Most of the attention surrounding the higher mortgage rate environment has been on the negative impact on the mortgage refinance market. However, that overlooks the fact that there are reasons a borrower may want to refinance in a modestly higher rate environment. For example, borrowers who have built sufficient home equity may want to cash-out some equity or refinance out of FHA to eliminate mortgage insurance premiums even when rates rise.
When the residential real estate market began to crash in 2008, the FHA share of the purchase market skyrocketed and reached a peak of 39 percent in November 2009, up from a low of 4 percent in February 2007. Since peaking in 2009, the FHA purchase-market share declined to 20 percent in September 2016, but it is still 5 percentage points above its late 1990s average.
The rise in the FHA share and an improving economy helped stabilize the housing market by late 2012. Since January 2013, the CoreLogic Home Price Index for the U.S. has risen 30 percent as of December 2016. The large rise in home prices during the last 3 years means that homeowners who used FHA loans to finance their purchase over the past few years have seen their equity grow, in many cases, past the 20 percent level where mortgage insurance is no longer required in the conventional market.
However, in January 2013 FHA announced a change in its policy on mortgage insurance cancellation, and it no longer allowed borrowers to drop mortgage insurance coverage when they reach 20 percent equity. So the only way to stop paying the standard 85-basis point premium on the average FHA loan is to refinance into a conventional loan with LTV of 80 percent or less.
And that’s exactly what in-the-money FHA borrowers are doing. They are refinancing into conventional loans, spurred on in part by the incentive of dropping their mortgage insurance premium. Last year, FHA to conventional refinances accounted for roughly 8 percent of all refinances or about 20,000 loans per month. Contrast this to 2010, when the rate was less than 1 percent or less than 4,000 loans per month (Figure 1).
CoreLogic is currently forecasting home prices to rise by 5 percent in 2017. Given that 2.9 million borrowers took out an FHA purchase mortgage since January 2013, that means a steady flow of borrowers will continue to refinance from FHA into conventional on the order of a 250,000 borrowers in 2017.
1 The mortgage insurance premium was 85 basis points as of February 2017, but was 135 basis points between 2013 and 2015.
2 Year to date August 2016.
3 FHA Single-Family Origination Trends, November 2016
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