FHA Reform Act Passed

On Thursday, June 10, the United States House of Representatives passed the Fair Housing Administration (FHA) Reform Act. Upon further(almost certain) approval by the Senate, the FHA will be permitted to modify its method of administering mortgage insurance premiums (MIPs) on new mortgages.

The FHA will then shift much of the cost of MIP from the down payment to the homebuyer’s monthly payments. A homeowner’s MIP will now be paid as part of the monthly payment at the annual rate of 1.55%, up from a former limit of .55% annual rate of MIP.

The annual rate of MIP as a percent of the loan balance, now 1.55%, will be coupled with the homebuyer’s interest rate on the loan. This will reduce the amount of the loan a buyer qualifies to borrow.  For instance, a purchase-assist FHA-insured loan with a 4.75% rate of interest will now be charged an annual MIP rate of 1.55%. When combined, the total annual rate on the loan balance is 6.3%.

The total monthly loan payment under FHA regulations includes interest, MIP, impounds for principal and interest, homeowner’s association (HOA) assessments and approved second trust deed financing payments. The combined payment cannot exceed 31% of the homebuyer’s gross effective income, called the mortgage payment ratio. Increased payments for MIP, which now equal 1/3 of the interest payment, will thus greatly reduce the buyer’s purchasing power. [HUD Handbook 4155.1 Rev-5 Ch-4 §F.2]

The FHA will also require lenders to indemnify it for losses stemming from loans granted in violation of FHA regulations, and may terminate a lender’s approval to operate nationally based upon the actions of that lender’s individual branches.

first tuesday take: The new FHA authority for MIP will give borrowers of FHA-insured loans (roughly 40% of homebuyers in California presently) a slightly lower front-end, non-recurring cost for MIP. Lowered closing cost requirements may make the dream of homeownership slightly more available for some homebuyers who have not shifted this non-recurring charge to the seller when negotiating the price and terms of purchase.

However, there is a catch to reduced front end charges. Since the homebuyer’s monthly payment to the lender is not permitted to exceed 31% of his income, an increase in the amount of the payment allocated to MIP will decrease the loan amount the homebuyer can borrow. For instance, a borrower with a gross annual income of $58,000 qualifies to make a monthly payment of $1,500, at 31% of his annual income.

When the combined interest/MIP of, for example, 5.3% (based on a 4.75% interest rate plus .55% MIP) is raised to a combined rate of 6.3% (4.75% interest plus 1.55% MIP), the buyer’s ability to borrow drops. He would formerly have qualified for a mortgage of $270,000, but now will only be able to obtain $245,000. This reduced purchasing power will not please homeowners selling to first-time homebuyers, since they will now have to drop their prices to find a match within that buyer’s market.  [For more on the immediate effect of rate changes upon the amount a homebuyer can qualify to borrow, see first tuesday’s Market Chart, Buyer Purchasing Power.]

The real winner is the federal treasury – and thus the taxpayer – since a failure to pass this legislation would have necessitated more drastic measures to bail out the FHA, in the form of more federal subsidies for homeownership, home sales, construction, etc.  The financially-beleaguered FHA is thus put back on the road to solvency. At least for the moment, all the expense appears to go to homebuyers who borrow funds from FHA-insured loans.

However, it is the seller that really takes the hit from this MIP increase; a point agents need to keep in mind. Buyers subject to FHA terms, who will nearly all be first time homebuyers, cannot borrow more than 31% of income, and lenders will not relax their interest rates. The price the seller can get on the market thus falls approximately 10% on the sale to a buyer funding his purchase with an FHA-insured loan.

The FHA Reform Act will also drive repeat homebuyers out of the FHA market, leaving FHA-insured loans primarily for first-time buyers – which was the purpose of FHA in the first place. The reduced down payment requirements are an especially timely measure, since they will once again make the FHA competitive with private mortgage insurance (PMI) providers, who have had the opportunity to profit from the FHA’s recent switch to higher down payment requirements. [For more on MIP and the FHA, see the May 2010 first tuesday article, Private mortgage insurers come back to California as FHA raises eligibility requirements.]

Re: “Statement from HUD secretary Shaun Donovan,” from the US Department of Housing and Urban Development (HUD)