FHA Should Expand the Opportunity

The FHA made an important change to its refinance program Tuesday, March 6^th.[1] The FHA lowered the  premiums on refinances for some homeowners who originally purchased with an FHA loan.  However, the FHA put certain limitations on this opportunity, limitations that may prevent a substantial group of homeowners from taking advantage of today’s low rates.

The FHA has changed its annual mortgage insurance premium several times in the last two years.  On October 4^th of 2010, the FHA raised its annual insurance premium from 0.5%/0.55% (for loans with a downpayment of more than 5% down versus less than 5%) to 0.85%/0.9% and then again to 1.1%/1.15% on April 17^th of 2011.  Consequently, anyone wishing to refinance today, but who purchased prior to the change in October of 2010 would see an increase in their monthly payment due to the higher mortgage insurance rate that would wipe out most if not all of their incentive to refinance.  For example, the monthly payment (principle and interest) on a $200,000 home purchased with a 30-year fixed rate mortgage at a rate of 5% would be $1,074.  Refinancing at 4% would lower the monthly payment to $955, a savings of $119.  However, the monthly insurance premium which was originally $92 (0.55%) would jump to $192 (1.15%), an increase of $100 which would eliminate most of the incentive to refinance.  Furthermore, while the refinancee might receive a refund of her upfront premium (originally 2.25%), it likely would not offset the 1% to 1.5% fees on the refinance, creating a situation where she would need to bring cash to the table, further reducing the incentive to refinance.

The change on March 6^th will allow homeowners with an FHA loan who purchased prior to June of 2009 to refinance at the original 0.5%/0.55% annual insurance premium (yellow above) and will lower the upfront charge to 0.01% from 1.0%.  The FHA estimates that this change will impact 3.4 million households who will save an average of $250 a month or $3,000 a year by refinancing.  However, the FHA did not extend the reduction in its annual premium to buyers for the period from June of 2009, through October 3^rd of 2010, the date when the premium was raised to 0.85%/0.9% from 0.5%/0.55%.  This group still faces an increase in their refinance rate from 0.55% to 1.15% for borrowers with less than 5% downpayment as pictured in red above.  Roughly a million homes were purchased with an FHA-financed loan over this period, many with rates above 5.0%.  Furthermore, FHA loans originated in 2010 have outperformed those loans originated in every year from 2006 to 2009 as depicted in the chart below by the lower 90-day delinquency rate[2] in the 22 months after origination.  Stronger employment and home sales figures suggest that this trend will likely persist.

To make matters worse, those homeowners who utilized an FHA loan to purchase between June of 2009 and October of 2010 won’t just face the increase in annual premium from 0.5%/0.55% to 1.1%/1.15%, they will also be impacted by the FHA’s planned increase in the annual premium to 1.2%/1.25% for most loans and 1.45%/1.50% for loans in high-cost areas.

One might argue that borrowers in this period were able to take advantage of the $8,000 tax credit, but so were FHA borrowers who purchased from January 1^st of 2009 through June of that year.  Borrowers who purchased in 2008 were able to take advantage of a $7,500 tax credit.  What’s more, the $8,000 tax credit pales in comparison to the $9,000 benefit that the average refinance would bring in just 3 years and the $30,000 benefit over 10 years.

If the FHA’s intent was to, “make a real difference to help homeowners who are doing the right thing, paying their bills on time and want to take advantage of today’s low interest rates” as FHA Commissioner Carol Galante was quoted in the FHA’s new release, then the FHA might consider extending this opportunity to all borrowers who would be impacted by the FHA’s increase in annual premium in October of 2010.  These homeowners have performed well and the spending that this opportunity would bring will help the economy and further reduce delinquency rates for this group helping the FHA’s bottom line.

[2] the foreclosure rate is typically significantly lower than the 90-day delinquency rate as borrowers can rectify their situation