The FHA announced important changes to the pricing of its mortgage insurance today. This change will help to shore up the long-term solvency of its mortgage insurance fund, improve affordability and sustainability for most borrowers, and price in a significant number of borrowers locked out of the market in recent years. It will also provide a strong signal, along with solid recent employment growth and lower mortgage rates, to first-time buyers who might be on the fence. Its not the silver bullet, but an important step toward normalization of the housing market.
Changes in Context
The President announced that the FHA will reduce its annual premium by 0.5%, or from 1.35% to 0.85% for a borrower using a 30-year fixed rate mortgage with a 3.5% downpayment. In historical context, that reduces the annual MI charge to its lowest level since since early October of 2010. The fee that FHA charges for its credit enhancement is a combination of an annual fee (MIP) which is paid monthly and an up-front charge (UFMIP) which can be paid as a lump some at closing or more often it is rolled into the balance and financed for the life of the loan. The total fee, estimated as an upfront price now stands at 6.0% , down from 8.5% prior to this change. The total fee is at its lowest level since 2011, but remains higher than other non-recessionary periods over the last 30 years.
Even with the rate reduction, the fee charged by the FHA for its mortgage insurance (6% of originated balance) more than covers the expected losses (5%), allowing excess fees to continue to build up the capital reserve to its required minimum of 2.0%. Furthermore, the added volume generated by the lower fees will help to ameliorate the income lost by reduced premiums. In short, by modestly reducing rates and expanding the pool of borrowers, the FHA is still on trajectory to meet its capital requirement over a modestly longer horizon, while reducing the amount that it charges borrowers beyond the cost of the program.
For a borrower with a $200,000 mortgage, this changes amount to a reduction in the monthly payment of $83, an improvement of 7.1%, or nearly $1,000 over the first year. By year five, this borrower has saved nearly $4,800, but over 30 years the borrower would save roughly $18,000. This later point is important as FHA still charges its annual MI fee for the life of the loan, a change instituted in 2011. Mortgage rates are expected to rise as much as two percentage points in the coming years, which will significantly reduce borrowers ability and incentive to refinance out of the FHA program as they have done in recent years. As a result, this change will have a larger impact for many homeowners over the life of their ownership.
The lower fees will also help to stymie the flow of lower-risk borrowers from the FHA to the conventional market. The FHA pools its expenses for low and higher risk borrowers, thus allowing it to provide lower average pricing than the private market would for moderate risk borrowers. To do so, the FHA must maintain some lower risk borrowers in its portfolio, vets its borrowers, and provides only vanilla products with no risky features. High pricing of its MI caused a flight of quality borrowers in 2013 and 2014 putting the FHA’s ability to fund middle class borrowers and its very mission in jeopardy.
Beyond stabilizing the shift between the conventional and FHA markets, the lower pricing will draw thousands of credit worthy borrowers back into the market. NAR Research estimates that the fee reduction will price in an additional 1.6 million to 2.1 million renters along with many trade-up buyers, resulting in 90,000 to 140,000 additional annual home purchases based on the standard affordability limits at the FHA and conventional market and dynamics in the housing finance market.
Implications for the MI Industry and the Housing Market
The reduction of rates at the FHA will make it tougher for the private mortgage insurers to compete for these homebuyers in the interim. As depicted below in yellow, the pricing advantage shifts from PMI to FHA for a significant portion of the credit box. Later this year, the FHFA is expected to announce new capital requirements for the PMI industry as well as a decision on the future of the GSE’s loan level pricing adjustments (LLPAs). Many have argued that the combined capital requirements of the PMIs and LLPAs provide too much capital protection, leading to inefficiency and high costs to consumers. If the FHFA follows the FHA in providing capital relief, pricing should shift back toward the PMI industry helping it to maintain its footing. This step is important as a healthy PMI industry, like a healthy FHA, is critical for a robust, safe, and liquid housing finance system over the long-term.
The FHA’s proposed changes to its pricing for 2015 are good for consumers and the economy. It puts money back into consumers’ pockets, improves affordability for many borrowers, and unlocks the opportunity to purchase a home for tens of thousands, while preserving the stability of the FHA’s fund and protecting tax payers. Sluggish income growth, low inventories and nagging tight credit remain headwinds for the market, but this shift is an important bell weather of returning health for the market.
 This is a conservative estimate with a multiple of 5. As rates rise and loan life extends due to reduced refinance incentives, the fees could generate higher revenues, further building reserves. Extension to a multiple of 6 would imply a total fee of 6.85%