With housing affordability eroding before their eyes, mortgage experts agree that something needs to be done to give first-time and underserved homebuyers a chance in this market.
They just can’t seem to decide on what.
One issue currently being debated is whether the Federal Housing Administration (FHA) should lower the monthly mortgage insurance premium (MIP) that comes with its home loans.
MIP is a safeguard that protects FHA lenders if borrowers default on their loans. This insurance policy enables borrowers with lower credit scores to get a home loan with as little as 3.5% down.
There are two parts to MIP:
- Upfront MIP, which equals 1.75% of the initial loan amount
- Annual MIP, which is typically 0.85% of the loan amount, divided into 1/12th payments that are included in your monthly mortgage installments
On a $300,000 loan, a borrower would owe $5,250 at closing for upfront MIP and $212 per month for annual MIP.
That’s no small chunk of change, and in today’s market it can be the difference of being able to afford a home or not.
The question is, should the Department of Housing and Urban Development (HUD), which oversees the FHA, reduce the annual MIP rate to give homebuyers some breathing room?
Representing team “Lower MIP Now” is Dave Stevens, a rugged mortgage veteran who served as FHA Commissioner under President Obama.
In fact, as FHA Commissioner during the Great Recession, Stevens actually raised mortgage insurance premiums several times and made it so it lasted for the entire life of the loan.
Now, Stevens argues in a column for HousingWire that we are in an entirely different mortgage environment (there’s no disputing that) and it’s way past time to reduce the MIP.
“HUD needs to act now and lower the MIP,” Stevens wrote. “It’s long overdue and as a former FHA Commissioner in the last Democratic administration, and as one who had to raise premiums to secure the fund, I can state now unequivocally that this is a different time and action is needed.
“The call is simple: lower the MIP and lower it now.”
If you want to get into the nitty-gritty of why it’s time to lower MIP, Stevens points out that the Mutual Mortgage Insurance Fund (MMI) reserve ratio is at record-high 8.03%, meaning it has a cash reserve of more than 8% of all outstanding FHA loans. The funds would be used to cover defaulting loans in case of a major housing downturn.
It might not sound like much, but the congressionally mandated amount is only 2%.
Stevens also points out that HUD Secretary Marcia Fudge has made a point to close the racial housing gap and that nearly 85% of FHA purchase loans go to first-time buyers, but these are the exact buyers getting priced out in today’s market. Maintaining the current MIP rate isn’t helping them at all.
Stevens final point is perhaps his most compelling. Lowering MIP is a simple, effective, speedy move that can be made at the stroke of the pen. The gears of government typically move slow and today’s homebuyers need help now. Reducing MIP is an immediate way to move the needle.
Opposite Stevens (well, maybe not opposite but just imagine them at opposite corners of a boxing ring for dramatic effect) is Ted Tozer, President and CEO of Ginnie Mae, the government-sponsored agency that backs FHA loans.
In a column for the Urban Institute, Tozer agrees that housing affordability is a problem, especially among first-time and underserved buyers.
However, he doesn’t believe that reducing MIP for all FHA borrowers is an effective solution because it could further fuel price growth and further reduce affordability.
His logic goes like this: Yes, reducing MIP would reduce monthly payments for FHA borrowers. But by doing so it would increase the loan amount they qualify for based on their income.
So instead of qualifying for a $300,000 loan at 0.85% annual MIP, a borrower may qualify for a $320,000 loan at 0.50% annual MIP, as a purely hypothetical example (no actual MIP reduction amounts have been discussed that we can find.)
If the borrower purchases a home at their maximum loan amount, not only do they have the same mortgage payment, they’ll have brought more money into the market, fueling price growth.
So what does Tozer propose instead to help today’s FHA borrowers?
1. Make certain COVID forbearance policies permanent
One way to help current and future borrowers is to institutionalize some of the temporary safeguards put in place during COVID. For example, the complete lack of a forbearance wave in 2021 suggests that homeowners were able to get back on their feet when given the time and resources to do so.
Tozer proposes allowing FHA borrower to defer up to three mortgage payments if they have a three-month income loss or sudden expense such as a family emergency.
Unlike COVID, the event would not have to be a presidentially declared natural disaster.
The borrowers would resume mortgage payments after three months and the missed payments would get tacked onto the end of their term, turning a 360 month mortgage into a 363 month mortgage.
While this wouldn’t lower mortgage payments, it would help FHA borrowers through unfortunate and unforeseen events.
2. Eliminate the upfront MIP
You’re probably thinking, “Wait, isn’t Tozer the ‘Keep MIP Guy?’”
Well, yes and no.
While Tozer doesn’t believe in reducing annual MIP, he is in favor of eliminating upfront MIP. That’s because this would have a much smaller impact on purchasing power (providing less fuel for price growth) and create instant equity for new FHA borrowers.
As it stands today, FHA borrowers need a minimum 3.5% down payment and 1.75% upfront mortgage insurance payment. Even though the upfront MIP is usually financed into the loan amount, it’s still a fee. The buyer is left with a loan amount of more than 98% of the purchase price upon closing.
By eliminating upfront MIP, the borrower puts the full 3.5% down and effectively doubles their initial home equity.
3. Reduce MIP for certain borrowers
Remember when I told you Tozer and Stevens weren’t exactly at polar opposites?
Tozer’s third solution is to lower MIP for borrowers that have 22% equity in the home and have made 12 consecutive on time mortgage payments.
This is similar to private mortgage insurance falling off of a conventional loan at 20%-22% equity.
The logic is that after building 22% equity and making a year’s worth of regular payments, borrowers pose much less risk of defaulting. So why treat them like a brand new borrower with 3.5% equity and no history of on-time payments?
This could also incentivise FHA borrowers to stay in the FHA program instead of refinancing into a conventional loan to eliminate MIP. That would strengthen the FHA’s profile with high-quality borrowers to help fund MMI alongside marginal ones.
Should homebuyers pause their searches to see the results of this heavy-weight bout? No. But it’s good to know that two mortgage industry giants are actively calling for solutions to help underserved homebuyers compete in today’s insane housing market.