Wednesday, May 12, 2010

Every Loan a Government Loan Part II

In an earlier post this week, we talked about the explosive growth of FHA loans. Five years ago, FHA had about 2% of the market. The reason--it simply was not competitive. FHA was expensive for the brokers and required a down payment for the consumer whereas other products on the market did not. Also FHA upfront premiums and monthly premiums did not compete well with free market products like My Community Mortgage and Emerging Markets programs which required no down payment and had lower cost mortgage insurance than other conventional loans. At one point, it looked as though FHA was about to join the dinosaur and the dodo bird on the extinct species list.

What a difference five years makes. Recent statistics published in the Scotman's Guide (a trade publication for industry professionals) indicate that FHA and government loans comprise 50% of new purchase loans. The reason--today FHA and other government loans are basically the only game in town when it comes to low down payment financing. FHA still allows a 3.5% down payment (which is up from 3% in the past), while most conventional loans require 5-10% down payment, and 20% is better. So a government product that could not compete with free market products five years ago now has no competition.

FHA reminds us that they have insured approximately 37,000,000 loans since the program was established in 1934. For a program that is 76 years old and has seen one of the biggest real estate booms in history, that number should be larger. And even David Stevens, the FHA commissioner, admits that the FHA program was not designed to handle the volume it is handling today and that free market solutions are needed so that FHA can go back to normal levels of lending. The volume of loans going through is simply a strain on the reserves--which are Congressionally mandated. But in lieu of free market solutions, FHA is raising prices.

In January, FHA raised the Up front Premium for borrowers from 1.75% to 2.25%. For a borrower buying a $200,000 house, the financed MI premium went from $3500.00 to $4500.00. Since this figure is spread out over the life of the loan, consumers don't feel it so much, but they are still footing the bill for restoring the financial health of FHA. Now, with Maxine Water's (D CA) new bill, HR 5072, the FHA Reform Act of 2010, consumers are looking at another increase, and this one they will feel more directly. HR 5072 raises the monthly MI premium from .55% to 1.55%--almost three times what it is today. And since the monthly MI is paid, well, monthly, consumers are going to feel this much more directly in their wallets.

Let's look at an example. For the $200,000 loan that we just mentioned, the current MI premium is $91.66 per month. If the increase is approved, the premium will be $258.00 per month. That is a $166.00 increase in the consumer's payment. To put it into perspective, for a $200,000 loan with a 5.25% interest rate fixed for thirty years, the consumer's principal and interest payment would be $1104.41. Under the current MI percentage, the payment with MI would be $1196.07. The payment with the new percentage would be $1362.41. These payments do not include taxes and insurance, which would be required escrows for FHA. In addition to costing the consumer more, this large an increase can actually prevent some consumers from qualifying for a loan.

This is just simply a case of what happens when competition disappears. When consumers have only one option, prices go up. To get prices down, we need competition. David Stevens has asked NAR, the National Association of Realtors, to have all of their members lobby on behalf of HR 5072. I believe that rather than lobbying for higher premiums to help FHA increase its reserves, NAR and all consumers need to be lobbying for reduced regulations and incentives for private market solutions so that more loan options can be introduced into the market. This will take the strain off of FHA and the consumer.

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