It was recently announced that the FHA, which has historically been the go-to mortgage option for borrowers with limited down payments and credit, is planning to reduce its mortgage insurance premium from 1.35% of a loan's value per year to 0.85%. This comes on the heels of an announcement that both Fannie Mae and Freddie Mac are rolling out new products designed to let first-timers buy a home with as little as 3% down.
This is a huge development, and could encourage a lot of current renters to finally take the plunge into homeownership. And more importantly, it could give the U.S. real estate recovery, which slowed down in 2014, a big kick-start in 2015.
What kind of an impact could the mortgage insurance reduction have?
First off, it's important to note that "FHA mortgage insurance" actually refers to two different things. Buyers pay an upfront premium when they buy a house, which is currently 1.75% of the purchase price, and there is no indication that this rate is going to change as of this writing. This premium can usually be rolled into the mortgage, so buyers don't have to actually pay it at closing.
The other part of FHA mortgage insurance is the annual premium, which is the part that is being cut from 1.35% to 0.85%. This is assessed as a percentage of the loan balance each year, and is tacked on to the borrower's monthly payments. So, what kind of difference does this make?
Well, a borrower with a $200,000 30-year FHA mortgage would see their annual premium drop from $2,700 to $1,700, which would save them about $83 per month on their mortgage payment. Over the life of a 30-year loan, the savings could add up to nearly $20,000. I think it's fair to say that this is a pretty significant change.
Competition for borrowers has created two great options for first-timers
I'm pretty sure that the reduction is a direct response to the recently announced programs from Fannie and Freddie, which allow first-time homebuyers to get a non-FHA mortgage with as little as 3% down (FHA loans require 3.5%).
Since the mortgage insurance on FHA loans has gotten much more expensive over the past few years, this is a very desirable option for borrowers. With a loan that is eligible to be purchased by Fannie or Freddie, the borrower qualifies for private mortgage insurance, which is likely to be at a much lower premium rate that the FHA's current 1.35%.
Now the FHA has decided to drop its premium to a level that is more competitive with what a buyer could obtain on a private market. Since the FHA is still trying to build up its capital reserves to ensure it will never need another bailout, the agency certainly doesn't want to see all of its first-time homebuyers apply for low down payment conventional loan options instead.
Not only are FHA loans finally becoming a more affordable option for renters who want to buy a house, but there are two options to choose from. And, like the saying goes, when companies compete, consumers win.
How much of an impact could this have?
This has the potential to be a very big deal for housing. It's getting more expensive to rent an apartment or house, and a recent Federal Reserve report found that 45% of renters were delaying buying a home because they couldn't afford the down payment.
Since more than 30% of all housing units in the U.S. (or about 41 million) are currently renter-occupied, this translates to more than 18 million renters who want to buy a home but could benefit from a low down payment option. Well, now they have it.