Take a closer look at mortgage insurance

By KATHLEEN PENDER
San Francisco Chronicle

If you buy a house with less than 20 percent down, your lender might require you to buy mortgage insurance.

Fannie Mae and Freddie Mac generally won't buy mortgages that exceed 80 percent of the home's value without insurance. Some lenders require insurance on loans they can't sell to Fannie and Freddie, such as jumbo loans, to protect themselves.

If you default on your loan and the sale of your home doesn't cover your loan balance, the insurance company will pay the mortgage holder all or part of the loss.

Seven companies -- PMI Group, Radian Group, MGIC Investment, Triad Guaranty and subsidiaries of American International Group, Genworth Financial and Old Republic International -- account for more than 95 percent of the U.S. private mortgage insurance market.

In recent years, the percentage of home loans with insurance has declined considerably as more buyers opted for piggyback mortgages, which usually carry a higher rate.

Fannie and Freddie can generally buy the first mortgage (assuming it meets their other requirements) and the homeowner does not have to buy mortgage insurance.

The holder of the second mortgage takes on the risk the insurance company would otherwise assume.

Although piggybacks have been around more than a decade, they surged in popularity starting around 2003, when short-term interest rates were so low that getting a second mortgage was often much cheaper than getting mortgage insurance. Moreover, lenders and mortgage brokers make money on piggyback loans. They don't make money on mortgage insurance, putting that product at a disadvantage on the sales floor.

The share of mortgages with insurance fell from about 18 percent in the late 1990s to 8 percent at the end of 2005, according to one estimate. The decline was especially steep in high-cost areas with a predominance of jumbo loans. Most insurance is on mortgages sold to Fannie and Freddie.

This drop in market share helped shelter the mortgage insurance companies from the brewing housing storm. So did the fact that mortgage insurers were not heavily involved in the subprime market.

"A lot of the loans that are turning out to be really problematic don't have mortgage insurance," says Beth Haiken, a spokeswoman for PMI Group. "For PMI, less than 8 percent of our portfolio is on loans with credit scores below 620."

Tom Abruzzo, a managing director with Fitch Ratings, estimates that 13 percent of all loans originated in 2006 with a credit score below 630 had mortgage insurance.

The holders of second mortgages will bear a large share of loan losses. If a home is sold to pay a debt, the first-mortgage holder is paid off before the second.

Many second mortgages were pooled into asset-backed securities that were sold to investors worldwide. Today, investors are reluctant to buy any mortgage-backed security that is not backed by Fannie, Freddie or government agency Ginnie Mae. That has led many lenders to stop making loans that can't be sold to these agencies, or charge more for them. This as at the root of today's liquidity crunch.

As piggybacks have become harder to get, mortgage insurers have started to recapture some of their lost market share.