Should the FHA Cut Insurance Premiums?

Sometimes you can have too much of a good thing. This is true of holiday dinners, and it’s also true in more mundane situations. For instance, the FHA has too much money and that’s a problem for mortgage borrowers and real estate investors. We need to ask, is it time to cut FHA premiums?

In its latest annual report, the FHA explains that fiscal 2021 — the period that ended September 30th – was a very good year. Okay, ridiculously good, the kind of numbers you might expect from a Silicon Valley Internet giant.

This may seem odd because the FHA is a government entity. It does not make a “profit” in the usual sense. It generally goes along from year-to-year, quietly insuring mortgages that allow borrowers to purchase with 3.5% up front. In return for funding with little down, borrowers pay a 1.75% upfront mortgage insurance premium (the upfront MIP) and a .85% annual premium (the annual MIP).

The program is obviously needed. It’s estimated that 85% of all first-time buyers finance with FHA-backed mortgages. In October, according to the National Association of Realtors, 29% of all existing home purchasers were first-time buyers.

First-timers buy a lot of entry-level housing and are the linchpin of the entire real estate marketplace. The homes bought by first-timers allow sellers to move and in many cases to move-up to bigger and more expensive homes. Those purchasers, in turn, allow other sellers to move and so forth. Without first-time purchasers, much of the real estate market would be stagnant and home values would be far lower.

FHA insurance premiums

The insurance premiums add up. The FHA backs mortgage loans with an outstanding balance of about $1.2 trillion. The program is required to have a 2% reserve, or about $24 billion. In fact, as of fiscal 2021, the reserve balance stood at 8.03%, up 1.93% in a year. That’s an additional $23.2 billion or so, almost $2 billion a month. It’s not “profit,” but it’s a notable cash addition to the FHA reserves.

All that money filling government vaults raises an issue. Is there too much of it? Should FHA premiums be lower? After all, the FHA reserves are already four times bigger than the guidelines require.

Lower FHA premiums would make homes more affordable and open the market to additional borrowers. At least in theory that means more entry-level home sales and thus additional sales higher-and-higher up the financial ladder.

While the case for lower FHA insurance premiums seems fairly straightforward, lower FHA costs at this moment might be unhelpful if not damaging. Here’s why.

Foreclosures

The FHA reserves are designed to cover lender claims in the event a borrower fails to make their payments. More claims and more-costly claims are the real challenges the FHA faces, but claims have fallen through the floor. In fiscal 2017 the FHA was insuring nearly 8 million mortgages and took title to 44,157 insured properties, so-called REOs (real estate owned). In 2021, with roughly 7.5 million insured loans, the FHA wound up with just 5,519 REOs.

The FHA has been able to bulk-up reserves in part because foreclosures were largely banned from March 2020 through the end of December 2021. Few foreclosures equal few claims, meanwhile insurance premiums continue to be paid. It’s a sure formula for big reserve gains.

With the FHA foreclosure moratoriums ending in January the big question is what happens going forward. Will the FHA see a flood of pent-up insurance claims that rapidly erode its massive reserves? At this moment we just don’t know.

The FHA’s secret asset

It seems very likely that the FHA will see few foreclosures in 2022. The reason is that FHA-insured loans are backed by real estate and property values have soared in recent years.

According to the Federal Reserve, household equity went from $19.5 trillion at the end of 2019 to a pandemic-fueled surge of $23.6 trillion as of June. That’s a $4.1 trillion increase in just 18 months.

For the third quarter of 2021, ATTOM Data Solutions reports that 39.5 percent of the mortgaged residential properties in the US were considered equity rich, meaning that mortgage balances were less than half of fair market values. In contrast, just 3.4% had mortgages that were 25% greater than fair market value.

“Vast and widespread equity is the biggest protection the FHA and other mortgage insurance programs have,” said Rick Sharga, Executive Vice President with RealtyTrac. “Owners who have financial troubles today may be able to quickly sell the property, repay their loan in full, and perhaps walk away from closing with a big check. There’s no foreclosure and generally no lender insurance claims against the FHA reserves in such a situation.”

“Plus,” said Sharga, “if the inflation rate rises that will be good news for the FHA and other mortgage insurance plans. With a higher inflation rate it will take more cash to buy a given item. Home prices will rise in cash terms and the FHA will have less risk as a result.”

Timing

It might seem as though the moment has come for lower FHA premiums. Reduced costs are always appreciated by borrowers, but the reality is that the timing is not good.

Lower FHA insurance fees are attractive, but adding more demand to a market with little inventory will not reduce the bidding wars that are common today or moderate the soaring prices seen during the past two years. More demand will make the lack of inventory worse, and higher prices will simply freeze additional buyers out of the market, defeating the potential benefit of lower FHA fees.

Should FHA fees be reduced? Sure, but not at this moment. Let’s instead see what the market looks like in the next few months.