Why FHA Mortgages Should Cost Less
By Peter Miller, Contributor
The importance of the FHA program is undeniable. FHA mortgages have been used more than 40 million times to finance and refinance real estate, often for first-time and moderate-income borrowers. The program is hugely attractive because it requires little down — just 3.5 percent in most cases — and has liberal qualification standards. In fact, a new report by Ellie Mae shows that FHA mortgages now make-up 21 percent of all new mortgages.
The big role played by the FHA program is a source of debate. Some would like to see fewer FHA loans, meaning less competition for private lenders. Indeed, there is a considerable effort to strangle not only the FHA program but also Fannie Mae and Freddie Mac by synthetically raising their costs. As evidence, just consider that the Federal Housing Finance Agency actually issued a 2013 report entitled, “FHFA’s Initiative to Reduce the Enterprises’ Dominant Position in the Housing Finance System by Raising Gradually Their Guarantee Fees.”
“The current housing finance system,” said the White House last year, “where the government guarantees more than 80 percent of all mortgages through Fannie Mae and Freddie Mac and FHA, is unsustainable. A reformed system must have a limited government role, encourage a return of private capital, and put the risk and rewards associated with mortgage lending in the hands of private actors, not the taxpayers.”
It has now been announced that Fannie Mae and Freddie Mac have repaid their entire $187 billion loan from Uncle Sam and yet the government refuses to give up any claim to future profits from either company. The additional money collected from Fannie Mae and Freddie Mac is simply cash that goes into the Treasury, a way to reduce the national debt while not directly increasing taxes. Meanwhile, loans to the auto industry have not been fully repaid and yet — curiously — there is no talk of appointing a government conservator to nationalize those firms.
If we make Fannie Mae and Freddie Mac artificially more expensive borrowers will switch to private lenders. And with less competitive mortgages will become more expensive: Mortgage expert William A. Frey writes in “Way Too Big To Fail” that without Fannie Mae and Freddie Mac mortgage costs will increase by one percent, not because the product is better — a conventional loan is a conventional loan — but because there is less competition. The result will be massive profits for the big banks that replace Fannie Mae and Freddie Mac, lower profits for small lenders and steeper costs for borrowers.
How much steeper? Without Fannie Mae and Freddie Mac the cost of a $200,000 mortgage will increase by $75 to $135 a month said Mark Zandi, the chief economist at Moody’s Analytics, in an interview last year with the Associated Press. That’s an extra $900 to $1,620 per year.
The situation with FHA mortgages is a different. Everyone acknowledges that the FHA has needed to raise its fees because of the massive losses it suffered from 2000 through 2009. Everyone also agrees that the FHA should have a 2 percent cash cushion for its reserves as a matter of financial prudence. The question is what happens when the 2 percent threshold is reached, something that could happen within the coming year or so.
FHA mortgages have produced huge profits since 2009 — they’re expected to reach nearly $13 billion just in fiscal 2014. That’s on top of substantial profits in 2010, 2011, 2012 and 2013.
The FHA needs money today to clean up the incredible mess inherited from 2009 and the prior eight years. That’s fine in the short term with many small lenders because they want a functioning and competitive FHA program for two reasons: It gives them an attractive and affordable product to sell and when lenders originate FHA mortgages they get a 100-percent guarantee against losses. Over the longer term, however, they want FHA fees to go down and not up.
The Community Home Lenders Association (CHLA) argues that fees today may be appropriate but they will soon be too high — very soon. The Association says the 2 percent reserve will be quickly reached and that the FHA’s fiscal plan should reflect a far-lower rate schedule. What the CHLA proposes is this:
- Reduce the annual FHA premium from 1.35 percent to .75 percent (and down to .5 percent for homeowners who complete HUD-approved pre-purchase home ownership counseling);
- Increase the upfront FHA annual premium to as high as 3 percent from today’s 1.75 percent (as a partial offset to the revenue loss from reducing the annual premium), and;
- When the FHA reaches its 2 percent net worth standard, further reduce the annual premium to .5 percent for all borrowers.
With this plan, says CHLA, the FHA program will still be hugely profitable, producing an annual income of at least $10 billion.
Rather than raise the up-front mortgage insurance premium (MIP) the better option is to lower it. The reason for a smaller up-front MIP is that first-time buyers and moderate-income households have trouble saving up-front costs. Combine a 3.5 percent down payment with closing costs and a 3 percent up-front MIP and man prospective buyers will never qualify. That means fewer purchasers, reduced demand and less pressure to raise home prices.
Having a smaller up-front fee means that the FHA will not have a profit of $10 billion a year, but that’s okay. As long as the FHA has sufficient income to pay all claims and maintain at least a 2 percent reserve it doesn’t need massive up-front premiums because it’s a government program and not a listed corporation in need of ever-higher quarterly profits.
CHLA has offered a reasonable proposal, something HUD should surely consider. As to those who want to privatize the secondary market and artificially-hobble the FHA wit ridiculous costs, here’s an alternative way for big banks to gain a greater share of the market: Offer more competitive products.