First – Some Background
Most of us know little about FHA, so let’s start with some basic history. The FHA was formed by congressional decree in 1934 to help improve the housing market. Back then, buying a home was tough. Mortgage approvals typically required a down payment of 50 percent and loans would normally balloon within 5 years, requiring the buyer to pay them in full or try to refinance.
The creation of the Federal Housing Administration changed all that. FHA set minimum loan approval standards and, if a bank would make a loan subject to those standards, FHA provided mortgage default insurance on that loan. This allowed banks to shift the risk of default off of themselves which made them much more willing to extend mortgage loans.
Even though Congress created FHA, FHA wasn’t funded by tax dollars. Instead, FHA created a mortgage insurance system in which they charged insurance premiums to the home buyer and used that money to self-fund their costs and losses. This system was put in place almost 80 years ago and, even with the challenges our housing market has faced, FHA still operates entirely from the insurance premium income today.
Fast Forward to Today
While FHA has been able to continue covering its costs with insurance premiums, it’s not nearly as solvent as it should be. The FHA is expected to keep $2 in reserves for every $100 insured. As of November 2011, though, it held just 24 cents per $100 insured. To try and strengthen the reserves level, the FHA has raised its mortgage insurance premiums 4 times in the last 4 years. Still, the solvency of FHA is a high concern for our economy as a whole.
Just how much of a concern is it? It worries our elected officials so much that a whopping 98% of the House of Representatives voted to pass the Federal Housing Administration Fiscal Solvency Act of 2012 this fall. This act, along with some additional changes being implemented by HUD, will impact FHA buyers in 2013.
What to expect in 2013
One key thing included in the FHA Fiscal Solvency Act is the permission for HUD to raise the monthly mortgage insurance premiums (MIP) being charged to buyers. Currently, monthly MIP is set at 1.25% of the original loan amount per year. For example, let’s say a buyer has a $100,000 FHA loan. That buyer will pay $1,250 per year in MIP ($100,000 x 0.0125) which works out to $104.17 per month.
The Solvency Act grants HUD permission to raise the annual MIP up to 2.05% if needed. This would increase the MIP for our example above to $170.83 per month, which is quite a chunk on a loan amount of only $100,000.
While this is disturbing, even more disturbing is HUDs plans to no longer allow buyers to remove the annual MIP once their balance hits a certain level. Currently, monthly MIP goes away once the balance hits 78% of the original price or 5 years has passed, whichever comes last. HUD will be canceling this provision, meaning that mortgage insurance will stay on the loan as long as it exists, regardless of the balance. MIP levels stay the same each month, even as the balance declines, so our $100,000 home buyer could still be paying $170.83/month in MIP even when the balance is down to $10,000 or less if they don’t pay the loan off or refinance it into a new loan.
What You Need to Do
While we don’t know exactly when these changes will take place, the expectation is early 2013. Given this, a FHA buyer should do one of two things:
· Become Conventional Eligible – FHA buyers typically use FHA financing because they need the flexibility it offers with credit history, income or down payment. If you need it for one of these reasons, work with your lender to see if you can strengthen that weak area and make yourself eligible for conventional financing. Conventional mortgage insurance is significantly lower and can typically be removed once you have 20% equity in your home.
· Buy Now – if your situation is such that a conventional mortgage will not work for you, start home shopping in earnest. If at all possible, you will want to close on your FHA loan before these changes are put in place.
If You Want to Know More
These changes look severe and, frankly, they are, but they won’t stop buyers from buying homes with FHA financing. They will hopefully encourage buyers to explore their options more deeply, though, and not go with FHA just because it’s the first thing their lender suggests.