Shares of mortgage-insurance companies have soared since Dec. 6, the day before word leaked out that Congress was finally ready to let homeowners deduct mortgage-insurance premiums.
On Dec. 9, Congress did approve the deduction. Yet it has so many strings attached, it's not likely to be a boon for home buyers or mortgage insurers.
The federal tax deduction only applies to mortgages taken out since Jan. 1. It expires at the end of this year. Homeowners can't claim the full deduction if they have more than $100,000 in household income and can't claim it at all if their income exceeds $109,000. They must itemize deductions to claim it.
Even if Congress extends the deduction beyond this year, it's not likely to solve the mortgage insurance industry's loss of market penetration.
Mortgage insurance pays the lender if a borrower defaults on a loan. Most lenders require borrowers to buy mortgage insurance if they put down less than 20 percent of the purchase price of a home. Borrowers can cancel the insurance when their equity in the home reaches 20 percent.
The cost varies depending on the particulars of the loan, but it averages 0.6 to 0.8 percent of the original loan amount per year, says Greg McBride, senior analyst with Bankrate.com.
On a $200,000 loan, that works out to about $1,400 annually. On that amount, the federal tax deduction would save someone in 25 percent federal tax bracket about $350 a year.
The deduction will make mortgage insurance more competitive with piggyback loans, which have always been tax deductible.
Piggyback loans are home equity loans or lines of credit that let buyers who don't have 20 percent down avoid mortgage insurance. They borrow 80 percent of the home's value with a first mortgage, then borrow whatever else they need with second, and in some cases third mortgages.
These are also called 80-20 or 80-10-10 loans. The piggyback portion has a higher interest rate than the first mortgage.
Piggybacks have taken a big bite out of the mortgage insurance market in the last five or six years.
When mortgage rates, even on second mortgages, were rock bottom, piggybacks were much cheaper than mortgage insurance, even without the tax deduction. Piggybacks also benefited from a relaxation in credit standards.
In the late 1990s, about 18 percent of new loans had mortgage insurance. That share fell to 8 or 8.5 percent at the end of 2005, says Michael Grasher, an analyst with Piper Jaffray & Co.
Since then, the share has crept back up to 9 or 10 percent, he estimates, mainly because interest rates have climbed, making second mortgages, especially variable-rate ones, costlier.
The downturn in residential real estate also has made some lenders less willing or able to make piggyback loans.
Many second mortgages are sold off to hedge funds and other large investors. "That demand has declined because their credit performance has been below expectations," says Paul Miller, an analyst with Friedman, Billings, Ramsey.
The new tax deduction puts mortgage insurance "on a more even footing with piggyback loans," Miller says.
But even with equal tax treatment, in many cases piggybacks "are still more competitive," Miller adds. "The mortgage insurance product tends to be a little overpriced relative to the risk they are taking. The home equity loans are underpriced compared to the risk they are taking."
The largest stand-alone mortgage insurance companies and their approximate market shares, according to Grasher, are MGIC Investment Corp., 22 percent; PMI Group, 16 percent; Radian Group, 15 percent; and Triad Guaranty, 8 percent.
Subsidiaries of insurance giants American International Group and Genworth Financial have 16 and 15 percent shares, respectively, Grasher says.
Since Dec. 6, shares of the stand-alone mortgage insurers are up 7 percent on average, outstripping a 2.5 percent gain in the Standard & Poor's 500 index (see chart).
Grasher says most of that increase stems from improving market fundamentals -- higher interest rates and tighter credit standards. The rest comes from a belief that the tax deduction will steer more customers toward mortgage insurance. That assumption could prove wrong.
McBride says borrowers who qualify for the tax deduction should give mortgage insurance a "second look."
Even with the same tax treatment, the piggyback might be cheaper than a loan with mortgage insurance. But when you take on a piggyback mortgage, "you are saddling yourself with two loan payments for 15 (or so) years," McBride says.
Mortgage insurance can often be canceled sooner.
By law, borrowers can ask their lenders to cancel mortgage insurance when the equity in their homes, based on the purchase price, reaches 20 percent. It can take many years to reach that point by making mortgage payments alone because, in the early years, payments are mostly interest, not principal.
However, most lenders will let borrowers cancel their mortgage insurance if their loans are at least two years old and they get an appraisal showing that, thanks to appreciation, their equity now exceeds 20 percent.
Of course, if their home appreciates, borrowers also could get out of their expensive piggyback loan by refinancing, assuming their credit rating is still good and interest rates have not shot up.
Mark Leaver, a broker with LoanLane Residential Mortgage in Atherton, is skeptical that the tax deduction will help the mortgage insurance industry.
He says many borrowers and loan brokers prefer piggybacks because, in many cases, the same lender is making the first and second mortgage and the borrower needs only one approval.
"When you get mortgage insurance, you are seeking approval from the primary lender and the insurance provider," he says. "The mortgage insurance folks can turn you down."
More importantly, brokers and lenders make money on piggyback loans. They don't make money on mortgage insurance, putting that product at a distinct disadvantage on the sales floor.
"Most states prohibit insurers from paying (mortgage brokers or lenders) for business," says Glen Corso, senior vice president for public policy for PMI Group in Walnut Creek.
That "has certainly been a significant challenge (for PMI) ever since piggybacks got popular," Corso adds.
Despite a boom in the overall mortgage market, "our insurance portfolio in the U.S. has been hovering around $100 million for the past four or five years," Corso says.
Mortgage insurers have been hurt somewhat by problems at Fannie Mae and Freddie Mac, which are large purchasers of loans with mortgage insurance. "As their activity has not been as robust, that has affected our market," Corso says.
Corso says his firm urges lenders to discuss with their clients the risks of piggyback loans, especially the possibility that the cost of variable-rate second mortgages could rise if interest rates go up.
The new tax deduction won't do Bay Area homeowners much good because most people making less than $100,000 can't afford a house. But Corso says it could help most PMI clients.
"The average mortgage we insure is $135,000. The average mortgage (nationwide) is $185,000. To get that kind of mortgage, you need $75,000 to $85,000 in income," he says.
Even if mortgage insurers convince Congress to extend the tax break, it won't solve their problems.
"Piggybacks are still stiff competition for us, even with the tax deduction. It levels the playing field, but lenders are constantly coming up with new products," Corso says.
That's why PMI is setting up shop in countries where piggybacks are not common, such as Australia, Canada, Hong Kong and parts of Europe. Overseas operations generate 35 percent of revenue, about twice what they did five years ago, Corso says.
PMI and some of its competitors also have begun insuring other credit products, such as municipal bonds and derivative securities.
Despite its lost market share, mortgage insurance is still a highly lucrative business, with net profit margins in the 30- to 40-percent range, Grasher says.
Return on equity is less robust -- averaging 12 to 13 percent compared with the "high-mid-teens" for property/casualty insurance companies, he says.
Grasher predicts that Congress will extend the tax break, but the industry's future really depends on the economy.
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