The reserve fund the Federal Housing Administration (FHA) holds to cover losses—the Mutual Mortgage Insurance (MMI) Fund—is substantially overfunded (PDF), and some housing experts have called for cutting the monthly mortgage insurance premium (MIP) borrowers pay into the MMI Fund. But cutting the monthly MIP will not lead to lower mortgage payments for FHA borrowers, and with the limited supply of affordable homes on the market, the cut could lead to home price increases.
My colleagues at the Urban Institute have proposed another solution: a targeted cut in the monthly MIP for borrowers taking out smaller mortgages. Although a targeted MIP cut won’t have the systemic inflationary impact that an across-the-board cut would have, it’s likely the average FHA borrower will still channel the targeted MIP cut into greater purchasing power, given today’s overheated market.
Instead of an across-the-board or targeted cut, I believe policymakers can enact three short-term solutions that can address the surplus of MMI reserve funds and help homebuyers build wealth.
How cutting the MIP could increase home prices
For a typical home purchase, a potential homebuyer contacts a real estate agent about buying a home, and the agent requires the buyer to be prequalified by a mortgage lender. The prequalification determines the maximum amount the buyer can borrow, which the agent uses to determine the price range of homes they can show or search for on the internet.
To calculate the maximum borrowing amount, the lender determines the maximum total monthly housing obligation the borrower can afford based on their income. As such, reducing the MIP will reduce the monthly payment for the same size mortgage, which allows the borrower to borrow more. In other words, if the MIP is cut, the homebuyer’s purchasing power will increase, and if they borrow at their maximum limit, the homebuyer’s monthly payment will not change.
In a market where the supply of homes matches demand, this increased purchasing power would enable buyers to buy larger homes or live in more desirable neighborhoods. But today’s market has substantially more families looking to buy a home than there are homes for sale, which compels homebuyers to offer the maximum amount they can. In this market, cutting the MIP will mean the savings will not decrease the buyer’s monthly mortgage payment but instead encourage increased offers that end up in the home seller’s pocket.
Three policy changes that could slow the MMI Fund surplus and benefit homebuyers
For policymakers who want to reduce or eliminate the MMI Fund’s ever-building surplus but still maximize value for the homeowner, the current tight housing supply requires more creative thinking. From my analysis, I believe the following three policy changes can slow or eliminate the growth of the MMI Fund surplus, benefit homeowners, avoid putting further pressure on the housing market, and be immediately implemented by the FHA.
- Institutionalize pandemic forbearance policies, and allow short-term financial distress to be treated like a disaster. Forbearance policies implemented during the COVID-19 pandemic have demonstrated that foreclosure can be avoided when a borrower has a short-term income disruption. By allowing servicers to use all the tools available in the natural disaster toolbox, the FHA can keep borrowers in their homes whether the financial distress was caused by a presidentially declared disaster or not. I propose that the FHA should allow borrowers to defer up to three mortgage payments if they have up to a three-month income disruption or a major one-time expense, such as a family medical challenge. At the end of three months, borrowers can resume their monthly mortgage payments if possible, with the deferred payments added to the end of the loan. This solution minimizes the likelihood of a borrower going into foreclosure because of an income disruption while only marginally raising the potential FHA loss if the borrower defaults.
- Eliminate the up-front MIP. In addition to the monthly MIP, borrowers also pay an up-front premium into the MMI F Eliminating the 1.75 percent up-front MIP will have less of an effect on the borrower’s purchasing power. Most FHA borrowers start out with razor-thin levels of home equity because the FHA requires a minimum down payment of 3.5 percent and allows borrowers to add the up-front MIP to the loan. By eliminating the up-front MIP, the typical borrower will start out at a 96.5 percent loan-to-value (LTV) ratio instead of 98.25 percent. This solution would allow the FHA to increase wealth building by maximizing homeowner equity.
- Reduce the monthly MIP of borrowers who make consecutive timely payments. When an FHA loan reaches a 78 percent LTV ratio through appreciation, amortization, or both, and the borrower has made 12 consecutive on-time payments, the FHA could reduce the borrower’s monthly MIP to the actuarily appropriate level. The MIP required to support a 98.25 percent LTV ratio is substantially higher than that of a loan with a 78 percent LTV ratio. This policy change rewards borrowers who make timely payments and reduces the incentive for FHA borrowers to refinance their loans into a non-FHA program, which would keep high-quality loans in the FHA program and support the MMI Fund at a level fair to borrowers and taxpayers.
The excess funds in the MMI Fund give the FHA an important opportunity to help homeowners build equity and wealth. Although an across-the-board monthly MIP cut is an expedient and politically popular idea, the FHA should consider the unprecedented supply shortage in the single-family housing market when allocating the excess MMI funds. By thinking outside the box, the FHA can reduce the MMI Fund surplus and support borrowers who are in temporary financial distress, borrowers who have built up substantial home equity, or borrowers who need to make the minimum down payment.
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