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FHA Policy: How to Rebuild Cash Reserves?

by Karen Lawson
June 8th, 2010

FHA is between a rock and a hard place as it struggles to recoup losses that have depleted the reserve fund used for paying mortgage insurance claims on defaulted FHA loans. Although FHA does not directly make mortgage loans, it insures FHA approved lenders against losses on loans backed by FHA. When the sub-prime market all but disappeared in 2007 and 2008, FHA became the major source of mortgage loans for low to moderate income borrowers. As the FHA market share rapidly increased from single digit percentages to about one third of mortgage loans, FHA didn’t adequately enforce its lending guidelines. Against the backdrop of the economic crisis, foreclosure rates soared, which caused the shortfall in FHA reserves.

FHA Reserves: No More Bailouts

Legislators and policy analysts have been quick to nix any idea of a bailout for faltering FHA reserves; the FHA home loan program has been self sustaining through borrowers paying an up-front mortgage insurance premium at closing and annual mortgage insurance premiums that are pro-rated and added to monthly mortgage payments. The current rate of annual mortgage insurance premiums is .55% of the original mortgage balance, but FHA is requesting an increase in the annual premium rate to .90%. FHA views increasing mortgage insurance premiums as essential to restoring its reserves to the mandatory minimum of 2% of FHA insured loans. Increasing foreclosure rates have decimated the FHA reserve fund to .53%, about three quarters less than the mandatory minimum.

FHA Guidelines: Reorganizing Mortgage Insurance Premiums

FHA commissioner David Stevens advised legislators that once the agency can increase annual mortgage insurance premiums, it plans to reduce the up-front mortgage insurance premium (UFMIP) from its current level of 2.25% to about 1%, which would reduce borrower closing costs on FHA loans. Adding more to borrower costs means that some borrowers may not be able to afford FHA mortgage loans, which is counter to the agency’s purpose of facilitating affordable home loan options for low and moderate income families. Another idea for reducing FHA risk is increasing the minimum down payment from 3.5% to 5%. Although this increases borrowers’ “skin in the game,” it could also shut out potential buyers who cannot afford the higher down payment.

It’s true that owning a home is not an entitlement, but as the economy begins to show signs of recovery, encouraging home ownership is an important aspect of reviving sluggish housing markets. There are no easy answers, but the rearranging how FHA mortgage insurance premiums are charged and collected seems to be the least painful option for consumers interested in financing a new or existing home with an FHA loan or refinance mortgage.

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