The nation's go-to housing finance program for the past few years is about to become more expensive. Or is it?
A closer analysis of the changes that go into effect beginning Oct. 4 in the way borrowers pay for the privilege of using low-downpayment, government-insured mortgages to buy or refinance a house shows that, although the monthly premium will rise 64%, the overall cost will fall—at least in the short term.
That's because the Federal Housing Administration also is trimming its upfront premium, from 2.25% of the loan amount to 1%. And the net result for most people will be lower monthly payments for the first few years their loans are on the books.
I'll get into a couple of examples of how the changes will impact borrowers in a moment. First, let's go over the basics: The FHA doesn't make mortgages; rather, it insures them. The insurance takes the place of the 20% downpayment lenders would otherwise require. If the borrower fails to make his payments as promised, the insurance steps in to make the lender whole.
Currently, FHA-insured loans are practically the only low-downpayment game in town. As such, the FHA's share of the mortgage market has gone from an all-time low of about 3% just a few years ago when the housing market was going gangbusters to 30% or more today. Some estimates put the FHA's market share at almost 50%.
By either count, the powers that be in Washington have decided that's too big a piece of the pie for a program that was originally intended to serve just those who cannot obtain financing anywhere else.
Moreover, because most of the FHA-insured mortgages written today are made to borrowers with just a minimal 3.5% cash outlay from their own pockets, the default rate is higher than it has ever been. As a result, the agency's capital-reserve account has fallen below the level mandated by Congress.
Thus, the government had to decide how to maintain the viability of the FHA's mutual mortgage insurance fund while continuing to support the housing market during this time of need. So here is what it's doing.
On new low-downpayment FHA-insured loans originated on or after Oct. 4, the monthly premium will rise from 0.55% of the loan amount to 0.9%. At the same time, though, the upfront premium will be lowered from the current 2.25% of the loan amount to 1%.
And because most borrowers choose to finance the initial fee as part of the loan amount, the overall net impact will be easier on borrowers’ checkbooks—for a few years, anyway.
With a special shout-out to Zillow Mortgage Marketplace for crunching the numbers, let's look at a $200,000 house being purchased with 3.5% down to see how all this works out.
Currently, the 2.25% upfront premium on a $193,000 mortgage would cost $4,343, and the 0.55% annual premium would be $1,062—or $88.50 month, but starting Oct. 4, that all changes.
Under the new fee structure, the upfront premium drops to 1% of the loan amount, or $1,930, while the annual premium jumps 0.9%, to $1,737, or $144.75 a month.
For borrowers with enough money to pay the upfront fee at settlement, the changes mean $2,413 less cash to close but a monthly payment that is $56 higher.
But remember, these are mostly low-downpayment mortgages made to people with not a lot of cash on hand. Indeed, most FHA borrowers roll the initial fee into the loan amount. And if borrowers do that, the bottom line is that their payments will be lower for the first few years of the mortgage.
The numbers may come out differently depending on the loan amount—and the FHA currently backs loans up to $729,250 in high-cost markets. But here's how they play out with the $193,000 mortgage above.
In the first year, according to Zillow, the payout for mortgage insurance will be $3,667 under the new premium schedule, as opposed to $5,404 under the old one. In the second year, the cumulative MI payout will be $5,404 vs. $6,465.50. And in the third, the cumulative payout will be $7,141 vs. $7,527.
It isn't until the fourth year of this loan that the FHA-insured mortgage actually becomes more expensive under the new fee structure. Then, the cumulative cost will be $8,878, as opposed to $8,588.50 under the old schedule.
Now let's look at a $200,000 house with 5.5% down. Here, the mortgage amount would be $189,000.
Under the old fee structure, the 2.25% initial premium at closing would be $4,253 and the 0.55% monthly premium would be $86.63. But as of Oct. 4, the upfront fee falls to 1%, or $1,890—a decrease of $2,363—and the monthly fee rises to 0.85%, or $133.88—an increase of $47.25.
The overall impact: If borrowers roll the upfront charge into the loan amount, as most borrowers do, the FHA loan going forward won't be more expensive until some time in the fifth year.
Of course, most borrowers keep their mortgages for more than four or five years. And at today's super-low rates, it's hard to see how there would be much of an incentive to refinance—unless it is to get out of paying for FHA insurance.
Consequently, private companies that offer lenders the same coverage as the government can be expected to mount campaigns to wrestle business away from Uncle Sam on the basis of cost.
Already, the Radian Group in Philadelphia, one of a handful of private-mortgage insurers, has begun touting itself as the lower-cost alternative. "Come Oct. 4, there's just no comparison," the company boasts at its website. "See how FHA's new pricing changes made Radian an even better value…We're ready to prove why we are the compelling alternative to FHA."
Recently, private-mortgage insurers like Radian, MGIC, PMI and United Guaranty have been largely out of the marketplace, licking their wounds from the huge number of bad loans they backed. But the FHA welcomes the competition.
"We would love for the [private insurers] to come back into the market," says Vicki Bott, deputy assistant secretary at the Department of Housing and Urban Development, who is responsible for the FHA's single-family mortgage-insurance programs.
FHA officials would be happy if the agency's market share fell back to a more reasonable percentage, say, 12% to 18%. But their real fear is that private insurers will "skim off" the most creditworthy, low-downpayment borrowers, leaving the government with the most risky. If that happens, it's a good bet that Uncle Sam will have to raise the ante once again.
