FHA mortgage premium may rise to 2.05% and delay the recovery

Over the last five years of falling real estate values, the government and federal reserve has done everything in its power to prevent the price collapse. The FHA was pressed into service as a replacement for subprime lending, and it became the only financing available for first-time buyers with less than 20% down. The current FHA minimum down payment is only 3.5%, which effectively puts every buyer underwater when transaction costs are factored in.

Since the FHA has originated over a trillion dollars in loans, most of which are underwater, and since prices are still falling, the delinquency rate on FHA loans has been steadily rising, and the loss severities are very high. It’s no big secret that the FHA is facing the prospect of a bailout, and it’s also no secret that politicians really don’t want to approve one.

As a result, Congress is now considering raising the FHA mortgage premium to a whopping 2.05% — a rate double the California property tax rate. In fact, that would be a nice rule of thumb to estimate the FHA insurance premium; take your estimated property taxes and double it. That’s how much the FHA insurance will cost.

Obviously such an increase in the cost of an FHA loan will help the FHA avoid a bailout, and Congress may pass it for that reason, but it will also have a devastating effect on the housing market. First-time homebuyers are the housing market. The move-up market using conventional financing is dead due to lack of equity and savings. Any increase in the cost of FHA insurance is going to reduce available loan balances as the cost of FHA insurance directly reduces the amount available to support a mortgage. Smaller loan balances translates to lower bids and ultimately lower prices. The combination of rising interest rates and increasing FHA loan fees will destroy any market recovery.

FHA bill to boost MIP caps moves forward in House

By Andrew Scoggin — March 27, 2012 • 6:09pm

A House committee voted unanimously to pass a bill that looks to give a boost to the Federal Housing Administration through increased mortgage insurance premium caps and other changes.

The FHA, under the bill, could charge up to 2.05% for its annual mortgage premium, up from a current 1.55% maximum. It also sets a minimum of 0.55% for the yearly payment.

The current FHA maximum of 1.55% is only charged on loans between $625,000 and $729,750. The rate for everyone else is 1.2%. An increase to 2.05% is a 70% in the cost of FHA insurance. On a $400,000 Orange County loan, that’s an increase from $400 per month to $683 per month. At 4% interest rates, a decline in payment of $283 per month will reduce loan balances nearly $60,000. That’s a 15% reduction on a $40,000 loan, and it will equate to a 15% decline in house prices to match.

Those premiums are set to rise by 10 basis points in April to 1.2% for new mortgages, or 1.25% for loans with a loan-to-value ratio above 95%. That increase stems from a December law that temporarily extended a payroll tax cut.

The House Financial Services Committee agreed to the bill, H.R. 4264, by voice vote Tuesday, more than a month after approval by a subcommittee.

“These are commonsense, targeted changes that would ensure accountability and financial stability within the FHA,” said the bill’s sponsor, Rep. Judy Biggert, R-Ill.

The Department of Housing and Urban Development could also force lenders to pay HUD back if a loan goes bad and it finds fraud or misrepresentation in the underwriting process.

The bill, at the same time, calls into question the fiscal solvency of the FHA, specifically its insurance premium reserve fund.

Nobody truly believes the FHA is solvent. Politicians are proposing this legislation to head off an more difficult and damaging bailout of the FHA. Unless one of the two parties believes they can gain advantage by blocking this stealth bailout, some version of this bill will likely pass. When it goes into effect, it will have a predictable negative effect on house prices.

The FHA would have to submit an “emergency capital plan” regarding its financial security, including whether it would have to dip into Treasury Department funds. The bill also requires the FHA to review its actuarial report process, or assessment of the insurance fund, to verify its accuracy.

Verify its accuracy? They have avoided a bailout so far by making unrealistically rosy estimates of future losses. What will prevent them from doing that again?

The mortgage insurance fund fell to 0.24% in 2011, below the required 2% threshold.

Since they aren’t enforcing current laws, I have my doubts about the efficacy of this new law.

The committee rejected two amendments to the bill that would have lowered the FHA insurance guarantee to 80% from 100% of a loan balance, and require the agency to max out its premiums until it meets that 2% requirement.

Lowering the guarantee to 80% of the loan balance would leave risk of loss with someone. Would this be on the originator? Who is going to be willing to take on this risk, and how would they be compensated in the transaction. This has the potential to severely curtain FHA lending.

In debate, Rep. Barney Frank, D-Mass., said he’d “hate to see” controversial amendments to an otherwise bipartisan measure.

“At this point, to send a jolt to the housing market I think is a mistake,” Frank said.

The FHA bill moves to the floor of the House for consideration.

Something will be done to avert an FHA bailout. Despite the ominous ramifications for the housing market, Congress will pass this bill in some form, the ramifications of an FHA bailout looms larger for Congressmen and their reelection chances than passing this bill and dealing with the resulting drop in prices.