By Julian Hebron of The Basis Point.
NEW YORK (
) -- The home loan product that carried low-down-payment consumers and the U.S. economy through the worst of "The Great Recession" has been winding down this year, and by June 3 will no longer be the smart money for most consumers.
The product is a Federal Housing Administration (FHA) loan, which enables borrowers to buy homes with 3.5% down and get 30-year fixed rates of 3.25%. The catch is mortgage insurance, an additional monthly fee borrowers pay as a risk premium.
Today, a borrower has an option to get rid of mortgage insurance within five years. As of June 3, FHA is eliminating that option.
Big FHA Changes June 3
The FHA is not a lender but rather insures lenders against losses using a fund that's maintained by borrower-paid mortgage insurance premiums.
That fund has been depleted as the FHA stepped in to absorb the shock of the housing bust: FHA insured just 4% of home purchase loans as housing peaked in 2006, and by 2011, that number ballooned to 40%, according to recent
As such, if the FHA shut down today and had no new business to offset expected claims for the next 30 years, the agency would be $16.3 billion short of being able to meet those claims.
To bolster the fund, the FHA has raised annual mortgage insurance fees charged (monthly) to borrowers five times since 2010, from a 0.5% to .55% range back then to a 1.3% to 1.55% range as of April 1, 2013.
So on a $500,000 loan in 2010, a borrower's monthly mortgage insurance was $229 on top of their mortgage payment. A great tradeoff for only putting 10% down.
After the April fee hike, the mortgage insurance on that same scenario jumped to $542.
That's $313 higher per month for an FHA loan now vs. 2010. Still, it has been justified up to now for two reasons:
1. FHA rates have dropped to 3.25% on a 30-year fixed loan, from 4.375% in 2010. In our $500,000 loan example, that lowers the mortgage payment $321, offsetting the higher mortgage insurance.
2. FHA borrowers can eliminate mortgage insurance at five years (or anytime thereafter) if they pay their loan down to 78% of the original purchase price. In our $500,000 loan example with 10% down, the borrower would eliminate their mortgage insurance after six years of monthly payments. Then they're left with a 3.25% fixed rate loan and no mortgage insurance.
But that second reason for FHA is void as of June 3. Starting then, 30-year fixed FHA loan borrowers with 10% down won't be eligible to cancel mortgage insurance for 11 years, and those with less than 10% down must pay mortgage insurance for the full 30-year term of their loan.
FHA Mortgage Insurance Fee Hikes (Effective April 1)
FHA Mortgage Insurance Cancellation Eligibility (Effective June 3)
How to Beat FHA's June 3 Changes
To obtain an FHA loan before June 3, borrowers much have an FHA case number, which lenders must order after following a Federally required loan application and disclosure process.
To get through this red tape and obtain a case number before June 3, borrowers should apply with a lender no later than Friday, May 24.
Low-Down-Payment Alternatives to FHA
After June 3, FHA won't be the smartest approach for borrowers with less than 20% down, and two other options are rapidly evolving to fill the void.
First is the return of private mortgage insurance (PMI). This is the same concept as FHA, but it's private firms insuring the loans. These firms were hobbled by losses as the FHA ramped up during the crisis years, but they're now recovering. Teresa Bryce Bazemore, president of Radian, the top PMI firm by market share, recently told Congress:
In 2012, the private MI share of the insured low-down-payment market increased from 26% in the fist quarter to 35% in the fourth quarter.
PMI fees are cheaper, ranging from .64% to 1.02% depending on credit score (or $267 to $425 per month on that same $500,000 loan example used above) but rates are a bit higher for loans above $417,000: about 3.75% for a 30-year fixed instead of 3.25% for FHA. And PMI parameters for eliminating the mortgage insurance are more favorable: the borrower must hold the mortgage insurance for two to five years
pay the loan down to 78% of purchase price.
Second is the return of piggyback loans, where a borrower can get 90% financing for a home purchase by qualifying for an 80% first mortgage and a simultaneous 10% second mortgage. To qualify, borrowers must have a credit score above 700, and the rates are also higher than FHA: about 3.75% for the first mortgage (above $417,000), and 5.25% for the second mortgage.
But there is no mortgage insurance on a piggyback loan, which more than offsets the higher rate cost.
Currently piggyback loans are available for 90% financing on home purchases up to $830,000.
The FHA was never meant to control such a large share of U.S. housing. But Moody's chief economist Mark Zandi said economic damage would have been much worse without the FHA,
So borrowers have one last chance to obtain favorable FHA financing as it winds down its post crisis support. Then it's back to PMI and second mortgages.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Julian Hebron runs housing blog The Basis Point.