There’s a growing sense in Washington that the smartest people in finance are nestled together in the warm, cozy offices of the Federal Housing Administration (FHA). It’s difficult to name another federal program which has done so well during the past year, so naturally it’s fair to wonder what they will do in 2016. One possibility is a new and big FHA discount.
Will this really happen? To get to the answer we first need to look at some recent history.
With the collapse of the mortgage marketplace in 2007 and 2008 it was the FHA which literally saved the housing sector.
“Private lenders exited the market when the crisis hit,” said Scott Olson, writing in the American Banker. Olson, executive director of the Community Home Lenders Association (CHLA), explained that at the time “Fannie and Freddie pulled back as they entered conservatorship. Thankfully, FHA filled the void, at one point financing as much as 50 percent of all new home purchases. Without FHA, housing prices would have cratered — and losses on existing FHA and GSE loans would have increased by tens or hundreds of billions of dollars more. Taxpayers would have paid the price.”
This bit of history is important but it wasn’t free.
The FHA insures mortgages made by private-sector lenders that meet program standards. The insurance is paid by borrowers with an up-front mortgage insurance premium (the up-front MIP) and with annual mortgage insurance premiums (naturally, the annual MIP). In late 2008 the up-front MIP was 1.5 percent while the annual rate was .55 percent. By 2013 the rates had jumped to 1.75 percent upfront plus 1.35 percent for the annual MIP. For a $150,000 mortgage a 2013 borrower would face first-year insurance fees of roughly $6,967 — almost as much as the entire 3.5 percent down payment.
The FHA may have been saving the housing market but to protect its reserves HUD had raised insurance rates to the point where they were making use of the program prohibitively expensive. In fiscal 2009 there had been 1,831,320 forward FHA endorsements, a number which fell to 786,354 in fiscal 2014, according to the FHA.
To get back on track, HUD proposed lower FHA insurance premiums for first-time buyers with the “Homeowners Armed with Knowledge” program (HAWK). The program was set to start in 2015 but Congress gutted the effort by declaring in the budget that “none of the funds made available by this Act nor any receipts or amounts collected under any Federal Housing Administration program may be used to implement the Homeowners Armed with Knowledge (HAWK) program.”
Who was the author of these words? Who wanted the credit for legislation which was passed without a hearing? No one seems to know, except perhaps for a few joyous lobbyists intent on sinking the FHA program. Such K-Street elation, however, was temporary because HUD turned around and in January 2015 simply announced a .50 percent reduction in the annual MIP for 2015 for most FHA-backed loans.
Forward endorsements in fiscal 2015 reached 1,116,214, an increase of 329,860 loans. No less important, $19 billion was added to FHA coffers and it now tops the congressionally-mandated 2 percent reserve requirement for the first time since 2008, reported HUD.
FHA Discounts in 2016?
Given that a lower annual MIP worked so well in 2015, why not another discount in 2016? Olsen says the FHA should lower the annual MIP to .55 percent, the rate in place before the mortgage meltdown started. He says the FHA “should also reverse the step it took in 2013 when it imposed premiums for the “Life of Loan.”
Let’s take these one at a time.
Reducing the annual MIP from today’s .85 percent to .55 percent is not unreasonable for three reasons. First, the reserves are doing remarkably well. Second, the reserves are likely to keep doing well because FHA foreclosure rates are falling through the floor. For instance, in May 2012 there were 30,158 FHA foreclosure starts versus 11,544 in October 2015. Third, if the FHA drops the annual MIP again it will attract hordes of new borrowers who will instantly pay 1.75 percent of their loans into the program in the form of the up-front MIP. The total could amount to billions of fresh dollars for the FHA’s reserves.
As to the “Life of the Loan” proposal that requires a little explanation.
Under the Homeowners Protection Act of 1998 (HPA) — also known as the PMI Cancellation Act — lenders were required to end the requirement for private mortgage insurance once the loan balance reached 78 percent of the original value of the secured property. According to the Federal Reserve, this figure is “based solely on the initial amortization schedule in the case of a fixed rate loan or on the amortization schedule then in effect in the case of an adjustable rate loan, irrespective of the outstanding balance.” In addition, borrowers can request cancellation once the loan balance reached 80 percent of the original amount.
In 2000, the FHA adopted an automatic cancellation policy: for most loans the annual MIP ends once the loan balance is reduced to 78 percent of the initial debt. Then, in 2013, the FHA reversed its policy. Under the theory that its insurance continued for the life of the loan, the FHA said the annual mortgage insurance premium would continue for the life of the loan. The FHA could do this because its insurance is not “private.”
The FHA change produced a big uproar and now there’s a demand for the 2013 policy to end. However, whether it stays or goes is just window dressing because virtually all FHA borrowers will pay the annual MIP for the life of the loan and always have. (The same, of course, is also true for borrowers who finance with private mortgage insurance.)
How can that be? If we borrow $100,000 at 4 percent interest the balance does not dip below 78 percent until we get to the 124th scheduled payment — that’s more than 10 years. However, the typical FHA loan is outstanding about six years.
So sure, the FHA can say it’s heard the voice of the people and for that reason is ending the “Life of the Loan” annual MIP policy. It would be a great PR move — and it would cost the government virtually nothing in lost MIP revenues.