Retaining the current price for government mortgages is a good idea
The Trump administration drew the ire of some housing experts on Friday when it suspended a planned price reduction in Federal Housing Administration (FHA) mortgages recently announced by outgoing US Department of Housing and Urban Development (HUD) secretary Julián Castro. A close look at the planned price reduction, however, reveals that the impact on the market would have been small and retaining the current price to help shore up FHA funds for a rainy day is a more prudent choice.
The planned 0.25 percent reduction, or 25 basis point (bps) reduction, in the FHA’s annual mortgage insurance premium was intended to take effect on January 27, 2017. Just hours after Trump took the oath of office, however, HUD issued Mortgagee Letter 2017-7, suspending the reduction indefinitely and stating that a subsequent Mortgagee Letter will be issued if the policy changes.
The cut would have had three potentially small effects on the mortgage market.
- Access to mortgages would have expanded marginally. The FHA has traditionally been the main provider of mortgages for low- to medium-income and first-time homebuyers who have little saved for a down payment. A reduction in the FHA insurance premium will always bring in more such borrowers and would expand access to mortgages. For example, an FHA borrower who pays a 5 percent down payment on a $250,000 home would have initially saved roughly $47 in monthly payments with the lower premium, although these savings would have decreased over time.
But this 25 bps in savings in annual FHA insurance premiums would have come when mortgage rates had increased 58 bps since the November election. The higher mortgage rates clearly offset the potential insurance savings, so no borrower would have been in a better position to borrow after the price reduction than they were two to three months ago when rates were lower. In comparison, the previous FHA premium cut was 50 bps and happened in early 2015 when mortgage rates were approaching historic lows.
More importantly, much more than the insurance premium has constrained access to FHA mortgages. We have identified three major constraints: the significant but uncertain litigation risk associated with defaulting loans created by overzealous application of the False Claim Act, the increasing cost of servicing delinquent FHA mortgages, and the risk that lenders will be required to indemnify the FHA if a loan defaults. Actions to address these bigger issues, particularly the first two, would be a much more effective way to improve credit access.
- More high-quality borrowers would have chosen FHA loans instead of GSE loans. The FHA premium reduction would make an FHA loan more desirable to some high-quality, low-risk borrowers who might otherwise have chosen a conventional loan with private mortgage insurance guaranteed by the government-sponsored enterprises (GSEs). Unlike the FHA, the GSEs and private mortgage insurers vary their fees and premiums according to the borrower’s credit or FICO score, with lower-risk, higher-FICO borrowers generally paying less. Currently, for borrowers making a 5 percent down payment, those with FICO scores below 700 would find the FHA loan more attractive. With the FHA premium cut, borrowers with FICO scores from 700 to 739 would have favored FHA loans. Because these loans would have been made either way, this simply results in a small shift in business from the GSEs to the FHA.
- The FHA would have seen a slight increase in refinance activities. The FHA premium cut would have helped stimulate the FHA’s refinance originations, which spiked after the previous FHA premium cut of 50 bps in January 2015. Nevertheless, the previous spike occurred during a time of particularly low mortgage rates, so we expect the uptick in FHA refinancing activity would have been small and short lived under the current rate conditions. Most borrowers who obtained their mortgages at lower rates before the election are unlikely to save money by refinancing because they would be paying a higher interest rate than before.
The premium cut proposed by Secretary Castro would have had a small impact on expanding access to credit. Forgoing this cut strengthens the FHA’s financial situation and allows the FHA Mutual Mortgage Insurance Fund to build its buffer.
Expanding access to credit should be a top priority of the new administration. But to significantly expand the credit box, the Trump administration should focus on the two big issues that limit lenders’ willingness to lend: removing the uncertainty over enforcing the False Claims Act and reducing the costs and complexities of servicing troubled loans.
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