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FHA Reform Act and Annual Mortgage Premiums; What an Increase Means for Borrowers

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RISMEDIA, July 6, 2010—The House of Representatives recently passed the FHA Reform Act (H.R. 5072). The bill, sponsored by Representative Maxine Waters (D-Calif.), would give authority to the Federal Housing Administration (FHA) to increase premiums (a.k.a. mortgage insurance) on loans guaranteed by the FHA. It passed by a vote of 406 to 4 and now heads to the Senate for a vote.

The FHA does not make home loans, it insures lenders against mortgage defaults. As a matter of fact, the FHA insures nearly one-third of all new mortgages in the U.S. This is up from just 4% percent in 2006. Due to the high number of mortgage defaults that have occurred over the past few years, the FHA reserves have fallen below the limit allowed by law. The proposed bill hopes to bolster the FHA reserve level.

FHA-backed loans are common among first-time home buyers because, unlike the traditional mortgages of today, FHA loans only require that you have a 3.5% down payment. However, because the down payment requirement is so low, a borrower is required to pay both an upfront mortgage insurance premium at closing (currently at 2.25%, up from 1.75% in April 2010) and an annual mortgage insurance premium, paid monthly.

Currently, the annual mortgage premium is 0.55% of the loan amount, but if the FHA Reform Act is passed, it would allow the FHA to raise the premium up to a maximum of 1.55%. However, FHA Commissioner David Stevens said their plans are to raise the premium to 0.9% next year, not the maximum amount–though the FHA does have the ability to raise it to the maximum amount without additional approval.

How would this change affect a new FHA-backed borrower? Could a small percentage increase really translate into big numbers? The answer is yes. Here are two examples of how the new, higher premiums will affect homeowners, calculated using two homeowners with specific adjusted gross incomes (AGI).

Example #1
In this first example, a homeowner with a $50,000 AGI (see AGI chart here) can currently afford the median valued U.S. home of $183,100, based on the rule of thumb that one’s house payment—including taxes and fees—should not exceed 30% of your income. At the current rate of 0.55%, the homeowner should expect to pay $80.92 per month in FHA mortgage premiums.

However, if the premium is raised to 0.9%, this same homeowner would only be able to afford a $175,000 home and would be required to pay a monthly premium of $126.66.

If a rate of 1.5% is applied, this homeowner could only afford a $163,000 home. In the latter example, the monthly premium has increased roughly 2.5 times the current rate–from $80.92 per month to $196.62 per month–requiring the homeowner to lower their purchase power by roughly $20,000.

Example #2
In the second example, a homeowner with a $113,000 AGI (see AGI chart here) can currently afford the median valued Los Angeles metro home of $419,500 and should expect to pay an FHA monthly mortgage premium of $185.54.

However, with the increased fee of 0.9%, the same homeowner would only be able to afford a $402,000 home at 0.9 % and would have to pay a FHA monthly mortgage premium of $290.95 and a $372,600 home at 1.5%. That is a difference of $46,700.

If a rate of 1.5% is applied, this homeowner could only afford a $372,600 home. In the latter example, the monthly premium has increased roughly 2.5 times the current rate–from $185.54 per month to $465.75 per month–requiring the homeowner to lower their purchase power by roughly $47,000.

Like example #1, the decrease in affordability is due to an increase in the FHA annual mortgage premium, paid monthly. In both cases, the premium paid currently makes up 7% of the total monthly house payment. If the rate of 0.9% were applied, that would jump to nearly 12% and at 1.5%, 20% of the monthly house payment would go toward the FHA annual mortgage premium.

“Individual borrowers should be aware of the impact of this change to the FHA program’s annual mortgage premium requirement because less of their monthly payment will go toward the equity in their home,” said Zillow.com Chief Economist Dr. Stan Humphries. “Additionally, as annual mortgage premiums rise, it will negatively affect a home buyer’s purchase power.

Humphries continued, “While additional fees will have some marginal impact on demand for housing, it’s likely to be quite small overall and significantly less than the alternative of higher down payment requirements. Although the latter would do more to lower the risk profile of the FHA portfolio.”

In addition to the FHA mortgage premium increase, the bill calls for a decrease to the portion of the “upfront mortgage premium,” which is paid at closing. Currently, the rate is at 2.25% of the loan value. The FHA plans to cut the rate to 1% if the bill makes it into law. Though helpful, it will not come close to counteracting increase annual mortgage premium.

The bill is awaiting a Senate vote and an effective date for this portion of the bill has yet to be set. The annual mortgage premium increase will only apply to new FHA borrowers.

Methodology
Zillow ran the numbers using two fixed adjusted gross incomes (AGI). We used an AGI of $50,000 to represent the U.S. median home value of $183,000 and an AGI of $113,000 to represent the median home value of $419,500 in the Los Angeles Metro. We then worked backward to determine the 3.5% down payment (current FHA down payment minimum) and loan amount. We plugged that data into the Zillow mortgage payment calculator to get estimated property tax and home insurance numbers.

Finally, to determine how the increase in FHA premiums would affect homeowners, we applied the three percentage rates mentioned above (0.55, 0.9, 1.5) to the fixed AGIs, verifying that the house payment never exceeded 30% of the AGI.

For more information, visit www.zillow.com.

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