Aug022016

Cuts to FHA insurance premium failed to activate first-time homebuyers

The cuts to the FHA insurance premium had little impact on sales overall, but more borrowers used FHA insurance. Was the policy a success?

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Lowering the FHA insurance fees was the right idea at the right time. Due to the losses sustained and expected at the FHA insurance fund, the fees were raised to very high levels, making FHA the new subprime.

When first-time homebuyer participation rates hit a three-decade low, I predicted that Pressure would mount to lower FHA insurance fees to revive home sales. Shortly thereafter FHA loan fees were cut in half, and I stated that Lowering FHA insurance fees will spur the housing market.

Why was lowering the FHA insurance fee so important? My market studies showed the housing market was relatively affordable, yet home sales were weak, particularly among first-time homebuyers. My reports measure affordability based on conventional mortgages with a 20% down payment because those terms don’t require mortgage insurance, a costly add-on that has varied in price significantly over time.fha-foreclosure

The super-high cost of FHA mortgage insurance increases house payments for first-time homebuyers significantly; thus the first-time homebuyer market is dead.

With such an important market segment participating at very low levels, any policy that offered hope was worth trying.

As it turned out, the policy lowering FHA insurance fees pushed up prices a bit further, but it failed to spark any sustained growth in construction or sales. Because it stimulated price without sales, Lowering FHA insurance fees made housing less affordable.

Even this incentive didn’t get millennials to buy homes

Last year’s cut in FHA’s mortgage insurance premiums didn’t create more first-time home buyers

Daniel Goldstein, July 29, 2016

The federal government’s effort last year to get more millennials and first-time buyers to purchase a home doesn’t seem to have worked. In fact, according to some industry watchers, it might have made it even tougher for them to buy a house.

Last year, as part of an Obama administration-wide effort to boost Homeownership, which is close to the lowest rate on record, the Federal Housing Administration lowered mortgage insurance premiums (MIP) on its loans in most cases by $800 to $900 a year (and in higher-priced areas of the country even more), in an effort to entice first-time borrowers to become homeowners. …

The advantage of an FHA loan is the 3.5% down payment barrier. No other loan program cost-effectively delivers loans at such high loan-to-value ratios.fha-lowers-score

While the potentially low FICO barrier sounds worrisome, many originating lenders have overlays that stop them from reaching that far down to generate business.

Indeed, the volume of FHA loans jumped substantially after the mortgage insurance premiums were reduced, according to data from RealtyTrac, an Irvine, Calif. based real-estate research firm.

“There was a definite spike in volume and share shortly following the mortgage insurance premium cut in January 2015,” said Daren Blomquist, senior vice president at RealtyTrac. Data from the research firm shows that the number of FHA loans originated a month rose from about 23,000 in January of that year (an 11.9% share of all the 193,000 home loans made that month) to a peak nearly 61,000 FHA loans in July of 2015 (with the share of all home loans increasing to nearly 17% out of a total of nearly 362,000).

That number was 53% higher than the approximately 40,000 FHA loans made in July of 2014, the summer before the FHA premium cut went into effect on Jan. 26, 2015, Most recently, 49,000 FHA loans were originated in May 2016, with a market share of about 16%. “The numbers remain elevated but have fallen back a bit in recent months,” Blomquist said.

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So did this rate cut succeed or not? I say yes.

The policy was selected as a tool that would stimulate home sales to buyers with low down payments and potentially lower FICO scores, the main group that uses their loans. After the policy, FHA originations increased 50% year-over-year, so it’s hard to argue the policy was not effective.

Did the policy meet some targeted demographic some activist believe needed aid? Could the policy have done more? I doubt it.

But some industry insiders say that while the volume of FHA loans increased, first-time buyers, especially millennials, weren’t convinced to jump in to the housing market.

”We’re still not seeing those first-time home buyers going to FHA,” said Bryan Sullivan, the chief financial officer of Foothill Ranch, Calif. -based loanDepot, the second-largest online lender in the U.S. “It’s still a relatively older borrower” for FHA loans, he said. Sullivan said that the drop in FHA loan premiums simply meant that other borrowers looking for a home loan opted for the FHA product, rather than bringing additional new buyers into the market. “It’s substantially just a reshuffling of the deck,” he said.

Since sales overall were not up this year, his statement is correct. However, I would counter that sales probably would have been down 5% year-over-year or more if the FHA insurance premium weren’t lowered. Prices are getting too high.

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In response, HUD spokesman Jereon Brown, speaking on behalf of the FHA, said that while millennial participation is up to nearly 50% of all FHA loans, up from 26% of loans in 2006, attributing the gain to the MIP reduction isn’t easy. …

But Sullivan’s conclusion was backed up by a recent analysis by the American Enterprise Institute, a conservative-leaning think tank in Washington, D.C., which said that far from the premium reduction encouraging first-time buyers, those buyers were already in the market, and simply opted for FHA loans over other products, such as loans backed by Fannie Mae, Freddie Mac and the Department of Veterans Affairs.

In the short term, its certainly true that the buyers who used this insurance were already in the market. So what? Did the policy motivate anyone else to come to market? Perhaps, the policy certainly made it possible for more buyers to come to market because some who were formerly priced out could afford to participate again.financial_literacy_activist

“Lowering the premium didn’t do anything to create more housing supply, but just created more demand in what’s already a seller’s market,” said AEI’s Pinto. …“The millennials have not been purchasing and it just comes back to lack of inventory,” Sullivan said, adding that the benefit of the FHA premium cut has mainly gone to the borrower in their mid-40s with better credit.

Indeed, the cut in the mortgage insurance premium may have just allowed borrowers to purchase bigger or better homes in more desirable neighborhoods, but the reduction in insurance premiums was negated by increased sales prices as borrowers fought over lower inventory. …

“Recipients just used the added buying power to purchase more expensive homes,” said Pinto.

Lowing the cost of FHA insurance fails to make houses more affordable because buyers quickly bid up prices to the new equilibrium price.

Lowering the FHA insurance rate did spur the low-end of the housing market as I predicted it would. The stimulus has now run its course, low-end house prices are higher, and the market rests at the new equilibrium price. However, houses are not more affordable; they are less so.

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