Homeowners Insurance Tops Inflation by 691%

Caveat Emptor

– By: Larry Walker, II –

Have you checked your homeowner’s insurance policy lately?

I’ve been with the same insurer for over 10 years through two residences. Even with the previous company my homeowner’s rates stayed about the same from 1998 through 2007. During a recent review, I discovered that my basic coverage amounts (i.e. dwelling, private structures, personal property and loss of use) have been inflated by around 3.0% annually since 2007, or slightly higher than the general inflation rate, and although I sort of get that, albeit the cost to rebuild is now around 150 times current fair market value (ugh, don’t get me started), over the same time-frame, my insurance premiums (bundled with auto and other discounts) have grown by an annual average of 11.4%. What do you call that?

In fact, excluding additional discounts received in 2009 and 2010, which helped dampen the rate of growth, my premiums spiked by 17.5% in 2008, by another 16.8% in 2012, and finally by a backbreaking 20.4% this year. Had it not been for those additional discounts, my homeowner’s premiums would have averaged 18.2% over the period. Yet, even with a generous discount, my premiums have ballooned by 65.3% since 2007. Now compare that to inflation, which rose by just 13.7% during the same period (via Dollar Times).

So in other words, from 2007 to 2013, my homeowner’s premiums grew 377% faster than inflation. But don’t just take my word for it. A May 2013 article by the Associated Press (AP) confirms that homeowner’s insurance rates have spiked, however it fails to mention why? More specifically, why homeowner’s insurance premiums are currently advancing 691% faster than inflation.

Of course, the insurance industry blames increasing replacement costs (the cost of rebuilding a home from the ground up). Okay, great! But that only accounts for a 2% to 3% annual increase. So how does this translate into an average annual premium spike of 18.2%? According to the aforementioned AP article, which I might add is based on antiquated data, “Nationwide, an average homeowner paid $909 for homeowner’s insurance coverage in 2010, up 36 percent from 2003. Inflation rose 19 percent during the same period.” It goes on to provide a list of what homeowner’s in states bordering the Atlantic Ocean or Gulf of Mexico were paying in 2010.

Following are the average costs in five of those states, ranked by the percentage change from 2003 to 2010:

  1. Florida: $1,544, up 90.6 percent.

  2. Alabama: $1,050, up 54.2 percent.

  3. Mississippi: $1,217, up 53.5 percent.

  4. South Carolina: $997, up 48.4 percent.

  5. Georgia: $833, up 46.1 percent.

Now if the AP had continued its research through the current year, it would have discovered that the situation has gotten a lot worse since 2010, as I mentioned above. Here’s an idea for the media – next time, if you don’t know, why not try asking people who are actually affected? My premiums actually went up by 16.8% in 2012 and by another 20.4% this year, for a two-year average of 18.6%, while inflation averaged a mere 2.35%. So over the past two years, premiums have risen 691% faster than the rate of inflation ((18.6 – 2.35) / 2.35). What’s up with that?

It’s not the miniscule annual dollar increase that bothers me, but rather what the cost will be 10 or 20 years from now. At the current pace, by the time I reach what used to be considered retirement age, God willing, which is less than 20 years from now, homeowner’s premiums will be simply outrageous, perhaps more than 4 times the amounts shown above (i.e. doubling about every five years). In other words, if this doesn’t stop soon, I could be paying around $3,500 a year in retirement. I’m sorry, but this is just unacceptable.

So what did I do? I requested quotes from several local insurers. And what did I find? I received some quotes for less than half my current rate, some 30% to 40% lower, and others around the same. So I struck a deal which comes in at just 64% of the proposed renewal rate. That puts my new rate just 5.7% above what it was in 2006. Now that’s more like it. Perhaps I could have done better, but somewhere along the way I’ve learned that if it sounds too good to be true, it usually is.

The bottom line: Why have homeowner’s insurance rates spiked? As one of my Google+ friends put it, “Because they can get away with it.” Do yourself a favor; check your policy and take action while there’s still a free market (caveat emptor).

References:

Time to reassess your Homeowners Policy

How Homeowner Insurance Rates Have Spiked

Off Grid Solutions 2: The Adjustable Principal Mortgage

~ By: Larry Walker, Jr. ~
My previous advice proffered the simple concept of a Mortgage in-Kind Exchange. If you didn’t like that notion, perhaps you will like this one. An Adjustable Principal Mortgage is a solution that would allow a mortgage company to temporarily write down the principal amount of a mortgage to an amount comparable to the contracts original debt ratio, and subsequently make adjustments every third year as home prices fluctuate. Once the value of the home equals or exceeds its original cost, no further adjustments are required. Neither the length of the loan or its interest rate is adjusted, nor may monthly principal and interest payments ever exceed the original amount.
An Adjustable Principal Mortgage would spread risk equally between mortgagor and mortgagee. When housing prices return to normal, both the lender and homeowner will have met their objectives; for the former a trustworthy return on investment and the latter a reasonable debt ratio. If housing prices continue to slump, mortgage companies and their investors will lose an amount comparable to the decline in value of the underlying asset, while homeowners losses are likewise mitigated. The value of all mortgage backed securities will be known at any point in time, rather than the present state of uncertainty. The idea is modeled after the Biblical proverb of the unrighteous steward.
The Unrighteous Steward ~ Luke 16:1-9
(1) “There was a rich man who had a manager, and this manager was reported to him as squandering his possessions. (2) “And he called him and said to him, ‘What is this I hear about you? Give an accounting of your management, for you can no longer be manager.’ (3) “The manager said to himself, ‘What shall I do, since my master is taking the management away from me? I am not strong enough to dig; I am ashamed to beg. (4) ‘I know what I shall do, so that when I am removed from the management people will welcome me into their homes.’ (5) “And he summoned each one of his master’s debtors, and he began saying to the first, ‘How much do you owe my master?’ (6) “And he said, ‘A hundred measures of oil.’ And he said to him, ‘Take your bill, and sit down quickly and write fifty.’ (7) “Then he said to another, ‘And how much do you owe?’ And he said, ‘A hundred measures of wheat.’ He said to him, ‘Take your bill, and write eighty.’ (8) “And his master praised the unrighteous manager because he had acted shrewdly; for the sons of this age are more shrewd in relation to their own kind than the sons of light. (9) “And I say to you, make friends for yourselves by means of the wealth of unrighteousness, so that when it fails, they will receive you into the eternal dwellings.”
It’s purely a matter of survival for homeowners, bankers, investors, the U.S. economy, and the nation as a whole. The unrighteous steward did what he had to do to survive. Presently, no one in the United States is doing anything to address the underwater vortex threatening to destroy the livelihood of millions of American homeowners. To date, the actions taken by both government and the private sector have done nothing to avert a looming global economic collapse and worldwide depression.
The Problem
Jane is a 50 year old Georgia resident. She is married with two children. Jane purchased her home six years ago for $333,333. She initially made a down payment of $33,333 and took out a 30-year / 5% fixed rate mortgage of $300,000. She currently has an outstanding mortgage balance of $270,290, and the appraised value of her home has fallen to $150,000. If she were to sell the home today, she would incur a loss of $183,333, which is not deductible for tax purposes. Jane is not in default and can afford her mortgage payments, but one of the things bothering her is that her debt ratio, which started out at 0.90, has risen to 1.80. A debt ratio is calculated by dividing the amount of mortgage debt by the value of the home. A debt ratio of less than 1.0 is considered healthy, while a debt ratio greater than 1.0 is indicative of a loan at risk of default.
Jane feels cheated. By the sixth year, her debt ratio would have been 0.81, but for the decline in the value of her home. Her blood especially boils when she reads stories about homeowners cutting deals with lenders to stay in their houses literally for free, or of others who are in default yet have remained in their homes even after missing a year or two of payments. Jane has a bad, bad feeling that home prices won’t be improving within her lifetime, and fears that she may be foolishly throwing her money away. She would love for her mortgage company to reduce the principal balance of her loan, but that’s probably not going to happen, at least not until after a foreclosure.
So I will pose the same questions that I did last time, even though some of you took issue. “Does it make sense for Jane to sit there, stuck in a home that she can’t sell or refinance; making a payment every month on what she knows is a bad investment?” “Would you continue to invest $333,333 in an asset that you thought would be worth less than half in the future?” Although housing prices may rise over time, they didn’t reach their previous peak overnight, and life is finite. Jane is 50 years old, and doesn’t have another 30 years to waste. Since Jane doesn’t qualify for a loan modification, what options does she have? Presently, there doesn’t appear to be any solution other than to close her eyes, mask her feelings, keep paying, and go down with the ship.
Solution: The Adjustable Principal Mortgage
An Adjustable Principal Mortgage would allow the mortgage company to agree to temporarily write down the principal amount of a mortgage to an amount comparable to the contracts deemed debt ratio, and subsequently allow the principal to be adjusted every third year as home prices fluctuate. Once the value of the home equals or exceeds its original value, no further adjustments are required. Each time the principal is reset, it is re-amortized over the number of years remaining in the original term. The home is re-appraised at the end of each third year, and a new principal amount is calculated based on the ending debt ratio, multiplied by the current value of the home. At the end of the original term, any remaining balance is cancelled and the debt is considered paid in full.
The home may not be sold until its value equals or exceeds its original cost, without incurring a prepayment penalty. The penalty is calculated by subtracting the amount of all principal payments made to date, from the amount of debt owed prior to commencement of the Adjustable Principal Mortgage. In other words, anyone who opts out early will not be able to escape without having to make up the difference between the original debt and the adjusted principal. When the value of the home equals or exceeds its original cost, the homeowner may sell without penalty, paying off the balance at that time.
How it Works
A home appraisal is required at the beginning of the term, and every third year thereafter. At the end of the sixth year, Jane’s home had a fair market value of $150,000 based on a 55% decline in value. That being the case, the principal amount of the loan is written down to what Jane’s debt ratio would have been in that year had her home not declined in value. In this case, had the home not lost value, Jane’s debt ratio would have been 0.81 (see ‘Year 6 Base’ in the table above). The principal amount of the loan is thus reset to $121,631 (150,000 * 0.81) [see note regarding rounding at the end]. Not only is the principal reset to $121,631, but the loan is re-amortized over a 24 year period (the original 30-year term minus the first 6 years). This results in a monthly principal and interest payment of $726 for the next three-year period.
Jane feels better already. There is no longer any reason to doubt. With her monthly payments reduced from $1,610 to $726, she now has an extra $884 to save or spend, both of which will help out her family and the ailing economy either way. At the end of the ninth year, Jane’s debt ratio is a healthy 0.75, and a new home appraisal is required. The new appraisal concludes that the home has increased in value by 50% to $225,000. Thus, the principal will be increased in the subsequent year.
In the tenth year, the principal is raised to $169,703. This is calculated by multiplying Jane’s ninth year ending debt ratio of 0.75 by $225,000 (the current value of the home). The loan is then re-amortized over the remaining 21 years, resulting in a monthly principal and interest payment of $1,089 for the next three years.
Although Jane would not be allowed to sell without incurring a prepayment penalty, she can see on paper that by the end of the twelfth year her debt ratio has declined to 0.69 with roughly $70,000 in home equity. Jane doesn’t mind the increased monthly payment because it is still lower than her original payment of $1,610, and because it was fairly determined based on the value of her home. At the end of the twelfth year the required appraisal determines that the home has increased in value by another 25% to $281,250, so the principal must rise again.
Since Jane’s debt ratio at the end of the twelfth year was 0.69, and the appraised value is now $281,250, the principal amount of the loan is stepped-up to $193,628 (0.69 * $281,250). The loan is re-amortized over the remaining 18 years resulting in a monthly payment of $1,361 for three years. Once again, Jane doesn’t mind the increase because she now has almost $110,000 in home equity, plus she is still paying less than her original payment.
The required home appraisal at the end of the fifteenth year results in another 20% increase in valuation, making the home worth more than its original cost. Since the terms of an Adjustable Principal Mortgage cap any increase in valuation to the home’s original cost, the new mortgage principal is limited to $204,018. This is calculated by multiplying the debt ratio of 0.61 at the end of the fifteenth year by $333,333 (the original cost of the home).
In the sixteenth year, Jane’s adjusted loan principal of $204,018 is re-amortized over the remaining 15 years, resulting in monthly principal and interest payments of $1.613. Jane doesn’t mind this at all because her payments are essentially the same as they were under the original loan, plus she now has over $138,000 in home equity. The biggest bonus is that because her home has returned to its original value, Jane may now sell it free and clear at any time. If Jane keeps the home and it maintains an equal or greater value over the remaining 14 years, her monthly payments will remain $1,613, and her debt ratio will continue to decline.
In the example above, Jane is a winner. If I were her, I would quit while I was ahead by selling the home in the sixteenth year, but that’s her call. If she remains in the home for the full 30-year term, and if existing home prices continue to rise, Jane will have reached her original objective. Now let’s see what happens to the mortgage company.
With an Adjustable Principal Mortgage, at the end of the 30-year term, the mortgage company will have earned $240,583 in interest income and will have recovered $278,235 of the original $300,000 principal. The reason that the principal repayments are short by $22,000 is because the mortgagor shrewdly wrote off a portion of the loan in order to keep the homeowner happy. The mortgage company still receives $218,818 over and above its original investment.
In comparison, had the terms of the original loan been fulfilled, the mortgage company would have received $279,767 in interest and the full amount of the principal. Overall the lender has given up $60,942 in interest and principal payments in order to help out a borrower whose underlying asset had declined by 55% in the sixth year of the contract. The alternative would be to risk foreclosure and an immediate loss, most likely in excess of $120,290 with the additional loss of interest income. In this respect, both the lender and borrower are winners.
Goals / Terms
  1. Temporarily reduce the principal amount of underwater mortgages to the product of the homeowner’s target debt ratio and the home’s current market value.
  2. Require a new home appraisal at the end of each three-year cycle.
  3. Re-amortize the loan over the remaining life of the original term every third year.
  4. Reset the principal amount of the loan every third year based on the homeowner’s ending debt ratio times the new appraised value.
  5. The original length of the loan may not be increased.
  6. The original interest rate remains fixed at the original rate and may not increase.
  7. The value of the home may not exceed its original cost, for purposes of adjusting the loan principal.
  8. Monthly principal and interest payments may not substantially exceed the amount of the original contract. Substantial is defined as meaning within $10 per month.
  9. The homeowner may sell the home at any time, however if it is sold before reaching a valuation equal to its original cost, the homeowner will incur a prepayment penalty. The prepayment penalty is calculated by subtracting the amount of all principal payments made to date, from the amount of debt owed prior to commencement of the Adjustable Principal Mortgage. (Exceptions may apply where reasonable cause exists.)
  10. Once the value of the home equals or exceeds its original cost, the homeowner may sell without penalty, only required to payoff the balance of the Adjusted Principal Mortgage.
Benefits / Costs
Lenders – By implementing the Adjustable Principal Mortgage lenders would potentially eliminate foreclosure losses such as may occur in the example above, multiplied millions of times over. If every underwater borrower decided to walk away tomorrow, it would spell the end of the mortgage industry, the end of the U.S. economy, and a sustained global depression. The costs of home appraisals, origination, and processing fees are passed on to homeowners. Although lenders will recover less than the amount stated in their original contracts, the amount forgone will be entirely based on how quickly home prices rebound, while failure to act would be catastrophic.
Homeowners – Borrowers will have a renewed confidence in the housing market. They will also receive the benefit of lower mortgage payments while their houses are underwater, allowing them to save or spend money that they otherwise would not have. This will result in an extraordinary amount of economic stimulus, at no cost to taxpayers. Homeowners will be responsible for the cost of home appraisals, loan processing and origination fees. Such fees may be paid for preferably out of pocket, or added to the principal.
The Economy – The resulting increase in economic activity will mean restoration of jobs for loan officers, administrative assistants, accountants, real estate appraisers, and others. By reducing the number of foreclosures, abandonments, and short sales, the housing market will improve. As real estate prices begin to stabilize and then increase, home builders and real estate agents will also return to work. Under a capitalist system there are winners and losers. Without changes everybody loses, but by taking action, by spreading the risk and by making the system fair, everyone’s a winner.
“And I say to you, make friends for yourselves by means of the wealth of unrighteousness, so that when it fails, they will receive you into the eternal dwellings.”
It’s time to implement solutions designed to solve real problems. While politicians have wasted time covering the loses of some private sector risk takers, lambasting others, and imposing more restrictive regulations, it has never once occurred to them to propose a real solution. Meanwhile, as private sector lenders have been mired in Congressional hearings, attacked with new regulations, and in many cases forced to accept government bailouts, they have likewise not taken time to resolve the real problem.
Note: All figures are rounded up to the nearest value. The approximation above is not intended to be a cure-all, it’s just an idea.

Data: Original Workbook

Off Grid Solutions | Mortgage in-kind Exchange

~ By: Larry Walker, Jr. ~

The first step in any recovery is acknowledging the problem. The second step is having faith that a power greater than oneself can restore sanity. Joe purchased his home four years ago for $300,000. He currently has an outstanding mortgage balance of $270,000. The appraised value of his home has fallen to $150,000. If he sells it for $150,000 today, he will eat a loss of $150,000 which is not deductible for tax purposes. Joe can afford his mortgage payments and has not missed any. Since he doesn’t qualify for a loan modification, what options does he have?
For one, he can continue to pay off the $270,000 debt, plus interest, on a home which has lost 50% of its value, thus incurring more than a $150,000 loss spread over time. Or if he finds this distasteful, he can simply walk away from the home and let the bank and the wizards of DC deal with it. Other than that he really doesn’t have many options. I say he doesn’t have many options, because I know some folks who have already walked away from their homes, renting them out to others while they rent elsewhere, with the idea of dumping them for a loss if things don’t improve in a couple of years.
Does it make sense for Joe to sit there, stuck in a home that he can’t sell or refinance; making a payment every month on what he knows is a bad investment? Would you invest $300,000 in something that you thought would be worth half in the future? Although housing prices may increase over time, they didn’t get to where they were overnight, and life is finite. Joe is 50 years old and doesn’t have another 30 years to waste. So what can the government or private sector do for Joe?
Solution: The Mortgage in-kind Exchange
One of the things eating away at Joe everyday is that he sees House B, a bank owned foreclosure which had an original cost of $600,000, still has an appraised value of $300,000, but has a selling price of just $150,000. Joe would love to purchase House B but he is not able to get out of his current mortgage without incurring a $150,000 loss. Joe would have to come up with a $120,000 payment to get out of his present mortgage, plus make a down payment on the bank owned home, which would make him even worse off.

A Mortgage in-kind Exchange is a unique idea that would allow Joe to sell his home for a loss and rollover the remaining $120,000 loan balance into a more valuable home. It would allow Joe to purchase House B for $150,000 with a $270,000 mortgage. House B would have an appraised value of $300,000 and a mortgage debt of $270,000, thus making Joe whole.
How it works – Joe is allowed to hold an option to purchase House B for a small earnest money deposit of $1,000 which will take the home off the market for up to a year giving him time to sell his old home. If the old home doesn’t sell within a year, Joe may either extend the option by making another deposit, or forfeit.
Benefits and costs – Joe would be better off by being allowed to purchase a more valuable home for the same amount owed on his underwater home. The banks would be better off because they will have reduced their REO inventories without incurring as big of a loss. The economy will improve by allowing faithful homeowners a chance to improve their personal debt-to-equity ratios. Housing prices will improve by removing homes selling for less than fair value from the market. The cost to taxpayers would be zero.
The banks can get involved by matching up faithful homeowners with qualified properties. The government can get involved by getting out of the way, and encouraging the free market to push solutions rewarding those who deserve it the most.
***Revised***