Weekly Column #2: FHA’s Mortgage Insurance is in the News Again
I keep a pretty close eye on economic data when it comes to housing and lending (kinda my job), but I’ve been especially eagle-eyed in the last couple of months as my husband and I are getting ready to get ready to buy a house in our adopted home of Dallas-Fort Worth, Texas. The market here is complex, so I don’t want to rush things, you know?
Of course you do.
We’re probably going to end up borrowing using an FHA loan. My husband would rather own than rent, even if we’re throwing a lot of extra money to the bank that doesn’t go towards the principal. I have mixed feelings, but I also want a pool, so there’s a lot to unpack there.
FHA’s Mortgage Insurance: A Little Background
If you check out some of the educational material here at Home.Loans, you’ll probably stumble across some pieces that explain how mortgage insurance works under the current FHA rules. If you haven’t, here’s the TL;DR version: FHA instituted a life-of-loan mortgage insurance requirement for any buyer who brings less than a 10% down to the table. That means you never get to stop paying mortgage insurance.
The reasoning back then was as spurious as it is now. Basically, the FHA needed a $1.7 billion bailout to keep it afloat as homeowners started sending them “jingle mail” (the keys to their home, symbolically saying those homeowners are outta there). The problem was absolutely serious and the destruction of the FHA would have hurt the wider economy worse than lifetime mortgage insurance, there’s no argument there.
However, because FHA has exceeded its congressionally mandated target for its capital adequacy ratio (the ratio of capital held by the bank versus the risks the bank has exposed itself to, like lending money to people who might not pay) for the last three years, only dipping slightly in 2017, it’s curious that the lifetime MI is still in place.
Barriers to Purchase are Everywhere
Real estate and mortgage professionals have been calling for the end of this lifetime sentence, but FHA Commissioner Brian Montgomery has told reporters that there won’t be any change to the FHA lifetime mortgage insurance policy, nor will there be a reduction in the mortgage insurance rate.
At the same time, the Federal Reserve has raised interest rates, which generally causes a cascade of rising interest rates by banks that act as mortgage lenders.
Everywhere you turn, it feels like walls are going up for buyers like you and me. Sellers aren’t selling, builders can’t build fast enough due to labor shortages in their segment. Banks are lending, but the overlays they’re using are still tight. Unless your credit is perfect and you’re buying your grandmother’s house (or have your own construction crew!), it seems like there’s no winning.
This is where I come back around to this FHA thing.
FHA Feels Like a Punishment
The way that FHA loans are now structured, it feels more like a punishment than a privilege to buy a house using one. Coming up with the $30k that represents a 10% down payment on a nationally average price house is daunting enough, but don’t forget that you’ve got closing costs. Lots of them.
You can roll the upfront mortgage insurance and other closing costs into your loan -- up to 6% of the home’s value (that’s $18k for that $300k house) -- but that’s just adding insult to injury. If you think about this for a minute, you’re literally paying lifetime mortgage insurance on the upfront portion of the mortgage insurance that you’ve financed into your home’s loan.
If the insurance on my insurance is my friend….?
It’s tough out there, there’s no doubt about it. The market is unforgiving, the tools many first time buyers need to use are much more demanding than they have been in a very long time and interest rates are rising. It’s enough to make you want to burrow into your rental and not let go.
We All Need a Game Plan
I spent almost a decade in the real estate industry, working with all kinds of buyers and lenders. Oh, boy, those lenders. But I digress. Despite the fact that I know a few things about real estate, my husband and I are going to buy as soon as we can. Jingle mail got us, too, but there is life after foreclosure.
We have a plan, and you need one, too. The biggest hurdles to overcome relate to that lifetime mortgage insurance. Before accepting that punishment, you need to be prepared to outsmart the instrument’s penalties. There are a couple of ways to approach this, let’s look at them together.
Plan 1: Bring All the Money!
If you’re buying in the current market, it’s probably a good bet that you have access to a 401(k) retirement plan, or something equivalent like a 403(b). Normally, I’d never advise anyone to touch their retirement account, but if you’re buying with FHA and intend to age in place (we’re in our late 30s, but that’s the plan for us), milk that baby to the bone. You can often borrow a significant chunk of your vested portion in order to buy a home, ask your HR rep about how to do this without incurring a tax penalty.
Many people don’t realize it, but your retirement fund can be used as a source of money for down payments, closing costs or otherwise considered to be “reserves” if you’re required to keep them. Banks love it when you use retirement funds rather than that box full of ones that you’ve been keeping under the bed for years. Retirement funds are easy to verify and track, saving them a lot of trouble sorting through wrinkled bills.
Bringing all the money will give you a better rate on mortgage insurance with FHA and allow that same insurance to drop off the loan when you reach a 78% loan to value ratio. You’ll probably have to request this insurance removal in writing, so keep an eye on your principal.
Plan 2: Consider This a Practice Loan
Plan number two requires that you keep your financial picture healthy, keep your house healthy, pray that the local market is stable or rising in value slowly and that nothing unexpected happens before you can refinance. With FHA, you typically have to wait at least six months to refinance and that refinance must give you some kind of significant benefit.
Due to the significant benefit stipulation, you’re probably not refinancing in six months. A year, maybe two, depending on your market? Sure, that’s something to shoot for. In the meantime, you’re not paying a massively different payment from what you’d have paid if you had been able to bring 10 percent down. This is good news.
Still, it’s a long wait while you hope that nothing changes dramatically. While you wait, be sure to stick as much as you can into savings (no, I’m not laughing here) so you can bring extra to closing if it’s necessary to get rid of that lifetime mortgage insurance.
If you can’t manage to refinance, you’re going to be stuck between selling the house you’ve come to see as a home and paying possibly hundreds extra a month for absolutely no reason until the loan is paid off.
Ultimately, You May Still Be Better Off with FHA…
After all of that, I’m sure you thought I’d end on a negative note, but I don’t intend to. FHA is a program that has long supported people with problematic credit histories. We’re the ones that have made a few mistakes, and learned from them, but they’re still haunting us. The alternative to FHA is what is sometimes kindly dubbed the “non-conforming conventional” mortgage type. Jumbo mortgages aside, this is a category that’s not a place for a buyer wanting a longer term solution.
Often, these loans have aggressive payment schedules, heavy punishments for early pay-off, obscure features like balloon payments and rapidly cycling adjustable rates. I’m not proud of it, but I did have some buyers who bought using these kinds of products (we used to call them “B/C Paper”). Most of those buyers, last I checked, weren’t able to refinance and lost their homes.
My FHA buyers? They mostly weathered the storm that was the Great Recession. Not only did FHA give them a permanent loan that didn’t require a refinance, the loan servicers tried really, really hard to help the owners who were having a bad time. There were a lot of programs that modified those loans to make them easier to maintain. FHA did not want to have so many failures as it did.
It’s because of what I saw and how many of my people were OK after our little national real estate debacle that I will use the FHA if that’s the option I’m left with. Despite lifetime mortgage insurance. Despite paying lifetime mortgage insurance on upfront mortgage insurance.
They say customer service is part of the price of a product, and I can attest that this is definitely the case for FHA. The FHA and its servicers aren’t perfect, but they’re pretty OK. And pretty OK is high praise in my book.