The Federal Housing Administration (FHA) recently revised its insurance policy by requiring borrowers to pay mortgage insurance premiums (MIPs) up to the entire loan term.

Previously, the FHA allowed borrowers to cancel MIP payments once the loan-to-value ratio (LTV) reached 78%. In contrast, private mortgage insurance (PMI) companies are required by law to cancel PMI payments at 80% LTV.

The FHA now requires borrowers to pay annual MIPs for:

  • the lesser of 11 years or the entire loan term for LTVs less than or equal to 90%; and
  • the lesser of 30 years or the entire loan term for LTVs greater than 90%.

With this coming change, the FHA continues a recent pattern of hiking rates and decreasing the attraction of their product. In April, the FHA raised their annual MIP rates. Currently, the average combined interest/MIP rate for a 30-year FHA loan is 4.7%. The average interest rate for a 30-year conventional loan with 20% down is 3.4%. The FHA is using this new policy, in addition to recent rate increases, to increase their reserves for losses.

first tuesday insight

This is a battle between federal and private mortgage insurance companies. And yes, it will reduce home sales volume for the next few years as buyers save for larger down payments. The FHA’s decision to extend MIP through the life of the loan will shrink the agency’s market scope, but brings life support to PMI carriers. Society is better for it than before.

Requiring borrowers to pay MIP deemed due over the entire life of the loan is logical, since the FHA (and by extension taxpayers) incurs risk for the entire loan term. But if their private competition plays a riskier game by nixing borrowers’ mortgage insurance payments at 80% LTV (and they do), PMI companies will attract every borrower interested in saving thousands of dollars during the life of the loan.

Financially, this means the end of a long, lean winter for PMI companies. Thanks to the FHA’s increasingly unattractive insurance product, PMI companies will regain their traditional majority of the mortgage insurance market. The FHA’s share of the mortgage insurance market will shrink back to its pre-Millennium Boom level. And eventually, government-guaranteed mortgages will become almost obsolete, but for desperate, low-credit, low-downpayment, first-time homebuyers.

Agent advice

The only advantage the FHA still offers borrowers over PMI companies is the minimum, no-skin-in-the-game, 3.5% downpayment. But permanent MIP is going to be a deal breaker for many potential homebuyers — even first-timers — as it dramatically reduces the amount they can borrow.

Financially, it makes sense to go with a slightly higher downpayment. Emotionally, some borrowers may decide immediate homeownership is more important. Prudent agents will inform their buyers of the long-term disparity in prices between an FHA-insured mortgage and conventional financing with PMI.

Re: “FHA’s solvency plan isn’t fair” from CNNMoney and “Changes to Mortgage Insurance Premiums” from The Department of Housing and Urban Development