For several years, the Federal Housing Administration has been the go-to financing resource for cash-strapped home buyers who can’t come up with a big down payment. It has zoomed from barely a 3 percent market share to nearly 30 percent of home purchase loans. But now, wildly popular FHA-insured mortgages could be on the verge of becoming more expensive and tougher to obtain.
In the wake of an independent actuarial study that found the FHA’s insurance fund reserves far below the congressionally mandated minimum, the agency confirms it is actively exploring ways to pump up its reserves – including raising insurance premiums, minimum down payments and other unspecified moves.
How might these changes affect home buyers and refinancers? FHA officials won’t discuss precisely what they’re looking at. But here’s a quick overview of some of the possibilities:
Higher down payments. FHA’s current minimum cash down payment is 3.5 percent. On a $200,000 house, a buyer can bring just $7,000 to the table, aside from closing costs. A purchase of a $500,000 house in a high-cost area requires only $17,500 in cash.
Critics say 3.5 percent does not force purchasers to have enough “skin in the game” to discourage them from missing payments or risking foreclosure. Rep. Scott Garrett, R-N.J., introduced legislation last month requiring a minimum 5 percent down payment for all future FHA loans. Ed Pinto, who served as Fannie Mae’s chief credit officer in the 1980s and is now a mortgage industry consultant, says FHA needs to move to a 10 percent minimum.
But many lenders and mortgage brokers argue that raising the limit could scuttle FHA’s core purpose – serving consumers of modest means. Jeff Lipes, president of Family Choice Mortgage Corp. near Hartford, Conn., says a move to a 10 percent minimum “would effectively eliminate FHA as an option for first-time buyers.” A 5 percent standard would reduce volume, he says, but not exclude such a wide swath of currently eligible borrowers.
Higher mortgage insurance premiums. Currently, FHA charges an “up-front” mortgage insurance premium of 1.75 percent of the loan amount. Most borrowers roll that into their loan and finance it. FHA also charges an annual premium, paid in monthly installments, of either 0.5 percent or 0.55 percent, depending on the down payment. To rebuild reserves, FHA could tweak one or both premiums to yield higher revenues. It could, for example, raise the up-front premium to 2 percent or as high as the current statutory maximum of 2.25 percent. It could also raise the annual fee, but the total premium could not exceed 3 percent under current congressional limits.
Mortgage industry officials say raising premiums would be a logical move, with a gentler impact on borrowers. Lipes calculates that on a $200,000 loan, an increase in the up-front premium to 2 percent – and a move to 0.6 percent on the annual – would raise a borrower’s monthly payment by just $10 at today’s interest rates.
Cutting home-seller “concessions” to borrowers’ loan costs. One of the big attractions of FHA financing has been the agency’s liberal allowance for seller contributions to borrowers to offset settlement and loan-related fees. The current FHA limit is 6 percent of the house price, which critics believe to be excessive. They say the policy effectively allows financially marginal borrowers to buy houses they shouldn’t, thereby raising FHA’s exposure to losses. Pinto calls the 6 percent allowance “insane on a loan with a 3.5 percent down payment.” He wants Congress to order FHA to reduce maximum concessions to 2 percent.
Toughening credit standards. In the mortgage market, FHA is by far the most lenient and flexible player when it comes to evaluating applicants’ creditworthiness. It does not have a minimum credit score, though it permits lenders to impose their own FICO score minimums. FHA also traditionally has been far more tolerant of credit history peccadilloes than Fannie Mae or Freddie Mac. When there are extenuating circumstances associated with credit problems – medical, marital or employment – FHA seeks to give applicants the benefit of the doubt.
But critics say underwriting generosity can lead to higher delinquencies, foreclosures and losses. They want FHA to toughen up. In fact, many mortgage market participants would prefer to see FHA move to the approach used by private insurers – risk-based pricing. Paul Skeens, president of Colonial Mortgage Group in Waldorf, Md., says FHA should calibrate premiums to a tiered system of credit scores and down payment amounts, charging more for borrowers with low down payments and low scores, and less for those with higher cash in the deal and better scores.
“If that’s what it takes to make FHA solvent, I’m all for it,” says Skeens.
Skyrocketing growth in loans from the Federal Housing Administration and Ginnie Mae have helped support the mortgage market — but could leave taxpayers on the hook for massive new losses.
