Is the FHA Mortgage Program Too Profitable?

Are you being overcharged for FHA mortgage insurance? There's a growing chorus which says the answer is yes -- and there's also a growing movement to do something about it.

The Community Home Lenders Association says the FHA is collecting too much insurance, and it calculates that the program will generate a $12.2 billion profit next year unless premiums are cut back. In comparison, Google earned a net income of $12.9 billion in 2013.

FHA Mortgage Down Payment

The attraction of the FHA program is that individuals can buy real estate with as little as 3.5 percent down. In basic terms, that means for a $150,000 home, you need a down payment of just $5,250 plus closing costs.

However, that low down payment is not the whole story. You also need mortgage insurance because you're buying with less than 20 percent down. The FHA "mortgage" is actually an insurance plan, and currently the FHA charges a 1.75 percent up-front mortgage insurance premium (MIP) as well as an annual MIP, which is 1.35 percent of the loan balance for most borrowers.

Upfront Mortgage Insurance

The up-front MIP is added to the loan amount (you can pay it out-of-pocket, but almost no one does). This means when people buy a $150,000 home with an FHA mortgage, the more precise numbers look like this: The property costs $150,000. With 3.5 percent down ($5,250) you need a loan for $144,750. Next, add the 1.75 percent up-front mortgage insurance premium ($2,533) to the basic mortgage amount, and the initial balance increases to $147,283.

The up-front MIP is a lot of money, but the financial sting is limited. Adding the up-front charge of $2,533 to the loan amount increases the monthly payment by $12.68 per month for a 30-year term at 4.4 percent interest. Of course, the up-front charge increases the size of the debt and eventually the debt must be fully repaid over time, when the property is sold or the loan is refinanced.

But Wait; There's More: Annual Mortgage Insurance

The annual MIP is a very different issue. It has a visible sting. If we borrow $147,283 at 4.4 percent over 30 years, the monthly cost for principal and interest is $738 per month. However, there is also that 1.35 percent annual MIP. In the first month it would be $166 in addition to the $738.

Given the cost of insurance why do one in five new borrowers opt for an FHA mortgage?

One answer is the small down payment required up-front. Another reason is that FHA loans are reliable and non-toxic, a real difference when compared with the loan products which lead to the mortgage meltdown. A third reason is that FHA rates are often lower than conventional financing -- last week the Mortgage Bankers Association reported that the typical conventional loan was priced at 4.56 percent while FHA mortgage financing averaged 4.21 percent. Points, if any, are extra.

Time to Reduce FHA Premiums?

The real estate community now argues that the effort to overcome FHA losses from 2000 through 2009 has succeeded and now the time has come to reduce FHA premiums. Lower premiums, argue those in real estate, would make FHA loans more widely available, boost home sales and even nudge prices a bit higher because of increased demand.

Critics point out that the FHA does not yet have a cash reserve equal to two percent of the loans it insures for the next 30 years. However, opponents counter, the two percent requirement is an accounting fiction -- the FHA actually has $48 billion in cash on hand

It's curious that while political thinkers yell and scream about the FHA, they have little-if-anything to say about the FDIC, the federal entity which insures bank deposits. It has a reserve ratio equal to just .35 percent of the $7.6 trillion in deposits it insures, a lack of liquidity which somehow doesn't seem to bother anyone.

Will FHA premiums come down? We don't know yet, but look for some movement on this issue in mid-November -- after the election.

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