FHA Mortgage Insurance and Seller Concession Changes – Ramifications

HUD has regrettably increased the annual mortgage insurance premium and soon will have succeeded in reducing the allowable seller concessions.  It's easy to know that this will have a big impact but it will actually change the lending landscape by dramatically decreasing FHA's presence in the marketplace and shifting loan volume to Fannie Mae and FreddieMac who share an uncertain future to say the least.  It will also shift loans to private mortgage insurers, most of whom are either financially anemic or are still reeling from the volatile markets of the last 2.5 years.  And it needn't be said that the private sector isn't ready, willing and able to jump into the residential housing lending market just yet.  In a time where tinkering with the housing market should be done delicately, this change will torpedo an already fragile housing market.

IMPACT ON AFFORDABILITY AND HOUSE PRICES

A buyer in Saint Paul, MN purchasing a three bedroom home at the median sales price and qualifying with Saint Paul's median household income, is going to be a harder thing to do.  Let's use these statistical examples and assume the borrower has a car loan of 330 dollars a month and a credit card payment of 65 dollars.  Currently, this is affordable.  Now that FHA has increased the annual mortgage insurance premium, this same buyer will now lose $6,500 in purchasing power and could not purchase at 151,000 dollars but rather at 145,500 or more interestingly 4.3% less of the Saint Paul median sales price (assuming market property taxes and hazard insurance rates).  So, with this change, an entire class of buyer has lost purchasing power and whenever this many people lose this kind of purchasing power, it would be naïve to think that it won't have an adverse impact on already precarious home prices.

With these changes in place, it will make more sense for nearly all buyers with a credit score of 680 or higher and debt to income ratios of 45% or lower to use conventional financing.  Firstly, private mortgage insurance will be equal to or cheaper than FHA insurance in most cases.  Secondly, there are more choices in types of mortgage insurance and means of payment with conventional financing.  Thirdly, after HUD reduces allowable seller concessions, the allure of a low down payment loan with FHA will be gone to this type of borrower (this change is a back door way of FHA increasing the down payment requirement).  Some may see a silver lining in these changes but it will have unintended consequences.

EFFECT ON BUYER'S LOAN DECISIONS AND UNFORESEEN CONSEQUENCES

Each mortgage insurance company has its own set of underwriting guideline overlays and most have their own declining markets lists.  With some, if a property is in the wrong zip code it will be subject to a loan amount cut of 5% of the appraised value or purchase price (whichever is less).  With others you won't know if a loan might get cut until the appraisal comes back.  If the appraisal comes back with the "oversupply" or "declining" box checked in the One Unit Housing Trends section, a loan officer might only know then that the loan will be cut. 

To navigate this, a loan officer must have control over the selection of their mortgage insurance provider and know their respective guidelines.  Some do but they are the best of the best.  In short, buyers, sellers and Realtors will be subject to unexpected transactional disruptions when this trend inevitably emerges.  Sadly, these transactional difficulties will happen to the very best of borrowers. 

WHICH BORROWERS WILL BE DRAWN TO FHA LOANS NOW?

Despite the changes, there will still be buyer and borrower profiles that make a match for FHA.  Here is a brief list:

• 203K rehabilitation mortgages
• HECM reverse mortgages
• Loans for borrowers with credit scores at or under 679  & with loan to values over 80 percent
• Loans for borrowers with high debt (many investors will approve FHA loans for borrowers with debt to income ratios of up to 55%)
• Loans for borrowers who either own or are buying a home in a declining market (FHA loans aren't cut if a property is in a declining market)
• FHA to FHA streamline refinances (although they are now less appealing as well)
• Loans in need of manual underwriting due to no credit or strange circumstances such as incorrect data on a credit report from an ex-spouse if the items are covered by a divorce decree

That's about it.

HAS HUD SUCCEEDED IN THEIR GOALS?

HUD's stated objective in making this change was to shore up their capital base.  The not so stated objective was to reduce their market share.  They will succeed in the latter (with a flight of high quality borrowers).  Ironically, they will fail in their stated objective.  While it may work out financially for HUD in the short term, we have to consider the long-term consequences of HUD chasing the highest quality borrowers away from their insured portfolio leaving behind an insured portfolio of loans that will have a lower average credit score, higher average debt to income ratios and the loans will be secured by housing that will be more susceptible to being in a declining market.  These soon-to-emerge portfolio weaknesses will increase the number of defaults and claims against the FHA insurance fund and, in time, this policy change will be looked back on as a disaster.  It is likely that this change is HUD cutting off its nose to spite its face.