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FHA Premium Pricing

How Consumers Are Winning

Stuart Quinn    |    Housing Policy

The Administration’s housing policy announcements continue to modify parts of the engine of the mortgage housing finance system. On January 8, 2015, the President delivered a speech in Arizona alongside Julian Castro, secretary of the Department of Housing and Urban Development (HUD), announcing a half percentage point reduction in the Federal Housing Administration’s (FHA) annual mortgage insurance premium. The President reiterated the premium decrease in his State of the Union Speech and reaffirmed the importance of the estimated $80 per month and annual average savings of nearly $900 per year for future FHA borrowers. However, existing FHA loans will not see a decrease in premiums as the reduction only applies to new mortgages and refinances.

Borrower Savings on Premium

Borrower Savings on Premium

The change from an annual mortgage insurance (MI) premium of 135 basis points (1.35 percent) to 85 basis points (0.85 percent) marks the fifth change to the annual premium since 2008. Through the past seven years there have also been changes to the upfront premium and how it was assessed, incorporating different risk characteristics at different points in time. While the annual premium structure in 2008 most closely resembled private market offerings, credit score dependent premiums and loan-to-value thresholds, this risk-based structure was short lived. An amendment to the National Housing Act in 2010 raised the ceiling of allowable premiums and offered the Secretary of HUD greater flexibility to set premiums, by allowing the Secretary to increase (or decrease) them through a mortgagee letter or the federal register. Following ratification of the law, the agency immediately elevated the annual premium to 90 (0.9 percent) basis points for low down payment borrowers and premiums have continued to climb even higher over more recent years, standing at 135 basis points prior to the President’s most recent announcement. The charge for the MI premium includes 10 basis points mandated by the Temporary Payroll Tax Cut signed in December of 2011 to fund the program.

The most recent reduction announced by the President was applauded by a number of mortgage market participants ramping up for the spring selling season. However, the reduction continues to be questioned by members of Congress who remain wary of the depleted FHA insurance fund that continues to be below the statutorily mandated 2 percent threshold. In November of 2014, FHA delivered their annual independent actuarial findings on the state of the FHA mortgage fund. The results indicated the fund was back in the black for the first time since 2011, although the FY2014 estimate to actual came in short by $57 billion, projecting the capital reserve ratio 2 percent attainment out a year to 2016. This projected shortfall taken in tandem with eased risk premiums will likely lead to a healthy debate when 2016 fiscal year presidential budgets are delivered to the 114th Congress on February 2, if not sooner.

In the interim, FHA will experience a minor refinance boom for borrowers with FHA mortgages and the Fannie Mae and Freddie Mac 97 percent loan-to-value product will supplement the upward swing in activity. The Mortgage Bankers Association announced on January 14 that their weekly mortgage application survey spiked, growing 49.1 percent in total volume from the first week of January and continued to rise another 14 percent in the third week of January as borrowing rates for 30-year fixed rate mortgage products remain near mid-2013 levels.

FHA New Endorsements By Credit Distribution

FHA New Endorsements By Credit Distribution

Leading up to the premium cut, FHA had been ceding market share to private mortgage insurers (PMI), with PMI making up 43 percent of total mortgage insurance as of the end of Q3-2014. The private market saw a $10 billion increase from the second to third quarter of 2014. Meanwhile, FHA portfolio composition of new endorsements has seen a nearly 15 percent decline in the proportion of endorsements for borrowers in the stronger 720 – 850 credit score cohorts from 29 percent of purchase originations in Q1-2013 to 16 percent as of November 2014.

The Dynamics of Premium Pricing

Premium pricing is no easy endeavor. Premiums that are too high can create adverse selection that results in an option of last resort generally comprised of the worst credit quality. Premiums that are too low do not appropriately price the risk to cover losses. There are certainly contentious components behind the announcement, but overall, FHA borrowers win to the tune of $900 a year and the broader housing market will experience a lift. The premium change becomes effective for loans endorsed after January 26, 2015, and HUD has released a frequently asked questions sheet for loan originators and appraisers concerned with borrowers that already have an application in the pipeline.

So far consumers continue to be the beneficiaries of lower housing financing costs and lower prices at the pump. Consumers are optimistic about this shift, with the Index of Consumer Sentiment figure for January indicating a reading of 98.2, the historical average reading of the survey from 1952 to 2014 is 85. Debates will continue as to what long-term safety and soundness repercussions these policy changes may have for taxpayers as more mortgages become guaranteed by the government without a first-loss private market credit enhancement. The short-term benefits align with the need for increased accessibility for existing and future homeowners. The residential real estate market is historically a key driver in economic recovery and this policy change attempts to harness the economic impact of a robust residential housing market going in to 2015.

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