Second Loan Interest Rate Reflects Higher Risk to Lenders

            Most homeowners are familiar with the concept of Homeowner’s insurance. This kind of insurance will typically insure the house against loss or damage.  If a home is damaged by fire or storm, most homeowners would know to call their insurer to report the damage and make a claim.

But some homeowners may not be familiar with mortgage insurance, also know as PMI.  This insurance typically provides coverage in the event of a mortgage default or foreclosure.  This insurance is typically designed to benefit lenders, but not homeowners. If a homeowner defaults on their loan, and their property is sold in foreclosure, then PMI mortgage insurance is designed to compensate the lender for the loss to the lender in the event the property sells for less than the amount of the loan.

Twenty years ago it seemed like many lenders were routinely requiring borrowers to purchase mortgage insurance. The PMI insurance payment was a monthly charge that borrowers paid in addition to their mortgage loan  payments of principal and interest.  In the event of a default or foreclosure, the borrower never received any payout from the insurer.  Instead, any payout went only to the lender.  In more recent years, it seems like lenders have often used a second loan to replace mortgage insurance.  Instead of requiring borrowers to purchase mortgage insurance, lenders often make two loans to borrowers.  The first loan, at a lower interest rate, often covers the majority of the house purchase price.  The second loan, at a higher interest rate, covers something like 10 to 20% of the price of the house.  If the market turns down, then this second loan is at a higher risk of not being repaid.  This increased risk is usually reflected in the higher interest rate charged by the lender.   Because the second loan is the one most at risk, such lenders have considered it unnecessary for borrowers to pay for PMI insurance when the property is purchased with two loans.

Copyright 2017 ROBERT B. JACOBS