Of all the problems faced by the incoming Biden Administration the FHA isn’t one of them. In fact, the venerable mortgage insurance program is a huge success. It insures the mortgage financing for 8.3 million households. It’s the go-to program for first-time and minority borrowers. It has massive capital reserves. And – of course – changes to the FHA will be hotly debated in 2021.
“Given its success why not just leave the FHA program alone?” asks Rick Sharga, Executive Vice President with RealtyTrac, a leading source of investor leads and real estate data. “The answer is that some believe the FHA can do better. A minor change to the FHA program could bring a significant number of additional purchasers into the marketplace. My question is whether it’s a good idea to increase the buyer pool in a market where demand already outstrips supply, and potentially push prices higher in many markets where affordability is an issue.”
What changes might FHA watchers advocate? Re-thinking premiums.
The FHA was established in 1934 in an effort to re-start the housing sector in the midst of the Great Depression. It did two things.
First, it offered a long-term alternative to the five-year term mortgages with balloon payments which were then the marketplace standard. A longer term meant lower monthly costs plus less borrower risk because the loan was self-amortizing. Because lenders were forced to compete against the FHA program five-year mortgages are today virtually unknown in the US.
Second, the FHA was not free. In exchange for the government’s promise to pay off lenders in the event a loan got into trouble borrowers agreed to pay insurance premiums. Those premiums are then placed in a reserve fund to pay off claims against the program. Today FHA premiums generally look like this:
- An Upfront Mortgage Insurance Premium (UFMIP) equal to 1.75% of the loan amount (a sum that can be added to the debt at closing to avoid the need for more borrower cash up-front) and
- An Annual Mortgage Insurance Premium (MIP) equal to 0.85% of the loan amount.
Insurance programs have reserves so cash is instantly available to fund claims. The FHA is required to have reserves equal to 2% of its outstanding loan coverage. Its just-released FY2020 Annual Report (for the period ending Sept. 30th) shows where the program stands.
- The outstanding balance for loans in the FHA program is more than $1.29 trillion.
- First-time buyers represented 83.1% of all new FHA borrowers.
- Nearly a third of FHA-backed loans were used by minority borrowers.
- FHA market share decreased from 11.56% in FY 2019 to 9.61% in FY 2020.
- The FHA’s Single Family Mutual Mortgage Insurance Fund (MMIF) had a year-end capital ratio of 6.10%.
To give some perspective, the capital ratio for the FDIC insurance program that protects bank depositors is just 1.3%. The National Flood Insurance Program (NFIP) is worse off. In 2017 legislation was passed forgiving $16 billion in NFIP debt owed to the Treasury. As of the third quarter the program owes the Treasury $20.5 billion.
What’s the problem?
A government program that works well is something to be admired. The big question for the incoming Biden Administration is whether the FHA can do better with lower premiums.
The MMIF reserves are flooded with cash. There are relatively few claims. If the upfront and annual MIP premiums are reduced that will make real estate financing more affordable. Better affordability will bring more buyers into the marketplace and more buyers equal more demand and generally pressure to move prices higher. Higher prices mean fewer MMIF claims because troubled properties can more-readily be sold for enough to repay mortgage loans in full.
The U.S. Mortgage Insurers (USMI) – a group which represents private-sector mortgage insurance companies – disagrees. It argues that lower FHA premiums are “unnecessary and imprudent at this time as consumers continue to have access to low cost mortgage credit. A reduction would diminish the MMIF’s ability to withstand potential stress caused by the economic fallout from the pandemic, evidenced in the nearly 11.6% of FHA-insured mortgages that are classified as seriously delinquent. Further, calls to end the premiums for the life of FHA loans are just a veiled way of reducing premiums.”
Why are FHA delinquency levels so high? “The agency’s portfolio of seriously delinquent loans,” explains American Banker, “grew by $117 billion thanks to provisions in the congressional stimulus package from earlier this year that allowed borrowers to request up to a year of forbearance.”
Whether current delinquency levels are a problem will not be known until various federal, state and local foreclosure moratoriums end. That could be at some point in 2021.
The Biden platform advocated a $15,000 tax credit for first-time buyers. Why not lower FHA fees as well? Or instead of a tax credit? Smaller premium costs might be a cheaper, easier, and quicker way to increase the pool of potential buyers without the complexity of new tax legislation.