Why the surge in PMI activity won’t force FHA to cut premiums anytime soon
After years of back and forth with the Federal Housing Administration (FHA), the private-mortgage insurance (PMI) industry is again the biggest player in the US mortgage insurance market. This is big news: in an era when government is backing most mortgage originations, any increase in the role of private capital is welcome. But will the FHA be forced to drop its prices to avoid overexposure to higher-risk borrowers? Probably not anytime soon, given the pristine quality of today’s mortgages.
Mortgage insurance (MI) keeps homeownership viable by helping lenders recover some of their money when borrowers default. The two types of MI available in the United States are PMI, which borrowers are required to purchase when they take out a conventional mortgage and put down less than 20 percent of the price of the home up front, and insurance provided by either the FHA or the US Department of Veterans Affairs (VA). (The VA is a smaller player because of its focus on insuring mortgages for veterans)
PMI gains came after a price cut
The PMI industry adjusted its pricing in April 2016, reducing premiums for lower-risk borrowers (credit scores above 700) and increasing them for higher-risk borrowers (credit scores below 700). Further, the higher (lower) the credit score, the greater the price reduction (increase). The price reduction motivated many high-creditworthy borrowers to choose mortgages with PMI backed by the government-sponsored enterprises (GSEs) over FHA mortgages, as we anticipated in May. The timing of the bump in PMI share strongly suggests that the price cut is a key driver.
Increased lender focus on conventional low–down payment lending
In 2016, we have also seen large lenders originate low–down payment mortgages outside the FHA. These programs are offered with the GSEs’ affordable loan offerings that allow for down payments as low as 3 percent along with reduced mortgage insurance.
Although the GSEs introduced these low–down payment programs nearly 20 months ago, volumes were extremely low, mainly because of the FHA’s pricing advantage (see page 33 in our August chartbook). But the PMI price cut changed these economics for borrowers with higher credit scores, giving lenders, especially those already wary of the FHA’s heavy enforcement, a reason to turn to the GSEs’ low–down payment programs.
Will this force the FHA to cut premiums?
In 2014, the PMI industry had a larger market share than the FHA. In January 2015, the FHA reduced its up-front mortgage insurance premium by 50 basis points, which caused the FHA’s market share to jump from 34 percent in 2014 to 40 percent in 2015, while the PMI share fell from 40 to 35 percent. But with PMIs once again pulling ahead of the FHA, the interesting question, particularly if the trend continues, is what action it will force the FHA to take.
If PMI pricing continues to appeal more to borrowers with higher credit scores, over time, this will pull the best-performing borrowers out of the government program and into conventional mortgages, leaving the FHA with a riskier mix of borrowers. And if the mix becomes too risky, the FHA might consider its own premium cut to take back some of these more creditworthy borrowers.
The good news is the FHA has time. Given today’s high-quality originations and very low delinquencies, it will be a while before these risks rise to a level that causes the FHA to lose sleep.
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