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Special Reports
Home Equity Lending
PMI Sees 80-10-10 Risk
by Brad Finkelstein
WALNUT CREEK, CA -- A study issued by PMI Mortgage Insurance Co. here claims the
use of piggyback loans may pose a threat to the financial strength of the mortgage banking system.
Piggyback loans, also known as 80-10-10 loans, combine a first mortgage of 80%
loan-to-value with a 10% LTV second. In this way the borrower can put down 10% and not have to purchase mortgage
insurance. This second loan can be either a closed-end loan or an open-end home-equity line of credit.
The company cites figures that said 42% of home purchase mortgage loan dollars
in the first half of 2004 involved piggyback loans, up from 20% in 2001.
A separate study conducted by SMR Research that was cited in this study noted
that when borrowers get a HELOC at the same time as their first mortgage, they use nearly all of the available
credit line almost immediately.
The study's author, Charles A. Calhoun, said, "Borrowers are able to afford
more expensive homes with smaller down payments, but may not be prepared for the increased payments they will face
as interest rates rise. Similarly, piggybacks allow lenders to increase profits because they are originating two
loans instead of one, but they may not be prepared for the one-two punch of rising interest rates and declining
house price appreciation."
He claimed that piggybacks might be a contributing factor to overheating in local
housing markets. "I expect that as interest rates rise and house price appreciation slows or declines, defaults
will rise and borrowers could lose their homes. It's particularly worrisome given that borrowers may not fully
understand the risks they face."
According to PMI's chief risk officer, Mark Milner, among the 10 metropolitan
statistical areas believed to have the highest market risk for lenders, seven of them, all in California, had more
than half of their purchase loans originated in the first half of 2004 included a piggyback second.
The study noted one "risk faced by borrowers with piggyback loans is an unexpectedly
large and rapid rise in short-term interest rates and a resulting increase in monthly payments on the HELOC component
of a piggyback structure. In the current economic environment, where interest rates have risen multiple times and
could continue to do so for the foreseeable future, the potential combined impact of these risks is an additional
concern.
"Unlike a conventional first-lien ARM, periodic interest rate adjustments
on HELOCs are not limited by annual adjustment caps, so monthly payments adjust fully in response to increases
in short-term interest rates.
"In addition, HELOC rates may reset monthly instead of annually, so rate
adjustments occur more frequently than the annual adjustments on standard ARM contracts.
"In addition, lifetime interest rate caps are much higher on HELOCs than
on standard ARM contracts, typically on the order of 18%."
As for the secondary market, the study claims that Fannie Mae and Freddie Mac
are vulnerable because current risk-based capital standards were developed prior to the growth in the use of piggyback
loans.
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