For would-be homeowners with little cash for down payments or low credit scores, Federal Housing Administration loans provide a path to homeownership. However, FHA loans come with a downside — their fees are high.
The Biden administration might deliver good news to FHA borrowers. President Joe Biden’s campaign platform focused on affordable housing and creating paths to homeownership for lower-income and minority families.
With that goal in mind, Biden could bring down the cost of FHA financing in the next few months. The Obama-era FHA announced a 25-basis-point cut in mortgage insurance premiums, but the Trump administration suspended that cut.
The FHA has “ample room” to reinstate the reduction in premiums, said David Stevens, who served as FHA commissioner during the Obama years. “The Biden administration will certainly be expecting all cabinet officials to do what they can to help stimulate the economy and assist middle-class Americans,” he said.
FHA insurance premiums
The FHA charges two types of insurance premiums to fund its reserves. First, there’s an upfront mortgage insurance premium (MIP) equal to 1.75 percent of the loan amount for new borrowers who finance or refinance. Borrowers don’t have to pay this amount in cash at closing; they can add it to the loan amount. However, when the loan is paid off through the sale of the property or by refinancing, there will be more debt to repay as a result of the upfront MIP.
The FHA also charges the 0.85 percent annual MIP. If you get a $200,000 FHA-backed mortgage at 3 percent interest, the costs will include a $3,500 upfront MIP charge, pushing the initial loan balance to $203,500.
The annual MIP adds $144 to the monthly mortgage payment.
If both the upfront and annual MIP rates are reduced by 0.25 percentage points, the numbers will get better for borrowers. The upfront MIP cost would fall to $3,000, a savings of $500. The new loan amount would be $203,000. The annual MIP would be lowered to $102 a month, for a savings of $42 a month.
For many borrowers $42 in monthly mortgage savings is the difference between a debt-to-income (DTI) ratio that works for lenders and one that doesn’t. It’s a big deal.
The case for lower premiums
The FHA is an insurance program. With FHA insurance, lenders are comfortable making loans with just 3.5 percent down for most approved borrowers, and low interest rates. Lenders know if a loan goes bad, the FHA will step in to make the lender whole.
However, because the FHA is an insurance program it must have cash to pay potential lender claims. Like all insurance companies, the FHA collects premiums and sticks some of the money into a reserve account, in this case the FHA’s single family mutual mortgage insurance fund — the MMI Fund.
Right now, the MMI Fund is flush. The program’s reserve cash-on-hand is equal to 6.1 percent of the amount insured. This is more than three times the 2 percent reserve ratio the FHA is required to maintain.
How strong are the FHA reserves? In comparison, the Federal Deposit Insurance Corp. — the federal agency that insures your bank accounts — has a reserve ratio of just 1.3 percent.
In other words, the FHA is collecting a lot of money but not paying out a lot of claims. This is ideal for an insurance program in the private sector, but for a government program the goals are different. No one expects the FHA to earn a profit. Instead, the FHA exists to provide a taxpayer benefit.
Delinquencies are rising
So far, it seems that lower FHA premiums should be a sure thing. But this is 2021. Things aren’t normal.
The FHA program faces two unusual headaches.
First, the program has a lot of delinquencies. The third-quarter delinquency rate was 15.6 percent, up from 8.2 percent a year earlier.
Second, the FHA has seen a big increase in serious delinquencies. The dollar value of seriously delinquent loans reached $158 billion in 2020, up from $41 billion a year earlier.
Do FHA delinquencies matter?
It might seem as though huge numbers of FHA defaults lie ahead. If that’s true, then lowering premiums would not be a good idea. But that’s likely not the case.
Most FHA borrowers are unlikely to go into foreclosure, because American homes have experienced major price increases in the past year. The National Association of Realtors reported that in December the typical existing home price rose 12.9 percent in just a year.
More equity means that FHA borrowers who face financial difficulties are in a very good position to simply sell their homes and pay off their mortgages from the higher value of their property. But it’s not just rising equity that protects the FHA. There’s a second out that reduces the FHA’s risk. The forbearance process allows borrowers to get back on track by restarting their mortgage payments. The missing payments are essentially moved to the end of the loan term. When the property is sold or refinanced the entire debt is retired.
In the end, the decision to raise or lower FHA premiums is a political one. Given the Biden Administration’s efforts to bring back the economy, an FHA premium reduction is entirely plausible.