When the Sting of FHA’s Fees Becomes a Bite

The FHA has more than doubled its mortgage insurance premiums since 2010 and most recently eliminated the phase out of mortgage insurance on certain products. As a result, the private mortgage insurance industry has been able to recover and to expand in the conventional space. However, buyers that cannot shift to the conventional space bear the brunt of these higher costs at a time when growth in both mortgage rates and home prices have cut into homebuyers’ affordability.

Highlights:

• FHA’s annual mortgage insurance is currently 1.35%, 0.8% higher than in early 2010 and for its most popular products the insurance must now be paid for the life of the loan.
• The higher rates have priced out numerous potential homeowners, shifting many buyers to the private sector
• However, conventional financing cannot serve many of the borrowers FHA is intended to serve, leaving those priced-out, potential homeowners in the cold.

Rates Climb

In late 2010, the FHA initiated a series of changes to the pricing of its mortgage insurance program. These changes included both the upfront portion (UFMIP) as well as the annual premium structure (MIP). The initial increase in the annual insurance premium was just 5 basis points between 2008 and 2010, but the changes accumulated to 85 basis points by 2013. Simultaneously, the upfront mortgage insurance premium, which is often financed adding only modestly to monthly payments, increased and fell before being set in 2013 roughly where it had been five years earlier. The net effect though is significantly higher costs for the consumer. As depicted below, holding the mortgage rate and home price constant, the monthly payment of principle, interest, annual MIP and financed UFMIP rose 13% from $834 in 2008 to $942 in 2013 by which time the FHA’s fees accounted for roughly 20% of the monthly payment.

These changes were intended to shore up the agency’s books while promoting growth of the private finance sector. Private mortgage insurers have indeed benefited from the higher rates but also the recapitalization of their industry and new entrants as discussed in an earlier post.1 Their rates are risk based and often cheaper than FHA mortgage insurance, particularly for borrowers with larger down payments and higher credit scores. However, these rates rise significantly as credit scores decline and down payments shrink and at least one of the larger private mortgage insurers does not offers insurance for borrowers with less than a 620 credit score. Herein has historically been the purview of the FHA.

The Impact

The increase in mortgage insurance rates at the FHA has had an impact on affordability for renters or potential first-time homeowners.   Based on income data from the American Community Survey and estimating a renter’s front-end debt-to-income level relative to historical standards for sustainable lending (28% to 31%), the number of renters adversely impacted by the increase in the annual mortgage insurance premium has increased in lock-step with the rise in the FHA’s MIP.  By 2013, the MIP was 80 bp higher than the rate of 55 bp from 2010.  These additional 80 basis points pushed an estimated 1.45 million to 1.65 million renters over a sustainable front-end debt to income ratio for purchase of a median priced home in 2013.  Adjusting for FHA market share and taking repeat buyers into account, these changes may have priced out as many as 125,000 to 375,000 home buyers.

An Alternative for Some

Could these potential homeowners migrate to private mortgage insurance?  Private mortgage insurance2 for a borrower with a down payment below 5% and a FICO score of 720 or higher is currently 1.1% annually, but that rate rises to 1.31% if the FICO falls between 680 and 719 and increases further to 1.48% if the FICO is below 680.  Combined with the higher funding cost of roughly 37.5 basis points for a conventional mortgage (e.g. the difference in base 30-year fixed rates, roughly 4.5% vs 4.125% for a prime borrower) as well as loan level pricing adjustments (LLPAs) and the adverse market delivery fee (AMDC), only borrowers with the highest credit could afford to migrate to GSE financing. For example, the difference in the monthly payment between a conventional loan for a median priced home with a down payment of less than 5% and a FICO score of 670 compared with the same loan financed through the FHA with annual MIP and financed UFMIP is approximately an additional $92 a month.  Likewise, for a larger down payment of 5 to 10 percent with a FICO score of 670, the cost of PMI falls to 1.15%, but the payment is still $58 per month more expensive than FHA when all costs are included. The higher pricing of conventional financing for borrowers with lower down payments and low credit scores suggests that many priced out of the FHA program would not have a private alternative.

The FHA has undertaken several important changes in recent years; expanding to support the housing market as the private finance sector pulled back and then adopting best practices to prevent adverse selection and softening books. However, there is a price paid for the higher costs placed on consumers, the impact of which will be amplified in an environment of rising mortgage rates and home prices.
1 http://economistsoutlook.blogs.realtor.org/2013/08/09/lending-shifting-but-still-tight/
2 http://mortgageinsurance.genworth.com/RatesAndGuidelines/RateFinder.aspx