Nov112014

Pressure will mount to lower FHA insurance fees to revive home sales

Record low first-time homebuyer participation and low savings rates will force bureaucrats to lower the FHA insurance premium to stoke demand.

fha-bailoutI believe 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 do I believe that? I recently noted that first-time homebuyer participation rates hit a three-decade low, a major problem for the long-term health of the housing market.

My market studies show the housing market is still relatively affordable, yet home sales are weak, particularly among first-time homebuyers. My reports measure affordability based on conventional mortgages with a 20% down payment because those terms don’t require mortgage insurance, a costly add-on that has varied in price significantly over time. The super-high cost of mortgage insurance makes houses much more expensive for first-time homebuyers than they have been historically; thus the first-time homebuyer market is dead.

Down payment savings is one of the largest barriers to buying a house. I recently wrote a post to help, How to save money for a down payment to buy a house. There are two key takeaways from this post: (1) it takes 13 years to save for a 20% down payment, and (2) it takes less than two years to save for a 3.5% down payment. It should be obvious why FHA financing is required by first-time homebuyers, and since they are forced to use FHA financing, they must endure the high costs.

Saving for a down payment? It could take you until 2027

Quentin Fottrell, November 5, 2014fha_rescue

If first-time home buyers start saving for their down payment today, in 10 years they still won’t have enough stashed away.

Stagnant wages and rising property prices don’t bode well for first-time buyers who don’t have equity or wealthy parents to help them out. It takes an average of 12.5 years to save up a 20% down payment — the usual requirement by banks — with the current personal savings rate of 5.6%, according to new research by real-estate firm RealtyTrac. It could take even more than that. RealtyTrac’s figure is based on current house prices — and doesn’t take into account possible further rises in home prices. …

During the housing bubble, many prudent savers changed their strategies and bought in 2004 or 2005 out of panic because they weren’t saving quickly enough to overcome rising house prices. These are the group of buyers I feel saddest for because they bought out of fear, and they got burned.FHA_loanownership

If the down payment for a conventional loan was lowered to 3% from the traditional 20% — as has been suggested by Melvin Watt, director of the Federal Housing Finance Agency — it would take less than two years. “To increase access for creditworthy but lower-wealth borrowers, FHFA is also working with the Enterprises [Fannie Mae and Freddie Mac] to develop sensible and responsible guidelines for mortgages with loan-to-value ratios between 95% and 97%,” he told the Mortgage Bankers Association last month.

It doesn’t matter what the GSEs do, the FHA already makes 3.5% loans available. If the GSEs start making these loans, some private mortgage insurer will need to insure that loan, and that insurance will be expensive. GSE loans are priced on the basis of risk (including loan-level pricing adjustment and mortgage insurance costs), while Federal Housing Authority (FHA) loans are not. Thus, borrowers with high LTVs and low FICO scores will find FHA loans less costly.

Millennials are the first to deal with this, says Anthony Carnevale, director of the Georgetown University Center on Education and the Workforce. It now takes the average worker until age 30 to earn the national median salary; young workers in 1980 reached that point in their careers at age 26, according to a 2013 Georgetown University study, “Failure to Launch: Structural Shift and the New Lost Generation. “What that all says is that you’ve got to be 42 to buy a house,” Carnevale says.

So much for the American Dream.

american_dream

What we have is a bifurcated market with first-time homebuyers paying a significantly higher price than repeat buyers due to the high cost of mortgage insurance, particularly FHA financing. Each day I featured a property for sale and show the cost of ownership for both 20% down buyers and FHA buyers. Have you noticed how much more expensive FHA financing makes the cost of ownership?

The projections from today’s featured property are below. The monthly cash outlays (lender PITI) is $1,150 more for the FHA buyer, partly due to the larger loan amount, but mostly due to the enormous FHA insurance fee. This higher monthly cost drives up the income requirement from $129,561 to $174,000 — that’s what’s pricing out first-time homebuyers while the market is affordable to move ups.

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Back in 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!

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 get more 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.

FHA-liability

There is only one way to solve this problem: 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 fund were made whole by taxpayers for all the losses from supporting the housing market from 2008-2012, bureaucrats can lower the fees for current buyers. Simple, right?

Well, as a taxpayer, how would you feel about your tax dollars going to bail out the FHA insurance fund knowing the losses were a direct and obvious result of making bad loans in a declining market to deadbeats in a clandestine effort to bail out the banks? That’s the bitter reality.bankers_hope

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 direct 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?

It’s a tough question, one that will be distorted by politicians and the mainstream media if they go the bailout route. Unfortunately, I see no way to revive first-time homebuyer participation rates without it.

Perhaps the new 3% down loans with the GSEs won’t carry such high fees because the GSEs aren’t paying for past sins, but then again, if the GSEs steal the FHAs market share, the FHA will need a bailout anyway, so I don’t believe that diverting first-time homebuyers from the FHA to the GSEs is a better solution.

What do you think should be done?

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[listing mls=”OC14235719″]