The agency that backs more than one million mortgage loans per year just reached an important milestone, and it could make home buying easier in 2016.
The Federal Housing Administration, or FHA, is getting back on its financial feet. Massive losses in the housing bust are coming to an end. After years of increased mortgage insurance premiums to pay for the losses, mortgage insurance premium (MIP) costs could actually go down.
It all has to do with the agency’s income and outflow. Just like a household budget, problems arise when more funds go out than come in. But these problems are diminishing for FHA as the economy improves.
How FHA Works
FHA allows home buyers to put just 3.5% down. Without FHA’s help, this amount of down payment would be a problem for banks.
The down payment is just too risky for ultra-cautious banks. The bank is on the hook if the borrower stops making the payments. The lender has to foreclose on the house and resell, possibly at a huge markdown. Contrary to popular belief, banks hate foreclosing. It’s bad for the bank, bad for the borrower, and really bad for the bank’s reputation.
So back in 1934 FHA came up with a plan to alleviate at least the financial risks of lending at low down payments.
FHA homebuyers would pay mortgage insurance premiums. Essentially, they would put money into a giant insurance fund. The fund would bank losses from the small percentage of homeowners who default on their FHA home loans.
The FHA System Works…Most of the Time
The system works great, that is until an epidemic dries up the fund like happened in 2008 and following.
FHA’s cash reserves dwindled as it paid out claims. Lenders were forced to foreclose homes and resell them at severely depreciated values. FHA was on the hook for the losses.
To make matters worse, it was an extreme seller’s market.
Many existing FHA homeowners sold their homes. Others were foreclosed on. These former owners stopped putting money into the fund.
Many other owners were severely late on their payments. Nearly one in four FHA loans originated in 2007 were in foreclosure or close to it, according to HUD’s annual report to Congress in 2014.
But then things started to change. By 2015 FHA was back in the black. That could spell lower cost borrowing for FHA home buyers.
FHA Back on its Feet
Long before the housing crisis, Congress had mandated that FHA keep in reserve 2% of all outstanding loans.
For instance, for every $1 million in FHA lending across the country, FHA should have $20,000 in its fund to cover losses.
That was not a problem until 2008 when reserves dropped below 2% for the first time in history. By 2012, the FHA mortgage insurance fund was $16 billion in the hole – equal to negative 1.44% in reserves.
In an effort to shore up its finances, FHA raised its mortgage insurance premiums five times in as many years. Monthly mortgage insurance rose 240%.
A buyer with a $250,000 FHA mortgage in 2008 would have paid $115 per month in mortgage insurance. By 2013, that rose to $280 per month, no small amount for cash-strapped first time home buyers.
FHA MIP Reduction in 2016?
FHA’s finances started turning around. In 2014, had nearly $5 billion in its reserve fund, nearly one half of one percent of all outstanding loans.
FHA achieved an even bigger milestone in October 2015. It had surpassed the 2% minimum threshold for the first time since 2008. The FHA capital reserve ratio now stands at 2.07%.
The question is, will FHA pass on its good fortune to new buyers? It’s not unprecedented.
In January 2015, FHA lowered its monthly mortgage insurance premiums by over 35%. FHA’s stated goal is to enable homeownership where it would otherwise be extremely difficult or impossible. The agency could roll out a cost reduction in 2016 that enables more people to own a home.
The agency was forced to increase costs over the past seven years. FHA buyers during that time period brought it back from a financial black hole. It is feasible that the agency would make their premiums reflect the current financial situation of the agency, better or worse.
FHA is not out to make money. It wants to break even while keeping a buffer on hand for hard times.
If it can lower costs without putting itself at risk, it will do so.
At this point we can only speculate FHA’s moves in 2016. But there is enough evidence – and precedence – to give future homeowners hope of lower FHA costs.
Types of Possible FHA MIP reductions
FHA collects mortgage insurance in two ways. First, it requires an upfront, one-time premium at loan closing. Second, FHA collects a monthly premium for the life of the loan in most cases.
FHA could cut one or both of these charges.
The monthly premium currently stands at 0.85% of the outstanding loan balance per year. As recently as 2010, monthly premiums were just 0.55%, or $550 per year for every $100,000 borrowed. Going back to 2010 levels would save $750 per year for the average homebuyer.
FHA also has the option of reducing the upfront premium. Homebuyers must add 1.75% of the base loan amount to their balance and are responsible to pay it back with the loan. For a mortgage of $250,000, that’s an additional $4,300 the borrower has to repay.
The upfront fee was just 1% in 2011. A reduction to this former level would cut the average FHA homebuyer’s loan balance by nearly $2,000.
These are significant savings and not out of the realm of possibility.
Check Your FHA Eligibility
It’s usually a good idea to see if you qualify for FHA at current terms. If mortgage insurance rates drop, mortgage applicants should be ready to lock.
Applicants do not need a property picked out to get pre-approved for an FHA loan. In fact, that would be the opposite of the traditional home buying practice. There’s no use looking for a home without knowing you can finance it.
Many lenders let you check current FHA rates and get your pre-approval online, over the phone, or via email.