After the implosion of Fannie Mae and Freddie Mac in 2008, the FHA was seen as the savior of the housing industry. Liberal underwriting guidelines combined with a low down payment requirement made FHA financing the preferred choice for many home buyers. As a result, the FHA’s share of total mortgage lending soared to almost 20% during 2009.
Despite the ease of obtaining loan approval, a major drawback to FHA financing was the costly mortgage insurance tacked on to every FHA mortgage. As discussed in previous posts, due to the high cost of FHA mortgage insurance premiums, FHA financing was not always the best choice for a borrower (see Sometimes, FHA Financing Is Not The Best Option For Homeowners and FHA Mortgage Insurance Very Costly For Borrowers).
FHA mortgage insurance premiums are imposed on borrowers to cover the losses incurred on defaulted FHA loans. Critics have charged that the FHA’s lending policies allow layered levels of risk which lead to high default rates while housing industry advocates lay the blame for defaulted mortgages on the housing industry collapse. Regardless of the reasons, the FHA’s default rate has soared and the FHA’s insurance reserve fund (which covers loan losses) has been virtually depleted.
At the end of last year, almost 10% of all FHA mortgages were classified as “seriously delinquent”, defined as a borrower being 90 days or more past due. Clearly, in order to stay solvent, the FHA had to take decisive action. In addition to imposing tougher underwriting standards, the FHA instituted large increases in both the upfront and monthly mortgage insurance premiums.
Earlier this year, Acting FHA Commissioner Carol Galante announced that the FHA had no choice but to increase mortgage insurance premiums due to large losses from defaulting loans. According to Galante, “After careful analysis of the market and the health of the MMI fund, we have determined that it is appropriate to increase mortgage insurance premiums in order to help protect our capital reserves and to continue encouraging the return of private capital to the housing market. These modest increases are one of several measures we are taking towards meeting the Congressionally mandated two percent reserve threshold, while allowing FHA to remain a valuable option for low- to moderate-income borrowers.”
The three tiered increase in FHA mortgage insurance premiums are detailed below.
1. The up-front mortgage insurance premium (UFMIP) will increased by 75%, rising from 1.00% to 1.75%. The UFMIP is calculated using the base loan amount and the FHA allows the UFMIP to be financed into the the loan amount. On a $350,000 loan a borrower will now be charged $6,125 instead of the previous premium of $3,500. Although the borrower does not have to pay the UFMIP in cash, adding the 1.75% mortgage insurance premium to the loan amount immediately wipes out 50% of the home buyer’s equity if he only made a 3.5% down payment.
The UFMIP will not be risk adjusted based on either loan term or loan to value. A borrower making a down payment of 50% (which would considerably reduce the risk of FHA losses on any future default) will pay the same 1.75% UFMIP as a borrower making a down payment of only 3.5%. In addition to the upfront premium, a borrower with a base loan amount of $350,000 will also be charged an annual mortgage insurance premium as high as $4,375.
2. The annual mortgage insurance premium (MIP), which is charged monthly to the borrower, will increase by 10 basis points. A basis point is one hundredth of a percent.
3. The FHA is increasing the monthly MIP by 25 basis points for mortgages with a base loan amount in excess of $625,500. This increase will be effective on or after June 11, 2012.
Will the large increases in FHA mortgage insurance premiums impact the housing market or simply result in a lower market share of mortgage lending for the FHA? Since peaking at almost a 20% market share in 2009, the FHA’s share of total mortgage originations declined to 18.3% in 2010 and declined again in 2011 to only 15%. This steady decline in the FHA’s share of total mortgage lending can be primarily attributed to the implementation of tougher underwriting standards.
Despite tougher underwriting standards and lower overall market share of the total mortgage market (which comprises both refinances and purchases) the FHA retains a critical role in the home purchase market. In 2010, the FHA provided financing for 40% of all new purchase mortgages, up substantially from only 4.5% in 2005. The latest increase in FHA mortgage insurance premiums (which increase monthly mortgage payments) is likely to contribute to a decline in FHA financed home sales.