Eliminating Mortgage Insurance through Risk-Adjusted Interest Rates (The Securitization of Mortgage Default Risk)

Mortgage Insurance (MI) provides protection to mortgage banks and investors of mortgage-backed securities (MBS) from the risk of default by the borrower. This paper will discuss several alternatives that could significantly diminish the need for MI. Some of these alternatives are currently available while others are purely theoretical. We will begin with a brief overview of basic mortgage concepts, products and the marketplace. This is followed by an overview of the securitization of mortgages into MBSs and the current requirements for MI. We will then discuss alternatives to traditional MI that are currently available in the marketplace. These alternatives (1) incorporate the default risk into the mortgage structure, (2) are less expensive to consumers and (3) provide banks and MBS investors with higher investment risk/return opportunities. With more widespread acceptance of these products, banks and MBS investors could significantly reduce the need for the mortgage insurance industry. Next, we will discuss additional alternatives that could facilitate the inclusion of default risk through risk-adjusted interest rates that vary with the risk appetite of investors. These products might be developed to further the securitization for these risks. Finally, we will discuss how other risks, such as homeowners risk, could be included in the mortgage and how these products might be structured.