There has been a flurry of recent articles prognosticating a decrease to Federal Housing Administration (FHA) insurance premiums. Several trade groups including the Mortgage Bankers Association have corresponded with the HUD Secretary in support of cuts. One news article suggested a possible presidential announcement of FHA premium reductions prior to the November elections.
A similar announcement was made by former HUD Secretary Andrew Cuomo a week before the 2000 presidential election when FHA lowered the up-front premium and reduced the “life of loan” premium once a borrower reached 22% equity in the home.
While it is doubtful FHA premium cuts are on voter’s minds today any more than they were in 2000, administrations frequently time what they view as positive news around election cycles.
This administration is understandably looking to reduce the costs that burden so many low- to moderate-income families with FHA loans in this high inflationary and high-interest rate period. FHA capital levels appear to some to be capable of handling across-the-board cuts to either the current 1.75% up-front or 0.85% annual premiums charged to most borrowers, perhaps both. But in the current environment there is reason to be cautious.
Before reducing FHA’s expected receipts, thereby decreasing its claims paying capacity, FHA should continue to address a persistent phenomenon that is not garnering many headlines but is a lingering economic effect of the pandemic. Approximately 345,000 homeowners remain on COVID-driven forbearance plans with their mortgage servicers. At least 137,000 of those borrowers have FHA-insured loans.
Another 225,000 FHA borrowers are seriously delinquent and have not sought forbearance or loss mitigation assistance, and 156,000 borrowers who exited forbearance have now become delinquent again.
Those numbers are not outsized by FHA standards and have come way down from pandemic highs. Nevertheless, we are in uncertain economic times: Inflation grinds on, interest rates are rising, and according to many experts a national recession looms. The housing purchase and refinance market has slowed materially, and home prices are dropping in almost every major metropolitan area, although many are still above pre-COVID levels.
If things turn tougher, FHA borrowers who are still in forbearance, along with those borrowers who have been unsuccessful in completing a COVID loan modification or returned to delinquency, will need further support. So too could more recent borrowers, as we have observed an increase in FHA early payment defaults over the past year.
What’s more, FHA servicers’ options for loan modifications are more limited when one of the principal tools, the interest rate reduction, is virtually eliminated in this rate environment, subjecting the FHA to higher costs for workouts and defaults.
We have suggested utilizing the Homeowner Assistance Funds (HAF) or FHA partial claims to temporarily buy down or subsidize interest rates on loan modifications, understanding it will require significant collaboration with mortgage servicers, HUD, Treasury, and the state housing agencies administering the program on behalf of their citizens.
FHA’s Mutual Mortgage Insurance Fund (MMI Fund) is there to be the primary buffer against these inevitable shifts in housing and the economy. It is a cornerstone of the countercyclical role FHA plays when lending in private markets becomes constrained or, more recently, a global pandemic negatively impacts the economy and by extension leads to unexpected job losses or reduced incomes.
In fulfilling its purpose of backstopping mortgage defaults, it is important to understand the sensitivity of the MMI Fund to macroeconomic outcomes and the assumptions built into the forecasting models that have been proven to change dramatically, most notably, home price appreciation (HPA).
As FHA has highlighted in their 2021 Annual Report to Congress, the MMI capital ratio has proven to be approximately three times more sensitive to HPA reductions than to reductions in interest rates. The MMI Fund calculations are such that a modest 1% reduction in HPA reduces the capital ratio by 1.26 percentage points.
Appreciating the correlation between changes in HPA and reported MMI Fund portfolio valuations is the key to understanding how quickly the financial performance of the MMI portfolio can change.
CoreLogic estimates that year-over-year HPA is expected to fall from the 20% reached in February to 3% in 2023. To illustrate the potential speed and size of impact on the MMI Fund, consider a similar 17% decline during the period between 2006 to 2009, highlighted in FHA’s FY2021 annual report, when HPA dropped from roughly 32% in 2007 to 15% in 2009.
In FY2007, the MMI Fund’s capital ratio stood at 7.4%. By 2008, the capital ratio had dropped to 3.2%, and by 2009 .4%. By 2012, FHA’s capital ratio had cratered into negative territory, -1.4%, requiring a $1.7 billion draw on the U.S. Treasury in 2013.
If the decision around premiums drags past the election, soon after, FHA will release the results of its annual review of the FY2022 Mutual Mortgage Insurance Fund. To be clear, we expect the annual review, which looks back at FY2022, to show an improved capital ratio – rising above the more than 8% ratio achieved in FY2021.
Indeed, if the recent quarterly report to Congress is any indication, which showed a positive economic value in the MMI Fund of $138 billion, the pressure will only mount for a premium decrease. But the coming report will be a look in the rearview mirror, reflecting economic assumptions more optimistic than currently forecasted.
Economic assumptions are just that — assumptions — and are subject to change.
We are not calling for doom and gloom. And we want FHA to serve its mission as a stabilizing force for U.S. homeownership and helping low- to moderate-income families and individuals get into homes in a sustainable way, as efficiently as possible, to fully participate in American life, particularly in challenging economic environments.
But a number of questions should be answered before lowering premiums can be considered a serious option. Can the mortgage insurance fund support a potential recession and possible home price declines in 2023? Are the needs of prospective FHA borrowers more important than those of currently struggling homeowners with FHA loans?
And if the administration plans to make this cut, why was it not included in the president’s proposed 2023 budget and, absent that, how will they pay for it?
We continue to believe FHA should carefully prioritize borrowers who are most in need, ensuring excess resources assist them first, helping them to preserve the equity in their homes, and preventing those at risk of losing their home from suffering that fate.
Brian Montgomery is a founding partner of Gate House Strategies and has served as Deputy Secretary of the U.S. Department of Housing and Urban Development from 2019-2020 and FHA Commissioner to the George W. Bush, Obama and Trump Administrations.
Keith Becker served as Deputy Assistant Secretary for Risk Management and Regulatory Affairs and FHA’s Chief Risk Officer at the U.S. Department of Housing and Urban Development. Previously, he worked at Freddie Mac for close to 26 years, most recently as Chief Credit Officer for Single Family Housing.
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Sarah Wheeler at [email protected]