As HUD considers mortgage insurance premium (MIP) changes in the aftermath of FHA’s record-breaking FY 2021 performance with $100 billion of capital reserves and a capital ratio of 8%, it is time to address the “elephant in the room.” Since the housing crisis, FHA premium policy has been more effective in “providing space for private capital” (as HUD referred to it in its FY 2011 Report to Congress) than providing fairness and equity to FHA borrowers.
Instead of increasing the upfront premium to minimize the impact on FHA borrowers, HUD took the unprecedented step of increasing the annual premium significantly and later adding the life-of-loan requirement. Together they make it harder for borrowers to qualify, more expensive for each year the loan remains in effect and, most importantly, send a clear message to mortgage originators to avoid recommending FHA financing if at all possible.
FHA’s rising prominence “to fill the void left by the reduction of private capital,” as HUD also said in the FY 2011 Report, had created a dilemma for those in Washington worried about FHA’s growing market share. In the FY 2011 Report, HUD explained its “challenge” this way:
“One of the challenges we face in the current environment is the balance between assuring mortgage credit flows for low-to-moderate income households, minorities and first-time homebuyers and providing space for private capital to return to supporting mortgage credit risk.” [bolding added]
The problem with HUD’s solution to “providing space for private capital” was not that it raised FHA premiums. MIP increases were necessary back then to ensure FHA’s actuarial soundness. What is disappointing was how HUD did it and the fact that these policies, to a large extent, still remain in effect today.
Between 2010-2014, FHA raised annual premiums by 145%. Even with the 50 basis point reduction in January 2015, current annual premiums are still 50% higher than before the housing crisis ($70 per month higher on average for FY 2021 originations). For borrowers who obtained FHA loans last year, they are paying an additional $1 billion in the first year alone as a result of the higher monthly MIP.
In June 2013, HUD went a step further in its effort “for providing space for private capital” when they added the life-of-loan requirement. This change increases “lifetime” premium costs for borrowers unable to refinance their FHA mortgages to more than $50,000 on an FHA mortgage of $200,000.
To make matters worse, this “lifetime” burden will likely fall disproportionately on families of color. A June 2021 Federal Reserve Bank of Boston study found that minorities are “significantly less likely to refinance to take advantage of the large decline in interest rates.”
The life-of-loan change is also detrimental to the FHA Fund as it is giving borrowers a strong incentive to refinance out of the program as soon as possible, costing FHA billions of dollars in premium revenue. FHA’s recapture rate (i.e. the percentage of loans that prepay and return as an FHA refinance) has plummeted since the life of loan provision was implemented falling from over 50% in the 2010 – 2012 period to 18% in the first four months of FY 2022.
Let’s also not forget who FHA borrowers are. Eighty-five percent of FHA purchasers were first-time homebuyers, and borrowers of color obtained over 40% of FHA loans in FY 2021. FHA also insured more than twice as many loans to Black and Hispanic borrowers last year as the rest of the mortgage market combined.
The life-of-loan policy has always been at the heart of the debate about FHA premiums. Advocates maintain that FHA must charge premiums for as long as the loan remains in effect. They act like charging monthly premiums for the life of the loan is the only way that FHA can protect the fund and taxpayer from the “tail risk” of loans defaulting after 11+ years of borrowers making their payments.
They must have forgotten that FHA’s private sector counterparts offer several upfront premium plans and that the Reagan Administration even introduced an upfront-only premium to the FHA program in 1983.
Of course, the life-of-loan requirement discourages borrowers from obtaining FHA loans in the first place. Just look at the marketing material of the private mortgage insurers highlighting the cancellability feature of their insurance.
I am sympathetic to the private mortgage insurers’ position since much of their competitive dilemma is dictated by the pricing policies of Fannie Mae and Freddie Mac. I just don’t believe that FHA borrowers who already face their own financial challenges should be required to bear unnecessary and significant financial costs for the purpose of “providing space for private capital.”
Instead of FHA charging high annual premiums for the life of the loan, the mortgage insurers and their allies should direct their efforts to the source of the problem, namely the Federal Housing Finance Agency’s (FHFA) pricing policies and Loan Level Price Adjustments (LLPAs) in particular. Acting Director Sandra Thompson has said that FHFA will be looking at pricing “holistically.” That’s encouraging, but regardless, families using FHA financing should no longer be victims in this debate.
We are already seeing proposals encouraging additional targeting of any MIP reduction. Targeting would only deny excluded borrowers the premium reduction that they deserve and also increase risk for the Fund.
It is important to remember that FHA was founded on fundamental insurance principles. Like any successful insurance program, FHA must spread its risk. At the same time, a cornerstone of the FHA program has always been charging all borrowers the same premium, in part to discourage borrowers with lower risk factors from using the program. However, to the extent those lower-risk borrowers do use FHA financing, their premiums certainly help offset losses projected for loans having higher risk characteristics (i.e. cross-subsidization).
As Housing Wire reported recently, FHA’s performance has gotten even better since the FY 2021 Report to Congress was published. Serious delinquencies have declined more than 20% in the first four months of FY 2022 on top of a 305 decline in FY 2021. FHA could now pay a claim on every serious delinquency and still have $70 billion in capital reserves and a capital ratio of 5.5% or more than 2 ½ times the statutory level of 2%.
For 10+ years, FHA has been charging very high annual premiums on arguably its best credit quality portfolio in at least 50 years. Gone are the seller-funded downpayment assistance loans that cost the fund over $16 billion and FHA’s low average credit scores in the run-up to the housing crisis that bottomed out at 630 for FY 2007. The strong house price appreciation numbers of the last two years only made FHA’s financial performance even better.
From Day One, the Biden Administration has made homeownership the cornerstone of its effort to reduce the racial wealth gap in our country. Eliminating the life of loan and lowering the annual premium will not solve all of the problems facing underserved borrowers, far from it. They will just remove unnecessary costs for millions of FHA borrowers who already face enough challenges in the pursuit of their American Dream.
Brian Chappelle is a partner at Potomac Partners and a former director of single-family development at both the FHA and HUD.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
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