Lowering FHA insurance fees will spur the housing market
Reduced borrowing costs increases the size of the buyer pool by pricing in marginal buyers thus stimulating demand.
Last November I stated that the FHA will come under intense pressure to lower the FHA insurance fees in order to increase home sales to first-time homebuyers. So why did I believe that? I noted that first-time homebuyer participation rates hit a three-decade low, a major problem for the long-term health of the housing market.
Further, Last September I noted that High loan costs cause FHA originations to plunge; in fact, FHA financing is so expensive, it’s like taking out a 12.4% second mortgage! Something had to be done if the housing market is to sustain current pricing or build any momentum for the future.
If first-time homebuyer participation is at record lows, and if FHA loan fees are pricing out first-time homebuyers, what is the logical conclusion to draw? FHA loan insurance costs are too high, and they must be lowered in order to increase first-time homebuyer participation.
So why are FHA loan insurance fees so high, and what can be done about it?
First, FHA loan insurance fees are so high because FHA became the replacement for subprime during the housing bust, and the default losses are so large that the FHA insurance fund became insolvent, and the federal government had to bail them out.
The high fees today are paying for the losses of yesterday. Is it right for today’s homebuyers to pay for the mistakes of yesterday’s homebuyers? The risk premium does not reflect current risks, it reflects future losses based on yesterday’s loans.
There is only one way to solve this problem: reduce FHA loan fees and risk a massive infusion of taxpayer bailout money. Government actuaries projected the future losses on yesterday’s bad loans and came up with a number needed to make the fund whole again, then they computed the fees they need to charge today’s buyers needed to cover the losses. If the government unilaterally lowers the fees, the FHA insurance fund will likely fall short and may require another government bailout.
Unfortunately, I see no way to revive first-time homebuyer participation rates without lowering fees, and apparently neither does the Obama administration.
The Obama Administration is directing, via executive action, the Federal Housing Administration to reduce annual mortgage insurance premiums by 50 basis points, from 1.35% to 0.85%.
“…(T)oday, the President announced a major new step that his Administration is taking to make mortgages more affordable and accessible for creditworthy families,” according to a statement from the White House.
The White House statement says that the typical first-time homebuyer, this reduction will translate into a $900 reduction in their annual mortgage payment.
“Existing homeowners who refinance into an FHA mortgage will see similar reductions to their mortgage payments as well,” the statement reads. “In total, this action will help millions of families save billions of dollars in mortgage payments in the coming years, helping to support the housing market recovery.” …
This will be a big deal for the housing market. Most market watchers expect an increase in demand from an improving economy. Reducing borrowing costs for first-time homebuyers will be a major catalyst by “pricing in” many marginal buyers who were priced out by rising prices. This may make for a robust spring rally unless rising mortgage rates offset the reduction in borrowing costs — which they might.
Sterne Agee analyst Jay McCanless says that while many in the industry would welcome the cut, it won’t have as big an impact on housing as many expect.“Such a change would be marginally beneficial for the average borrower, in our opinion, and consequently, we do not believe this news, if it proves true, is a catalyst for higher housing demand and higher earnings estimates,” McCanless says. “We Estimate the Riskiest Mortgage Borrowers Would Save about $25/month on their Mortgage Payment with Smaller Savings for More Creditworthy Borrowers. In a highly simplified model, we believe a borrower with a $100,000, 30-year mortgage required to pay the FHA’s mortgage insurance could save approximately $25 at most on their monthly payment which is the net result of lower insurance premiums (known as MIP) and a higher mortgage rate.
Their analysis conflates two unrelated issues. The reduction in FHA fees will have a big impact if mortgage rates remain steady; however, if mortgage rates go up and offset the cost, then yes, the impact will be minor. As I pointed out in The inescapable math of higher mortgage rates, mortgage rates will determine the course of the housing market. Everything else is a minor influence, including FHA insurance fees.
As to whether Congress will approve the change, McCanless is skeptical.
“We do not have an estimate of how long it might take Congress to approve such a change, and we would estimate the probabilities at 50/50 of it occurring. One media source indicated the President could take executive action to force the change, but we cannot verify that as accurate,” he writes. …
“Given that the FHA’s flagship fund – the Mutual Mortgage Insurance Fund – is expected to remain below the Congressionally-mandated 2.0% threshold until October 2016, a decision to lower FHA premiums in 2015 would undoubtedly be met by considerable opposition from Congressional Republicans,” said Lauren Burk, analyst with Compass Point Research & Trading.“Specifically, we believe that House Financial Services Chair (Jeb) Hensarling, R-Texas, and likely Senate Banking Committee Chair (Richard) Shelby, R-Ala., would publicly and aggressively attack a move to lower FHA premiums in advance of the MMIF clearing the 2.0% threshold,” Burk said in November.
So which is a bigger problem? Should we revive housing sales by lowering borrowing costs for today’s first-time homebuyers using FHA financing by lowering fees and risking a taxpayer bailout of the FHA, or should we endure the consequences of a weak housing market due to ongoing low first-time homebuyer participation rates?
The Obama administration would rather stimulate the housing market even if it requires a bailout later on, a convenient position for a lame-duck President facing a hostile Congress. This is a potentially politically damaging issue for Republicans, and they may choose not to fight it.
Nothing is certain yet because Congress must approve the change, but this issue is worth watching due to its potential impact on the housing market.