Since the bottom fell out of the housing market, FHA has become the best financing choice for a big slice of homebuyers and home owners (FHA makes up about 40% of the loans originated now). When all the private lenders dropped out of the market, and Fannie Mae and Freddie Mac tightened their guidelines and added big price hits, FHA stepped in to fill the gap. FHA is the only option for home buyers with low down payments (3.5% down, and this can all come from a gift) and though this is a fully underwritten loan, FHA is more forgiving of past credit mistakes if the underwriter can understand what happened, and why it won’t happen again. In many ways FHA has become the new conventional, and the financing terms work best even for many borrowers who could qualify for conventional financing. But all this success has come at a price. Over the last two years FHA defaults are at record highs, and their reserve fund, which they use to pay claims on defaulted loans, is the lowest it has ever been. Last year FHA  moved to bulk up the reserve fund by increasing the Up-Front mortgage insurance by .75%. With a new bill just passing the House, and now fast tracked in the Senate, it looks like FHA is about to restructure their formula again.

We need a little background to explain how this will work. FHA’s mission is to make homeownership more available. This isn’t a government give away or a loan for people who can’t qualify. First of all, FHA doesn’t make loans directly. They act more as a mortgage insurance company insuring the lenders who actually hold the FHA loans against loss if the home does get foreclosed on. This system has been around since the 1930s and has always been self funded, that is, the mortgage insurance they collect has been enough to pay for all losses without any additional government funds. But with true unemployment in the double digits, and home prices fallen, the FHA reserve fund has come under pressure. Compare this to Fannie and Freddie which have been bailed out and taken over by the government, or all the big banks which would have collapsed if Uncle Sam hadn’t stepped in to prop them up. So FHA has been a huge success and a key to any recovery in the housing market.

FHA funds their insurance in two ways: with an Up-Front Mortgage Insurance Premium which is rolled into the loan and financed over the course of the loan, and also with an additional monthly mortgage insurance premium. The last change increased the Up-Front MIP from 1.75% to 2.25%. The new bill will raise the maximum monthly insurance premium to a maximum of 1.55% (divided by 12) but the understanding from HUD (the agency which runs FHA) this number is to give flexibility and the real increase won’t be this much, and there will be some trade offs. HUD has previously said that the plan is to decrease the Up-Front MIP down to 1%, a big reduction, and increase the monthly factor to 0.9%(divided by 12). So this will be giving with one hand while taking away with other. I have a feeling that the law of unintended consequences could kick in and make FHA more attractive for many borrowers who have the choice to go with conventional financing, while making it a little harder for those most in need to qualify (it increase the monthly payments while decreasing the cost in the short run).

We will see how this all plays out, but if this insures that FHA will continue to be available in the market, it is a change worth making.

Peter Thompson 630-479-6424

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