New FHA Premiums

The Federal Housing Administration has decided to rethink how it protects itself with a new guidance last month. The new rules have implications not just for borrowers, but also for private mortgage insurance companies.

The new rules, known as the Loan Level Pricing Adjustments (LLPA – pdf here), say that most FHA borrowers will now have to pay an upfront premium of 150 basis points on the amount of their FHA loan. Subsequently, they will be expected to pay another 50 basis points each year. That second charge is paid with the monthly payment.

One analyst at a private mortgage insurance company called me to tell me how much of a difference this will make for his company. He paints a tough picture for the market in the last year: the private firms were being squeezed by the low rates at FHA and the high origination fees built in to the cost of delivering a loan to Fannie or Freddie. Since last year, the GSEs have been charging lenders fees to “deliver” mortgages. Naturally, those costs are passed on to borrowers. The fees have the effect of pricing in risk on loans. For instance, there is a premium at the GSEs to take an investor loan, or a mobile home loan, or any loan on a multifamily property. Other costs, based upon characteristics of the borrower or of the underwriting, impose additional layers. Lenders can expect to pay more to deliver high LTV loans and/or loans with low credit scores.

The net effect is to create a price burden for loans at the margins. The private PMI firms can work with the best case scenario loans, where a borrower with a 750 credit score is buying a single-family home in a city where home prices are stable.

Lenders aren’t making a lot of high risk loans, so there isn’t a lot of business below 620. However, from 620 to 720, FHA has been beating the private mortgage firms. FHA doesn’t have to pay those LLPA fees.

Unfortunately, there is a lot of pricing pressure in this segment. That means that the privates are losing their margins.

The problem for the privates had been that they were only competing in the low-margin space. They don’t want to do the sub-620s (and there isn’t much demand anyway), and they can’t beat FHA at 680 or 700.

This will change with the new rule. Again, my analyst friend is thrilled, because he’s suddenly working for a company that has a competitive product. The one hundred and fifty basis point fee that FHA is going to extract will go a long way toward equalizing the pricing for FHA and conventional loans.