There’s no doubt that 2014 was a year of recovery for real estate. Prices were up, equity increased and foreclosures were down but looming in the background is a problem which can sink the recovery: First-time home buyers have become a rare and exotic species.
“Despite an improving job market and low interest rates,” says the National Association of Realtors, “the share of first-time buyers fell to its lowest point in nearly three decades and is preventing a healthier housing market from reaching its full potential.”
Without large numbers of first-time purchasers it’s hard if not impossible for current owners to move up, move out or get higher values. That means owners with more expensive homes are also stuck because they need move-up purchasers and the result is that a lack of first-timers impacts sales through the entire marketplace.
The traditional way to motivate first-time buyers is to combine the natural urge to own with attractive financing and little down, meaning such programs as FHA and VA loans. A RealtyTrac analysis found that buyers nationwide would save from $250 to $5,000 a year on house payments — depending on the county and median home price in that county — with the lower insurance premium. For that reason you might think the just-announced .5 percent reduction for the annual FHA mortgage insurance premium would be greeted universally as good news but that’s not the case.
It’s “a reckless move in the wrong direction,” says Mark A. Calabria, with the Cato Institute, and he’s not alone.
“The fundamental problem facing any insurer, like the FHA, is that the risk profile of borrowers is influenced by the premium rates they are charged,” says Calabria. “Obviously a rate that is set too low will not cover losses and the insurance fund will lose money. But a rate set too high will drive away low-risk borrowers and leave the insurer covering only high risk borrowers (and likely also losing money). An insurance fund can easily find itself in a position where it needs to raise rates to cover losses from risky borrowers, but each rate increase only drives out the good borrowers, making the risk composition of the pool ever worse.”
Which borrowers represent heightened risk? According to Calabria, it’s first-time buyers who “are likely to be younger and hence have lower credit scores on average, or else be older buyers who have had trouble finding credit because they are high-risk.”
HUD says the lower premium will save two million borrowers $900 a year and “spur 250,000 new homebuyers to purchase their first home over the next three years.” But is this right? Is the decision to lower mortgage insurance premiums an invitation to more risk and perhaps the need for a taxpayer bailout?
Established in 1934, the FHA has received one bailout in 81 years. In September 2013, HUD took $1.68 billion from the U.S. Treasury — a rounding error compared to the $442.6 billion bailout to banks, auto companies other selected winners under the government’s Troubled Assets Relief Program (TARP).
Is this evidence of a troubled program and the need to steer clear of excess risk? Not quite. At the time of the 2013 funding request, the FHA had $48 billion in reserve. Under government accounting rules the FHA was required to ask for the money because of a pattern of past losses during the period from 2000 through 2008, thus the financial request. Moreover, no one complains about the surplus money from the FHA transferred to the Treasury. As examples, $3.583 billion was moved to the Treasury in fiscal 2003 and $1.044 billion in fiscal 2005.
Despite the unnecessary transfer from the Treasury the FHA’s reserves are plainly coming back. Powered by steep premium increases, a total of $21 billion was added to the FHA’s Mutual Mortgage Insurance Fund (MMIF) in 2013 and 2014.
The 2 Percent Ratio
Congress expects the FHA reserve fund to equal 2 percent of outstanding insured loan balances. This is a reasonable goal and one the FHA does not now meet: The current capital ratio, according to HUD, is just .41 percent.
Should premiums remain high so the capital ratio can be improved?
There’s no doubt that 2 percent is desirable but with an improving housing market it may only be necessary to gradually raise the capital ratio. To see why look at the Federal Deposit Insurance Corporation, the federal agency which insures consumer bank deposits. At the end of 2013 its capital ratio was .79 percent, a far cry from 2 percent and yet no one is asking the nation’s banks to pay higher premiums. In fact, the FDIC is only required to have a capital ratio of just 1.35 percent — and it doesn’t have to reach that goal until 2020.
In November, FHFA — the Federal Housing Finance Agency — directed Fannie Mae and Freddie Mac to buy qualifying mortgages from lenders with as little as 3 percent down. This order was notable for two reasons: First, it was a huge drop from the 5-percent down payment requirement that had previously been in place. Second, it undercut the 3.5-percent FHA minimum down payment, meaning that conforming loans with private mortgage insurance are more readily available to first-time buyers.
The FHFA move was widely-applauded by the lending industry and why not? It’s a good way to get more first-time purchasers into the marketplace.
FHA Market Share
The U.S. Mortgage Insurers, a Washington-based trade association representing private mortgage insurers, says that it has urged “policy makers to proceed cautiously and to carefully assess the impact of any potential FHA premium reductions on its solvency as well as its stated objective of returning the FHA to a smaller and more traditional share of the mortgage market.”
Of course, the FHA would have less market share if the private sector simply developed more competitive products. Barring a market-based solution, the banking industry has tried to hobble the FHA through lobbying on Capitol Hill.
For instance, the $1.1 trillion budget bill enacted in December included language to defund the FHA’s Homeowners Armed with Knowledge (HAWK) program.
And what was so dangerous about the FHA HAWK program that Congressional action was required? It was merely a plan that would have lowered FHA premiums by about $300 annually for a typical first-time buyer. The reductions would be earned by taking consumer education classes and having a history of good payments, conditions which could be expected to reduce risk and slash claims against the FHA — the very goals sought by Mr. Calabria.