FHA Mortgages: Will Risk-Based Premiums Return?

by Peter G. Miller
August 19th, 2009

When FHA reform was passed last summer it contained an important passage which related to the insurance fees that HUD would be allowed to charge. In essence, Congress beat back efforts by the Bush Administration to fund FHA mortgages with risk-based premiums.

The FHA program is an insurance plan, in exchange for a smaller down payment borrowers buy FHA mortgage insurance. If something goes wrong, the FHA will assure that the lender is paid off.

There’s a cost for FHA insurance, both an up-front mortgage insurance premium (MIP) paid at closing, typically 1.75 percent of the loan amount, plus an annual MIP of .55 percent paid monthly.

The Bush Administration wanted to dump the one-size fits all MIP system and instead move to a risk-based system. In other words, different borrowers would pay different fees, depending on their credit status. The mortgage insurance premiums, of course, are in addition to annual mortgage rate, meaning that if you got a loan at 5.5 percent your real cost would be the equivalent of 6.0 percent.

The result of the Bush approach would have been to make FHA mortgages unaffordable for many entry-level borrowers, you known, the very people for whom the FHA program was largely intended. In effect, the FHA program would have evolved into just another loan program, a change which would have eliminated a meaningful competitor to the private lending system.

HUD actually began charging risk-based fees on July 14, 2008 and would have continued to do so had not Congress stepped in. As part of the FHA reform legislation, Sec. 2133 provides that “during the 12-month period beginning on October 1, 2008, the Secretary of Housing and Urban Development shall not take any action to implement or carry out risk-based premiums, which are designed for mortgage lenders to offer borrowers an FHA-insured product that provides a range of mortgage insurance premium pricing, based on the risk that the insurance contract represents.”

In theory, we could see a return to risk-based pricing as of this October 1st, but don’t count on it.

The reason risk-based pricing won’t be back looks like this:

First, FHA mortgages now represent better than 35 percent of all loan originations. It’s the one form of financing which is working. Nobody wants to fool a mortgage product that’s actually successful in a marketplace which has been terribly damaged during the past two years.

Second, HUD raised MIP rates last year. The upfront rate generally went from 1.5 percent to 1.75 percent and the monthly premium for new loans typically rose to .55 percent from .50 percent. The risk of higher fees is fewer qualified borrowers and thus a reduced number of home sales.

So, while it could happen, no one wants to fool with a program which is now successful by changing the MIP rates or strategy.

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