FHA loans have long been a bright spot in the mortgage marketplace. When the foreclosure crisis hit, it was the FHA that picked up a lot of the marketplace slack and it still does – today 20 percent of all new loans are insured by the FHA.
What makes FHA loans attractive is their predictability. Finance with an FHA loan and you get a mortgage with 3.5 percent down and straightforward terms. It's all pretty mundane, but now the FHA faces a big problem: It's too successful.
The FHA is rolling in profits. By one estimate it will generate $12.2 billion in fiscal 2015, the government accounting year that starts October 1st.
The FHA is getting this money by insuring a lot of loans and paying fewer claims. The insurance premiums are typically 1.75 percent of the loan amount up-front as well as an annual mortgage insurance premium (MIP) equal to 1.35 percent of the balance. In rough terms, if you borrow $100,000 the FHA will collect $1,750 at closing as well as nearly $1,350 during the first year that the loan is outstanding.
The FHA takes the premium money it collects, puts it in a reserve fund, and then uses the cash to pay lender claims when borrowers are foreclosed. Because of the rocky economy there have many claims against the FHA reserve fund with the result that the FHA had to borrow $1.7 billion from the Treasury in 2013.
It is because of the many claims it has faced that the FHA has done what any insurance program would do: raise premiums.
"As recently as 2010," reports The American Banker, "monthly premiums for an FHA-insured mortgage totaled .55% of the loan amount. Today, it's 1.35%, a 145% increase that translates into an additional $120 on a monthly mortgage payment for a $180,000 loan. The up-front fee that borrowers pay to the FHA has also risen dramatically, from 1% of the loan amount to 1.75%."
The catch is that the FHA is raising premiums today for massive losses which took place between 2000 and 2009. Since 2010, the program has been profitable.
FHA Loans & Lower Rates
Higher FHA insurance fees are okay up to a point and for a purpose, but many in the lending industry argue that as reserves are restored, the FHA should begin cutting insurance premiums. This will not only save borrowers big money but it will also mean that large numbers of prospective buyers who currently do not qualify for financing will be able to get a loan. More buyers, of course, will help stabilize home values and maybe even force prices higher in some locations.
One idea is to cut the FHA's annual premium to .75 percent but increase the up-front mortgage premium to as much as three percent of the mortgage amount. This is more than many borrowers now pay with conventional financing and an approach that would saddle the FHA program with an artificial marketplace disadvantage.
As an alternative to sudden and large premium costs, why not borrow an idea from the Federal Reserve and taper insurance premiums over time? For instance, the up-front and annual mortgage insurance premium (MIP) could each be reduced by .10 percent every quarter until desired goals are met. Or, why not have fees based on credit scores. Those with good credit could be rewarded with lower insurance expenses.
Already you can see that the FHA is selectively cutting insurance premiums. For instance, the newly-emerging Homeowners Armed with Knowledge (HAWK) program, a loan plan scheduled for introduction next year, will have a 1.25 up-front mortgage insurance premium and an annual fee which could be as little as 1.10 percent for qualified borrowers.
But while helping new borrowers is appropriate and important, current FHA borrowers also need assistance. So how about reducing the annual MIP to 1.10 percent after three years for every borrower without a late or missed payment? They've proven that they're good borrowers so why not reward them?