual Case Study:  A snap shot - Countrywide told us that the homeowner must sign a 5 year $50k promissory.  We asked a question on who is asking the P.Note... they stated it was the MI company.  We asked for the contact info and called Radian... and spoke to a rep named "Joe".

We went back and forth and he clearly stated he would rather see the property go into foreclosure.  His view... if they take a discount - for a short sale Countrywide will make an immediate claim - if the property goes to foreclosure, they will not make a claim for another year.  The rep stated we rather "kick the can down the road, we are an insurance company who minimize losses".

Jeff Coga