In 2013, the Federal Housing Administration (FHA) began requiring borrowers to pay the Mortgage Insurance Premium (MIP) for the life of an FHA loan. This change triggered controversy. People have equated FHA insurance to that of private mortgage insurance used by the government-sponsored enterprises (GSEs), which is not life-of-loan. Understanding the difference between FHA and private mortgage insurance can shed light on why FHA changed its policy.
It can also help explain the benefits of changing the FHA MIP policy to a sliding scale to better reflect FHA’s actual risk and the economics of a GSE transaction.
To begin, the following description of the GSE programs versus the FHA program will help illuminate why FHA changed its policy to require life of loan MIPs but the GSEs did not.
The base GSE assumption in pricing their respective guarantee fees (g-fees) is the amount of first-loss protection that stands in front of their guarantees. The GSEs assume there will be first-loss coverage of at least 20% of the home’s value. The 20% requirement can be met either by the borrower making a 20% down payment or a combination of the borrower’s down payment and mortgage insurance.
For loans that require mortgage insurance, the GSEs permit automatic termination of the insurance if a borrower amortizes their equity to 22% or more of the original property value. This would bring the current loan-to-value ratio (LTV) to 78% or less, at which point the GSEs would have first-loss protection above their assumed level g-fee pricing assumption. The GSEs also allow borrowers to request that their MI be dropped at 75% LTV with acceptable third-party validation of the current property value.
The GSEs’ decision to permit mortgage insurance termination on these terms reflects their belief that there is no longer a need for mortgage insurance with this much first-loss protection in place. It is also important to note that the borrower is still required to continue paying the applicable g-fee — around 50 basis points — even after the mortgage insurance is dropped, and receives no refund of any loan level pricing adjustment (LLPA) included in the loan’s pricing at origination.
The FHA program is more of a loan guarantee program than a mortgage insurance program. FHA insures 100% of the loan’s unpaid principal balance and out-of-pocket expenses, replicating the GSE guarantor program.
Prior to the 2013 policy change, FHA did not collect the MIP on loans that had amortized to an LTV of 78%. This policy put the American taxpayer in what some stakeholders believed was an unfair position: FHA was still responsible for losses that occur on the loan in the future without receiving any compensation for that continuing liability.
FHA sustained uncompensated losses from the prior policy of dropping the MIP at 78% during the financial crisis. FHA estimates that when the policy changed to life-of-loan coverage, $350 billion of loans were not paying any MIP, causing FHA to pay claims on $26 billion of the loans whose mortgage insurance premiums had been cancelled.
I believe the basic criticism of the 2013 FHA life-of-loan policy change is valid. The loss severity on a 78% LTV loan is less than it is on a 97% LTV (which is the original LTV of the majority of FHA loans). There is a better way to determine the appropriate risk-based MIP for a 78% LTV loan than the FHA’s “all-or-none” approach: FHA should work with their actuary to determine an MIP that properly covers expected losses at a 78% LTV.
The FHA MIP at 78% LTV should be substantially lower than the 50-basis point GSE g-fee because FHA is a nonprofit program. For example, if FHA’s actuary determined that an MIP of 20 basis points is the appropriate risk-based premium for a 78% LTV loan, the borrower would save approximately 30 basis points in their mortgage payment’s interest rate component versus refinancing into a GSE loan.
In the absence of knowing the appropriate MIP for a 78% LTV loan, the following table reflects the monthly mortgage payment a borrower would be required to pay at various MIP levels versus a loan being refinanced into a GSE loan. The following assumptions were used:
- Base loan amount of $300,000 for both the FHA loan and the GSE loan.
- FHA note rate of 3.00%.
- FHA servicing fee of 44 basis points.
- FHA loan carries a Ginnie Mae guarantee fee of 6 basis points.
- FHA loan carries a current MIP of 85 basis points.
- GSE loan amount of $311,250 (including $6,000 in loan processing and closing costs and $5,250 in LLPAs based on an 80% LTV and 699 credit score).
- GSE note rate of 3.25%.
- GSE g-fee of 50 basis points.
- GSE servicing fee of 25 basis points.
Comparison of monthly payments between a GSE loan and an FHA loan at various MIPs
| Current Monthly Payment | 0.50% | 0.40% | 0.30% | 0.20% | |||||
| FHA | $1.410.70 | $1,347.13 | $1,330.44 | $1,313.87 | $1,297.40 | ||||
| GSE | $1,354.58 | $1,354.58 | $1,354.58 | $1,354.58 | $1,354.40 | ||||
| Difference | $56.12 | $(7.45) | $(24.14) | $(40.71) | $(57.00) |
FHA’s actual risk shifts along a scale as the loan’s LTV decreases. Accordingly, FHA should also develop a process that would allow borrowers to request that their MIP be lowered at a 75% LTV. The process should allow the loan to reach the 75% threshold through a combination of principal paydown and home value appreciation (subject to an acceptable third-party valuation).
By implementing this policy change, FHA would align its policy with the GSEs so that borrowers would not be required to refinance their loans to eliminate the need for MIPs and thus reduce their payments. Under this proposal, borrowers that request their MIP be dropped at 75% would have their MIP reduced to the value used for borrowers that had their MIP reduced automatically through amortization to a 78% LTV.
This policy change would allow FHA to retain the highest quality loans in its Mutual Mortgage Insurance (MMI) Fund. This is important since currently the highest quality loans in the FHA program are refinancing into the GSE loan programs. When these high-quality loans are refinanced into GSE loans, FHA no longer receives MIPs on loans that have a much lower probability of default.
If FHA reduced its MIP to reflect its risk more accurately for 78% LTV loans, it would improve the FHA program in the following ways:
- FHA borrowers would not have to refinance their loans into GSE loans to avoid paying an excessive MIP.
- FHA borrowers would no longer need to pay costly transaction costs to refinance their FHA loans into GSE loans.
- FHA would keep its highest quality loans in the MMI fund.
- Ginnie Mae mortgage-backed securities (MBS) owners would have less prepayment volatility.
- FHA borrowers would no longer be trapped paying excessive MIPs in the event GSE refinances no longer make economic sense where interest rates increase.
- Ginnie Mae mortgage servicing rights would increase in value because of slower prepayment rates.
- The FHA and GSE programs would be aligned on the policy of dropping the requirement for supplemental credit enhancement.
Reducing the FHA MIP a borrower pays when their LTV is reduced to 78% or less is valuable to all stakeholders, including borrowers, servicers, FHA and Ginnie Mae MBS owners. FHA should work with their actuary to develop a pricing structure to replicate the GSE structure of a base MIP for a 78% or lower LTV and supplemental MIP for loans with LTVs over 78%.
FHA should include in a loan’s mortgage note interest rate the base MIP and the supplemental MIP would be paid out of the borrower’s escrow account. This structure would allow for the borrower to have their supplemental MIP dropped when their loan reaches a 78% LTV or less through amortization or appreciation.
Until the new structure of embedding the base MIP in the note interest rate is implemented, FHA should change its “all or nothing” MIP policy and reduce borrowers’ MIP payment once the loan has reached an LTV of 78% or less through amortization or appreciation.
Ted Tozer is a senior fellow at the Milken Institute’s Center for Financial Markets. Prior to joining the Institute he served as the president of Ginnie Mae for seven years.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story:
Ted Tozer at tedtozer1@gmail.com
To contact the editor responsible for this story:
Sarah Wheeler at swheeler@housingwire.com
