FHA Loans Could Be Getting A lot More Expensive

On Wednesday we proposed this question: “Would a new FHA downpayment requirement of 5% really be that big of a deal?” Based on the monetary examples we provided, and given the fact that so many new FHA borrowers would have gone to Fannie and Freddie in the past, the impact of increasing the minimum downpayment requirement wouldn’t have as negative of an impact as the FHA’s commissioner said it would:

Using HSH.com’s Amortization Calculator, let’s examine the difference in the monthly payment if we put 5% down verses 3.5%.

We’re going to use a home price of $200,000 and a mortgage rate of 5.25% (that’s above current market levels for a 30-year Conforming rate, buy we’re allowing for some increase).

• 3.5% Downpayment ($7,000): $1,065 (loan amount = $193,000)

• 5% Downpayment ($10,000): $1,049 (loan amount $190,000)

As you can see, the $16 dollar difference in the monthly payment isn’t all that substantial, yet, the increase means the borrower needs to save an extra $3,000.

While a comment from one of our readers Steve showed that he was adamant that the FHA should raise the downpayment requirement to 5%, policymakers have been far less enthusiastic. While lawmakers currently aren’t pursuing an increase of the FHA’s downpayment requirement, they are voting to increase the annual insurance premium FHA borrowers must pay. And unlike a downpayment increase, raising the annual MIP could have a far greater impact to a borrower’s bottom line.

A bill approved nearly unanimously yesterday by the House of Representatives gives the FHA authority to nearly triple their annual MIP:

Currently, monthly mortgage insurance premiums are 0.55% of the unpaid loan balance, divided by 12.  The recently approved Federal Housing Administration Reform Act provides for an increase in monthly premium of up to 1.55 percent, among other details of the bill.

Despite the ability to charge 1.55 percent, FHA officials say an increase to 0.90 percent would be sufficient to self-insure its loans.

In everyday terms, assuming a $200,000 mortgage, the math to a homeowner looks as follows:

• Current Premium (0.55%) : $91.67 monthly mortgage insurance premium
• Expected Increase (0.90%) : $150.00 monthly mortgage insurance premium
• Maximum Increase (1.55%) : $258.33 monthly mortgage insurance premium

Why Raise It At All?

The reason behind increasing the costs of an FHA loan goes back to the start of the financial crisis. Even before the recession officially started, mortgage borrowers couldn’t find loans in the private market because credit restrictions and loan requirements were being made increasingly more stringent. Borrowers who couldn’t put 20% down on a home or whose credit scores weren’t high enough to qualify for a Fannie or Freddie-backed loan sought a mortgage through the FHA.

As a result, the FHA’s presence in the market skyrocketed from about a 2% market share of originations to around 30%. This increase in their share brought more risk and loan failures right along with it. In recent months, the FHA’s reserves dropped below their minimum requirements so they were forced to make changes. The first change came in the form of an increase to their upfront MIP. This new one — an increase to the FHA’s annual MIP — is designed to rebuild their reserves more quickly.

According to National Mortgage News, “The FHA estimates the changes will generate an additional $4.1 billion for fiscal 2011.”

A Downpayment Increase Doesn’t Seem So Bad Now

So while the numbers and the initial reader reaction indicate that an increase the the FHA’s downpayment requirement might have only a subtle financial impact, at this point policymakers seem to be opting for a change that might cost you even more.

The bill approved by the House yesterday will have to be blended with a Senate version before it’s sent off to become law. So while there’s still a ways to go, as it stands now, FHA loans will be getting considerably more expensive in the coming future.