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Jennifer Crosbie
Vice-President
Distinctive Home Lending
8101 East Prentice Ave #260
Greenwood Village, CO 80111
Phone: (303) 221-7100
Fax: (303) 221-8100
E-Mail: jennifer@distinctivehomelending.com
Website: http://distinctivehomelending.com

Market Comment 

Mortgage bond prices rose last week pushing mortgage interest rates lower. Stocks fell which helped bonds rally. Trading remained very volatile. Record high oil prices tempered improvements in mortgage interest rates as the fear of inflation continued to dominate the financial markets. OPEC blamed speculators and a weak dollar while some analysts expressed supply concerns associated with unrest in Nigeria. Foreign demand for US debt securities dwindled. For the week, interest rates on government and conventional loans fell by about 3/8 of a discount point. 

The consumer price index data Wednesday will be the most important event this week. Retail sales, industrial production, capacity use, housing starts, and consumer sentiment data all have the potential to cause mortgage interest rate Market Conditions  

There is a Chinese proverb that states, "May you live in interesting times." It is often argued that the word interesting is meant to be a synonym for turbulent or dangerous. This phrase hits the bull’s-eye given the current state of the financial markets. 

While stocks and bonds are swinging around wildly there is some good news. Interest rates for conforming and FHA/VA loans are still historically low by many standards. 

However, low rates are not a given considering the escalating inflation fears that continue to dominate trading amid rising oil prices. Many analysts predict oil prices will continue to rise. While this doesn’t automatically equate to higher mortgage interest rates, rising energy prices are usually viewed as inflationary. Inflation erodes the value of bonds causing bond prices to fall and rates to rise. Other investors believe slowing growth and the credit crisis will eventually stem the rising prices. This scenario would generally be positive for bonds. 

With so much uncertainty, a cautious approach to float lock decisions, especially heading in the inflation data this week, would be wise. 

Copyright 2008. All Rights Reserved. Mortgage Market Information Services, Inc. www.ratelink.com The information contained herein is believed to be accurate, however no representation or warranties are written or implied.Borrowers, insurers would save with new mortgage insurance
Part 2: Fixing the housing finance system
By Jack Guttentag, Monday, May 12, 2008.  

Inman News 

(This is Part 2 of a five-part series. Read Part 1, "Lenders wise to beef up default-risk reserves.") 

The first article in this series pointed to a serious weakness in the way the mortgage system deals with default risk. Interest-rate risk premiums collected from borrowers that are not needed to meet current losses are paid out as income to investors and not reserved to meet future losses. Because major default episodes occur infrequently, perhaps every 12 to 15 years, the system is never adequately prepared for one when it happens. It certainly was not prepared for the one we are now in. 

The remedy for this systemic vulnerability is to reserve a much larger portion of the risk-based dollars paid by borrowers. This article explains how to do that. 

Investors in mortgages face two kinds of risk from borrowers who default. Collateral risk is the risk that the investor who forecloses on a loan and sells the property will fail to recover the unpaid balance of the loan plus the foreclosure costs. On loans with small down payments on which the collateral risk is the highest, private mortgage insurance is available to protect investors.  

Investors also face cash-flow risk. While they ultimately may be made whole from their collateral and mortgage insurance, until that happens a loan in default is a nonperforming asset, which is not generating any income and is not saleable except at substantial loss. There is no insurance now available against cash-flow risk on individual mortgages.  

On conventional loans (those not insured by FHA or VA), investors pass the cost of both risks to borrowers. The major charge is an interest-rate risk premium -- the greater the perceived risk, the larger the premium. On low-down-payment loans, lenders can also require borrowers to purchase collateral-risk insurance from private mortgage insurers (PMIs). 

PMIs place roughly half of all the premiums they collect in reserve accounts. Rate risk premiums, on the other hand, are not reserved to any significant extent. 

The vulnerability of the system could be reduced by extending the reserving principle to cover both collateral risk and cash-flow risk. The best way to do this is to have private mortgage insurance policies cover both types of risk, with the borrower paying a single mortgage insurance premium. The insurers would reserve a major part of the premiums, as they do now on policies that cover only collateral risk.  

We call this new type of insurance "mortgage payment insurance," or MPI, recognizing that it covers both collateral risk and cash-flow risk. Traditional mortgage insurance, or TMI, covers only collateral risk.  

Under MPI, the insurer would guarantee timely receipt of the payments so that the loan remains in good standing when the borrower defaults. This is the cash-flow insurance part of the policy. If the default is not corrected, the payments continue until the foreclosure process is completed, at which point the investor is reimbursed under the collateral-risk insurance part of the policy. 

The insurance premiums covering both types of risk would vary from loan to loan, but since the insurer assumes the default risk there would be no interest-rate risk premiums. All borrowers would pay the prime interest rate on the type of mortgage they select. 

The incremental cost of MPI above the cost of TMI at worst is very small. That's because one way or another, the insurer ultimately gets back all of the payments it advances. If the loan returns to good standing, the insurer will be reimbursed for the advances it made. If the loan defaults, the advances will reduce -- dollar-for-dollar -- the bill the insurer has to pay after foreclosure.  

And here is the kicker: Since MPI removes the risk premium from the interest rate, the interest rate will be lower, and this reduces cost to the insurer. On loans that default, a lower rate means more rapid amortization and therefore a lower balance, and it also means smaller accruals of unpaid interest that the insurer must pay when a loan is foreclosed. In many cases, the interest-rate reduction will cause MPI to cost the insurer less than TMI.  

This is a mind-boggling insight, which I can write without blushing because it is not mine. The insight is Igor Roitburg's, although I have verified it. I have been working with Roitburg to develop MPI since he approached me with the idea last year.  

In the following weeks I will explain how MPI can protect the system against future default crises, reduce costs to borrowers, AND help get us out of the current mess.