Banks and Mortgage Insurance

When you make a down payment on a home of less than 20%, your lender forces you to take out a mortgage insurance policy that protects them if you stop making payments.  If you default, they collect on the policy which pays them the remainder of the 20% down.  On a $200k purchase price, a 20% down payment would be $40k.  If you only put down 5% or $10k, you pay a $90 premium each month included in your monthly mortgage payment.  You only pay this until you get 20% skin in the game, which in this case would take about 9 years. 

Now, if you default on the loan and the bank forecloses, they cash in on the mortgage insurance policy that you've been paying the premium on.  The mortgage insurance company, possibly AIG, pays them the $30k that you didn't put down.  Now, the bank puts the home on the market for sale.  Since they already have the $10k you put down and the $30k that AIG pays them, they can sell the home for $160k and break even.

This is starting to happen and there is no end in sight.  Banks are putting their foreclosures on the market at prices significantly below market value.  This is going to make it extremely difficult for a typical home owner to sell his home at market value.  Since 12/1/09, the percentage of homes under contract that are bank owned properties has doubled.  This could easily lead to home prices falling another 10-15% (the amount the banks are collecting on the policies) over the next couple of years while the banks sell all of their foreclosures.  Inventory of homes for sale is high now and that doesn't even count the shadow inventory of foreclosed homes the banks haven't even had time to put on the market yet.