“Piggyback” Loans Linked to Default

By:: Kirk Haverkamp | July 27, 2011

Home buyers who took out mortgage insurance rather than opting for a second “piggyback” mortgage prior to the downturn are turning out to be far less likely to default on their mortgages, a new study reports.

Buyers who put down less than a 20 percent down payment and opted for a second mortgage in lieu of mortgage insurance are defaulting at rates 21 percent higher than those who opted for mortgage insurance on comparable loans. The study, conducted by Promontory Financial Group, looked at 5.7 million mortgages originated between 2003 and 2007.

Second or “piggyback” mortgages were a popular option prior to the housing crash for home buyers who could not come up with a 20 percent down payment when buying a home. They enabled borrowers to take out a second mortgage to cover part or all of the down payment on their new home. This allowed buyers to avoid paying for private mortgage insurance, which is typically required on mortgages with less than a 20 percent down payment and typically adds about half a percent to the cost of the mortgage per year.

The study took into account such factors as total loan-to-value ratio, so that piggyback loan buyers who put up 10 percent of their own money were compared to mortgage insurance buyers who put up 10 percent – in other words, the difference couldn’t be attributed those who took out piggyback loans putting up less of their own money.

The study also accounted for borrower credit scores, income documentation, loan type, interest rates and home prices, among other factors.

The company that contracted for the study, Genworth Financial, is using the results to argue that home loans with mortgage insurance should be able to meet the requirements for a Qualified Residential Mortgage (QRM) under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

“The Promontory study shows that mortgage insurance reduces the frequency of mortgage default, without exposing investors or the broader housing market to undue risk,” said James Bennison, senior vice president of U.S. Mortgage Insurance Strategy and Capital Markets. “Regulators should include loans with private mortgage insurance as an acceptable exemption to risk retention requirements under QRM, so this reliable private sector source of capital can continue to support the nation's housing recovery through responsible lending to creditworthy borrowers.”

Mortgages that do not meet QRM standards will be subject to tighter restrictions and will likely carry higher interest rates than those that do. Currently, federal regulators are proposing that only mortgages with a loan-to-value ratio of 80 percent or better – that is, at least 20 percent down – will qualify as QRMs.

The goal of the regulation is to avoid the kind of high-risk, “exotic” mortgages that flourished during the housing boom and defaulted in droves once housing prices collapsed, resulting in millions of foreclosures. However, many in the mortgage and housing industry have been pushing back against the proposed 20 percent down payment standard for QRMs, saying it will exclude many well-qualified buyers and is stricter than is needed to guarantee sound mortgage lending practices.

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