In February, the Federal Housing Administration announced a new pricing schedule for its loans that will raise the cost of borrowing. The new prices change the upfront premium and the subsequent annual premium on all loans guaranteed by FHA.
FHA constituted 46.6 percent of all mortgage loans in 2009. In general, FHA loans
work to expand the availability of mortgage credit. Their chief distinction from conventional loans is their lower down payment requirement. A borrower can put down as little as 3.5 percent through FHA. That down payment can come from third party sources as well. It is not unusual for a builder to provide a bit of cash to ease sales for their properties.
The new plan will increase the MIP (monthly insurance premium) by 25 basis points. It covers single-family mortgages of 15 and 30 years. HECMs are not affected.
This is the second price increase at FHA in the last year. FHA increased its premiums in November 2010.
The pricing is dependent upon the down payment. Borrowers that put down more than 5 percent get a lower rate. However, both the above 5 percent and the below five percent rates are increasing in lockstep with each other. On a 30-year loan, the higher down payment nets a borrower a 5 bp savings on their future premiums. The cost of the MIP is factored by the outstanding principal. The monthly fee goes down as the borrower pays down the principal.
FHA's purpose is to bolster its cash reserves. The new approach should add at least $2.5 billion to their balance sheet. At the end of 2010, FHA had $3.6 billion in reserve.
FHA's new policy could place downward pressure on the macro level demand for homes. Yet FHA has its own challenges. Foreclosures remain a concern. Some believe we are still only about halfway through the entire foreclosure crisis. Millions more homes could end up in REO. Unemployment continues to drive those new foreclosures and it seems unlikey that the jobless rates will drop soon. Thus, FHA is in a tight spot. Their institutional objective is to expand access to housing, but their obligation to taxpayers prompts them to up the pricing on their loans.
The new pricing may not shift many borrowers to conventional loans. For the most part, borrowers have no choice but to use FHA if they don't have the ability to put up 20 or 25 percent. Those borrowers will end up paying a higher APR due to the MIP. Add to that the possibility that most of these borrowers will have higher LTVs, and you have a no-win situation: borrowers with less cushion are going to have higher monthly payments.
Conventional loans face their own increased costs, as well. Loan Level Pricing Adjustments add surcharges on conventional loans delivered to the GSEs. Unlike FHA, the fee schedule is very complex and leads to different pricing on loans according to FICO, LTV, property type, loan term, and loan type.