The FHA Insurance Cut is Cancelled – Why, and What Does it Mean?
The term “FHA loan” is a misnomer; FHA/HUD doesn’t offer loans. “FHA loans” signify that the Federal Housing Administration is backing the bank offering the loan. They account for approximately 25% of all first mortgage loans in the United States.
FHA loans are the loans of last resort for stretched homebuyers because the FHA’s guidelines are more relaxed. Lower credit scores are acceptable. FHA loans have lower down payment requirements than conventional loans. FHA loans also allow buyers to have up to the entire down payment gifted from a relative, government grant, etc. Conversely, conventional loans have stricter rules requiring higher credit scores and often forbid gifts and grants. In exchange for more relaxed guidelines, the FHA loan process requires that monthly mortgage payments are no more than 29% of the buyer’s income, at least 3 years between a buyer’s purchase and their last foreclosure, at least 3 years of good credit from that foreclosure, two years since the buyer’s last bankruptcy discharge, and two years of good credit since the bankruptcy discharge.
Since FHA loans are often to riskier borrowers with little money down, the borrower must also pay additional insurance to mitigate some of that risk. That insurance is currently 1.75% of the loan amount at closing and .85% of the loan amount yearly. Unlike standard conventional mortgage insurance (“PMI”) which stops when the borrower reached 20 or 25%, this insurance requirement either never ends or ends after 11 years depending upon the borrower’s original down payment amount.
The cancelled insurance cut was a 0.25% cut of the monthly portion of the PMI which would take it from .85% to .60%. Assuming a $200,000 purchase price with a 3.5% down payment, the buyers would have saved $500 per year. However, using the 2015 fiscal year numbers (latest available), that 0.25% cut would have cost taxpayers over $500,000,000.00 every year in lost insurance to use against bad FHA loans.
The additional half-billion of insurance is especially important because the FHA recently lowered its credit standards. While lower credit standards allow more buyers, it specifically allows riskier buyers. We learned about loans and riskier buyers in the 2007-2012 recession. FHA loan default rates were as high as 36% during this time. Delinquencies are also more common with FHA loans; 30/60/90+ late pays are higher because FHA borrowers are riskier. Delinquencies reached a height of 47%+ during the recession. While those figures have improved today, the quarter-point goes a long way to keeping the FHA program solvent and keeping taxpayers from covering losses.
Just a few years ago, the FHA was facing bankruptcy because so many loans were going bad. FHA loans are all but the sole remaining way for tight borrowers to buy a home. Further, the FHA is responsible for approximately 25% of all US mortgages. President Trump’s move to delay cutting insurance premiums appears to be a fiscally responsible move which helps to ensure the health and solvency of the program. While cancelling a $499+ a year cut seems cruel to these stretched borrowers, we are concerned about approximately nine dollars a week. If a $200,000 home buyer is stretched by nine dollars a week, should we ask reasonable questions about that borrower’s ability to handle their loan?
FHA loans are a vital part of the US housing market. Losing a program that is responsible for approximately 25% of all first mortgage loans would be an absolute disaster to these buyers, to sellers, and to the overall US economy. While we can have sympathy for those buyers not receiving the planned cut, this delay is a reasonable and fiscally responsible move to help to keep the FHA loan program viable and solvent for future buyers.
Would you like to talk more about how this change of plans affects your sale? Let’s talk and help you plan for a successful sale!
This article was reviewed for accuracy by Don Madison of PHH Mortgage.