1. Why was there so much attention on the cuts?
One of the very first things President Trump did, literally in the first hour of his presidency, the U.S. Department of Housing and Urban Development suspended the 0.25 percentage point premium rate cut for Federal Housing Administration-backed loans.
With this being a reversal of a policy just announced by Obama a week earlier, the Mortgage premium cut got a huge chunk of attention by the media and by politicians.
But what exactly does this mean for house-hunters?
Residential Pro president Rick Sanford said this about the cut:
“Trump’s so-called mortgage premium cuts will do very little to impact the real estate market. The only impact will be to those buyers that are on the extreme fringes of qualifying to purchase a home via FHA loan. These are the most likely pool of buyers to default on home loans. The intent of the action was to prevent the likelihood of another housing crash. To that regard, the action will succeed in its intended goal.”
Let’s have a thorough look at the mortgage premium cuts and how they affect (if at all) most home buyers.
2. What exactly was the executive order on mortgage premium cuts?
This premium cut was an Obama administration policy that was meant to reduce the cost of mortgages for millions of home buyers. This reduction of the annual mortgage insurance premium was expected to save FHA borrowers an average of $500 per year as estimated by people in the industry – although in reality the amount varies and is typically lower than this.
While you might have heard or seen headlines suggesting that Trump raised taxes on middle-class homeowners, this is an inaccurate way to portray what happened.
The Trump executive order keeps the cost of government-backed mortgage insurance through the FHA at its current level. The executive action halted the rate cut planned by the Obama administration.
In reality – there has been no change in mortgage premium rates.
The change is that what had been planned (as a parting gift?) by the Obama policy in their final week in the administration was not implemented by the Trump administration.
While there is essentially no change, the Obama policy was meant to pass along some savings to working families while still protecting the insurance fund.
Industry leaders had applauded the move, since it was a small way of boosting the housing marketing that is slowly becoming more expensive, with some people getting priced out of home ownership.
This policy would have helped first-time homebuyers and those with a poor credit score in particular.
These are people at the bottom end of the scale mortgage lending scale, who sometimes struggle to enter today’s market, as higher home prices and higher mortgage rates make it difficult to afford a mortgage.
On the other side of the coin, the premium policy cut would have put an increased risk that the government/taxpayer would have to foot the bill for another bailout should the FHA be in a precarious financial situation. It was only three ago, that the FHA was bailed out to the tune of $1.7 billion.
In reality, the people who could have possibly afforded a mortgage through the premium cuts, are the ones who are most likely to default on a loan. By definition, this increases the risk on the FHA, because they are exposing themselves to more risk.
Each premium cut which happens puts more strain on the FHA’s financial position.
3. Who is the FHA and how is it affected?
The Federal Housing Administration, part of the Department of Housing and Urban Development, is a government agency which helps to insure home loans by collecting fees from borrowers to reimburse lenders in the case of default.
Many homeowners are probably already familiar with the costs that come with low-down-payment mortgages. Mortgage insurance is essentially a backup plan for those who cannot make their mortgage payments. That’s because the owners will have so little equity in their homes that banks can’t be sure they’d make their money back if they foreclosed on the home and sold it.
There are several forms of this mortgage insurance, but the most popular are provided by the Federal Housing Administration through FHA-backed loans.
For an upfront fee and an ongoing monthly cost, the FHA guarantees a loan between a buyer and a bank — that gives banks the ability to lend money to buyers with as little as 3% down.
The fees collected from consumers go into the fund used to support the FHA loan program.
The program goes back to the 1930s. It helps create first-time homebuyer activity. The FHA has insured 34 million properties since its inception. The agency claims it is the largest insurer of mortgages in the world.
The FHA thus insures loans which are aimed at first-time homebuyers, or those with poor credit – in other words, those with a high-risk of defaulting.
With the help of an FHA-backed mortgage, down payments can go down to as little as 3.5%, and mortgage lending goes down for even those with a credit score as low as 580 (typically people who have had a dire financial situation in the past). There are limits to the price of a home loan the FHA will back.
In fact, the average credit score of an FHA borrower last year (2016) was 679, a credit considered to be fair.
While a premium cut is better for borrowers, it puts a higher risk on the taxpayers in the case of a bailout.
Senate Minority Leader Chuck Schumer during his opening statement on the Senate floor asked Trump to reverse the suspension of the rate cut.
“What a terrible thing to do to American homeowners,” Schumer said. “President Trump, with the flick of a pen, ended that new policy, making it harder for Americans of modest means to obtain their piece of the rock, the American dream — homeownership.”
On the other hand, Financial Services Committee Chairman Jeb Hensarling was critical of the proposed mortgage fee cut.
“It seems the Obama administration’s parting gift to hardworking taxpayers is to put them at greater risk of footing the bill for yet another bailout,” Hensarling said.
FHA loan fees had been raised during the recession to cover program losses. The Obama policy move would have returned the fees to about the level they were before the housing bubble burst.
For now, they remain above their 2008 levels.
Daren Blomquist, senior vice president at ATTOM Data Solutions, says the rate cut two years ago triggered a short-term jump in home sales to FHA buyers – yet, the impact of the rate cut wasn’t as dramatic as expected. This was partly due to the fast-rising prices of property which ate up much of the anticipated increased buying power.
“This decision not too surprisingly reflects the Trump administration’s fiscally conservative philosophical bent, favoring not putting taxpayers at risk — or at least what they perceive as risk — for the sake of a government program that helps people buy homes,” Blomquist said.
“This is not to say that the Trump administration won’t take policy steps to help the homeownership rate rebound, but the levers pulled will more likely involve trying to allow the market to address the situation with deregulation rather than addressing the situation through government programs that potentially put taxpayers at risk.”
4. Who are the people affected by the cut?
The premium policy cut will essentially affect those homebuyers who with an FHA-backed mortgage, which is about 16% of the country’s new mortgages.
FHA loans are also particularly popular with millennials; 38% of new loans closed by younger buyers are FHA loans according to mortgage data firm Ellie Mae.
Thanks to the FHA, these homeowners are offered easier credit requirements, lower down payments and smaller closing costs.
This assistance through the FHA would have allowed more people at the lower end of the spectrum to qualify for a mortgage. These borrowers who would typically be unable to meet the requirements of getting a mortgage would get a slight boost in their financial position. This cut would have potentially allowed them to meet the debt-to-income ratio required to borrow money.
Given that some lenders had already alerted their customers that lower rates were about to be set in motion, these lenders now have to re-disclose, go back to the borrower and advise them that their rate is going to be higher than they expected. For some people, this might be the straw that breaks the camel’s back – those who had qualified for homeownership, only through the planned premium cuts, will now not be able to afford a home.
“Some people will actually get priced out of the market; for others this will be more of a headache,” said Ken Fears, from the National Association of Realtors. “For those who will be priced out of the market, it’s a big deal.”
Putting this premium action into numbers, the National Association of Realtors estimates that the premium policy cuts affect 700,000 to 800,000 Americans, who will be paying more for their mortgage insurance than they otherwise would have, had the premium cut taken place. Some 30,000 to 40,000 people on the fringes of home ownership who would have been able to afford a home will also be affected, by not being able to afford a mortgage.
5. What does this mean for me?
For most people, this change will not make much of a difference. Mortgage rates will remain at current rates.
Buyers who might be tempted to wait and see what the Trump administration does with FHA fees should think again. If home prices continue to rise, any savings from lower potential FHA fees or other ways of propping up the housing market would be quickly eaten up.
For those who are affected by the premium cut, U.S. Sen. Chuck Schumer, a Democrat from New York, said the cut would have saved home buyers $29 a month on a $200,000 mortgage. As an average across the board, the cut would equate to an average of $500 per year.
According to Attom Data Solutions, the decrease would have saved average homeowners about $37 monthly. Owners in places where home prices are higher could potentially have saved much more — sometimes more than $1,000 annually in 13 counties across the United States.
If you are shopping for a home and planned to use an FHA-backed loan, it means you will be paying the same premium rate for required mortgage insurance that you would have since January 2015.
Although much ado has been made about the mortgage premium cuts, in reality, these will have little to no effect on most people.
Plans for reductions in the mortgage insurance rates for loans backed by the FHA which had been planned in the last week of the Obama administration were halted, leaving the same situation as has been for the last few years.
While this might have given a small boost to some people, the difference most people would have experienced are negligible or not significant enough to make a difference.
If you’d like to understand more about homeownership mortgages and other questions you have about buying your first or next residence, don’t hesitate to get in touch with us.