FHA Risk Based Premiums

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FHA Risk Based Premiums

FHA Risk-Based Premiums

May 1, 2006

Real Estate Finance Committee

The following is for study only and has NOT beenapproved by the Real Estate Finance Committee or the Board of Directors.Issue: At its May 2006 business meetings, NAR will be addressing proposed legislation to reform the Federal Housing Administration (FHA). Included in the proposed legislation are changes to how the FHA sets premiums that will allow for risk-based pricing.Action: Information OnlyOptions: Not ApplicableBackground: Representative Robert Ney (R-OH) has introduced H.R. 5121, the Expanding American Homeownership Act, to reform the FHA mortgage insurance program. The FHA was created in 1934 as a way to ensure that lenders would supply the home buying market with capital. The FHA helped to expand homeownership to low- and moderate-income home buyers and has since insured over 33 million properties. The FHA is a self-sustaining program in that it charges a premium to cover its risks and operating expenses. The FHA’s current portfolio is comprised of 79% first-time home buyers, 35% of which are minorities.Status/Summary: In 1999, the FHA insured approximately 127,000 homes bought in California. In 2005 that number dropped to roughly 5,000. H.R. 5121 would significantly reform FHA insurance to stop the hemorrhaging of market share, not just in California, but across the country. Additionally, the bill will attempt to expand the FHA’s reach into the subprime market. The reforms proposed include:

-Increasing the FHA insurable limits. Currently, the FHA insures 95% of an area’s median home price with a ceiling of 87% of the conforming loan limit ($362,790) and a floor of 48% of the conforming loan limit (not applicable in California). The legislation would increase the FHA limit to 100% of an area’s median home price capped at 100% of the conforming loan limit ($417,000), with a floor of 65% of the conforming loan limit ($271,050).

-Making it so that condos are insured in the same manner as single-family homes.

- Allowing for the coverage of zero-down loans. Currently, the FHA may only insure loans with a minimum ofthree percent down.

- Allowing the FHA to insure 40-year mortgages.Lastly, H.R. 5121 will allow the FHA to set its insurance premiums by risk. Under current law the FHA is limited to 2.25% upfront and .5% annual renewal premiums (the annual renewal premium is added to the monthly mortgage payment of the home buyer). The FHA currently charges a 1.5% upfront premium and .5% annual renewal premium. Under H.R. 5121, the FHA will balance the mortgage terms and borrower’s finances when calculating the upfront and monthly premiums. This means taking into consideration the income, assets and financial profile of the borrower as wellas the loan-to-value (LTV), loan period, fees and amortization schedule of the loan product. Presumably, this should allow the FHA to tailor products to borrowers’ specific financial circumstances. An example isa borrower with a small amount of cash to put down on a mortgage, but shows a strong monthly income. For this home buyer, the FHA may charge a lower upfront premium but with a higher annual renewal.Arguments in favor of risk-based pricing:

-Will bring the FHA up to date.

- Will allow the FHA to reach borrowers it can’t presently serve.

- Will lower the cost on home buyers with good credit, reducing their risk of default.

- Will reduce costly 80/20 loans.

- Will increase competition and lower prices by allowing the FHA into areas of the market presently dominated by private mortgage insurance (PMI).

- The legislation allows the premiums tobe adjusted during the loan, so as borrowers increase their equity and show a history of on time payments, premiums may be reduced.

- These changes will allow the FHA to insure home buyers who would otherwise only be able to get a sub-prime loan. This will potentially save home buyers thousands of dollars over the life of a loan.

- The FHA will be able to take advantage of the existing PMI market which uses risk-based premiums to ensure it sets appropriate levels to cover its risk.

- Because the FHA has no shareholders or growth requirements, it can take more risk and cover borrowers for less then PMIs.

- Risk-based pricing will help the FHA to compete and increase its market share to traditional levels. This will ensure the FHA’s continued viability and role in America’s housing market.Arguments against risk-based pricing:

- Under the current FHA system, borrowers with poor credit pay the same premium as borrowers with better credit. This allows the FHA to share the risk evenly among all borrowers and allows borrowers with poor credit to pay a lower premium than they normally would. Under the proposed legislation borrowers with poor credit will have to pay more, thus reducing their purchasing power and increasing their rate of defaults.

-Borrowers with lower down payments will likely be priced higher.

- The FHA could wind up mirroring the private market instead of focusing to help the low- and moderate-income home buying market. This could raise the cost of buying a home for people who can least afford it.

- In theory, HUD would have the authority to raise premiums to predatory levels without any statutory limits.

FHA Comparative Example of Risk-based Pricing

MORTGAGE COMPARISON	Prime Conventional Standard MI (660 FICO)	FHA Risk Based Premium (-575 FICO)	Sub prime High Cost (-575 FICO)
Purchase Price	$225,000	$225,000	$225,000
Mortgage Amount	$200,000	$206,000	$200,000
Mortgage Interest Rate (Fixed)	6.500%	6.500%	9.500%
Upfront Mortgage Insurance Premium (MIP)	NA	3.000%	NA
Annual MIP	0.520%	0.750%	NA
Monthly Principal, Interest, and MIP Payment	$1,351	$1,427	$1,682

NAR Chart

Home Price	FHA loan	Down Paymt	FHA fee	Other closing fee	Cash at closing	Loan amount	Mrtg rate	Monthly Mrtg	Lifetime Interest	Lifetime total payment
$200k	old	6,000	$3,000	$3,000	$12,000	$194,000	6.50%	$1,226	$241,436	$441,436
$200k	high risk 30-year	$0	$4,500	$3,000	$0	$207,500	7.00%	$1,381	$296,981	$496,981
$200k	high risk 40-year	$0	$4,500	$3,000	$0	$207,500	7.00%	$1,289	$418,946	$618,946
$200k	med risk 30-year	$0	$3,000	$3,000	$0	$206,000	6.75%	$1,336	$281,000	$481,000
$200k	med risk 40-year	$0	$3,000	$3,000	$0	$206,000	6.75%	$1,243	$396,599	$596,599
$200k	low risk 30-year	$0	$1,500	$3,000	$0	$204,500	6.50%	$1,293	$265,328	$465,328
$200k	low risk 40-year	$0	$1,500	$3,000	$0	$195,00	6.50%	$1,197	$374,684	$574,684
$200k	subprime 5% down	$5,000	$0	$3,000	$8,000	$195,000	9.50%	$1,640	$587,040	$787,040
$200k	Subprime no down	$0	$0	$3,000	$0	$203,000	9.50%	$1,707	$619,328	$819,328

Outlook: H.R. 5121 is currently in the House Committee on Financial Services with three cosponsors. Those cosponsors include California representatives Gary Miller and Maxine Waters. The House Committee on Financial Services held hearing for H.R. 5121 on April 5, 2006. Speaking in favor of risk-based pricing at the hearings were Brian D. Montgomery, Assistant Secretary for Housing at HUD and A.W. Pickle III., past president National Association of Mortgage Brokers. Raising concerns with the proposed risk-based pricing was StellaAdams from the National Community Reinvestment Coalition.While there is very little time left during this session of Congress, Secretary of HUD Alphonso Jackson has stated he will put his full weight behind ensuring H.R. 5121 passes prior tothe end of this Session.NAR Position: NAR does not have policy on FHA risk-based premiums. It is expected that the Conventional Finance Committee will address this at their May meetings.C.A.R. Policy: C.A.R. “SUPPORTS” increasing the FHA loan limits and insuring zero-down payment loans. C.A.R. does not currently have policy on the FHA risk-based premiums.Subprime

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