It looks as though things are heating up in the competition for qualified borrowers between FHA and the private sector. In most cases healthy competition is a good thing; in this case it is causing some concern for many people. (Premium Cut)
Fannie & Freddie (the Agencies) re-introduced their low down payment (3%) loans in an attempt to spur homeownership and lending by attracting into the market, buyers with limited capital, but adequate income.
Coupled with this, private mortgage insurers offer products with adjusted premiums based on credit scores to insure these products and help mitigate some of the risk. The rule thumb is, the higher the credit score, the better the premium and the more affordable the payments.
The Agencies serve consumers with adequate income and assets to buy a home, have credit scores at the higher end and, or those with less than 20% down payment, are supported by private mortgage insurance.
FHA’s role is to service those who may not have access to this standard conventional financing offered by the Agencies. To offset the risk of lending to those with lower credit scores, limited home ownership experience, and limited capital, FHA charges an upfront and annual insurance premium (MIP). For years, the two have complimented each other making the American Dream of Homeownership accessible to more consumers.
Along came the government to help. With the passage of Dodd-Frank and its QM/ATR rules, many potential home buyers with low down payments found it difficult to qualify for a loan under most conventional (Agency) programs.
FHA become the product of choice (or necessity) for anyone, regardless of credit score, for low down payment financing. This drove more high credit score borrowers to take FHA loans, increasing the money flowing into the FHA insurance fund. That was good because as a result of the loan defaults in FHA insured loans in the crash of 2008 this fund had been depleted to disastrously low levels.
However, not everyone could afford the FHA’s higher insurance premiums. So, many at the low to moderate income levels were shut out of homeownership. To the rescue came the Agencies with their version of the lower down payment loan.
With the Agencies reducing down payment requirements, the fear became that many of the high credit score borrowers who were getting low down payment financing through FHA would move over to better priced conventional financing. This might leave FHA being adversely selected, only getting those lower credit score borrowers who could not qualify for the Agency loans. Lower credit scores equal higher risk and potentially more defaults.
FHA then reduced their annual insurance premium by 50 basis points (.50%) to make their product more affordable. Was this done to help spur homeownership or to compete with the Agencies to retain the high-end low down payment borrowers? This also has the effect of opening up financing to more low credit score, low down payment and a lower-income borrower, with limited home ownership experience. The effect was increased risk to an insurance fund which at present is only at about 20% of its required level.
Douglas Holtz-Eakin, President of the American Forum, believes that in reducing the premium FHA is exposing taxpayers to unnecessary risks as it hasn’t taken the proper steps to restore the insurance fund to its required levels, while attracting a riskier buyer. My translation; more risk with less money may lead to another taxpayer bailout.
Is it good for FHA to reduce the insurance costs to help qualify more people to own homes, helping to spur homeownership and lending, to boost the economy? Or is a bad business strategy for a government agency to compete in the private sector?
What should be FHA’s role?