The FHA loan program has grown in popularity since the housing crisis began in 2008. It has become the financing tool of choice for many home buyers, especially those with limited down payments or shaky credit.
This trend will likely continue in 2013. In fact, new mortgage-lending rules could steer even more borrowers toward the FHA program in 2013. Here’s a rundown of recent developments.
Growth in FHA Market Share, 2008 – Present
The housing crisis came to a head in 2008. That’s also when the FHA’s market share skyrocketed. This is no coincidence.
During the housing boom of the early 2000s, it was fairly easy to qualify for a mortgage loan. You didn’t even have to document your income. You could opt for a ‘stated income’ loan, and simply tell the lender how much you made. Payments too big? Just defer the principal and pay only the interest. No credit? No problem. Try one of our subprime mortgage options. It was the real estate equivalent of a used car clearance sale.
Things have changed. Today, those same lenders will require a mountain of paperwork to verify your income, debts and assets. No more winks and handshakes. You have to provide evidence. Lenders are also requiring higher credit scores and lower debt levels than before the crisis. These tougher requirements have sent an increasing number of borrowers to the FHA loan program.
The chart below says it all. During the housing boom, on the left side of the chart, FHA’s share of the mortgage market fell below 5%. It was easier to qualify for a conventional loan back then. So fewer people had to resort to government-backed mortgages. When the bubble burst, FHA’s market share shot up to nearly 40% (represented by the green bars in the chart). So there is a direct correlation between conventional lending standards and the popularity of FHA loans.
The Department of Housing and Urban Development (HUD), which manages the program, summed it up this way: “In recent years, FHA has experienced significant swings in its market share as it has stepped in to provide capital for qualified borrowers who would otherwise be shut out of the borrowers mortgage market.”
This program is especially popular among low-income borrowers and minorities. According to HUD data, 60% of Latino and African American home buyers used FHA loans to buy a home in the last year.
Mortgage Insurance Will Cost More in 2013
While the popularity of FHA has risen, so too have the costs. Borrowers who use these loans must pay a mortgage insurance premium. In fact, there are two premiums. There’s an annual mortgage insurance premium (MIP), as well as an upfront premium. Despite their names, both can be rolled into the loan and spread over monthly payments.
HUD raised the annual MIP for FHA loans in April 2011, in response to capital reserve shortfalls. They recently announced they will raise it again. So any borrower who uses an FHA loan to buy a house in 2013 will face higher premiums, averaging an extra $13 per month.
They are charging the higher fees to avoid the necessity of a taxpayer bailout, which they haven’t ruled out. HUD Secretary Shaun Donovan believes the recent changes “have significantly decreased the chance of having a bailout at the end of 2013.”
Congress is pressing for reform at the FHA, so we can probably expect additional changes in the coming months.
Low Rates Expected to Continue in 2013
While FHA mortgage premiums may be rising, interest rates are expected to remain low. Some recent predictions from industry insiders suggest that 30-year rates on home loans could stay below 4% throughout 2013. Rates for conventional and government-backed loans generally track closely, so that prediction applies to the FHA program as well.
The Mortgage Bankers Association has also predicted that rates will remain below 4% next year, partly due to the Federal Reserve’s ‘quantitative easing’ policy. Fed Chairman Ben Bernanke said that the latest round of easing should “put downward pressure on mortgage rates and create more demand for homes and more refinancing.”
The interest rate assigned to a loan is partly influenced by the borrower’s qualifications. This may come as a surprise to some first-time buyers. For instance, we publish a weekly average of FHA rates being offered by lenders. But not all borrowers will qualify for the average. Some will qualify for a lower rate, and some will be assigned a higher one. Mortgage lending is a highly individualized process. Borrowers with excellent credit and minimal debt typically qualify for lower rates — and vice versa.
The bottom line: Well-qualified borrowers may find FHA mortgage rates below 4%, for at least the first half of 2013.
New Lending Rules on the Horizon
A new set of lending rules is scheduled to take effect next year. Collectively, they are known as the qualified mortgage, or QM. They are an offshoot of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
In short, QM creates a set of standardized rules and qualifications for home loans. Lenders who adhere to these rules when generating loans will be offered some degree of legal protection against consumer lawsuits. So the new rules could set the bar in terms of lending standards.
You can learn more in our qualified mortgage fact sheet.
We won’t know exactly what those rules look like until the January 2013 deadline for finalization. But if they turn out to be stricter than expected, a higher number of borrowers could resort to using FHA loans when buying a house.
In summary, we expect FHA’s share of home purchase loans to remain consistent next year, despite the increase in mortgage insurance premiums. If the new lending rules make conventional loans harder to come by, FHA’s market share could once more approach — or even exceed — the 40% level. Interest rates on 30-year fixed mortgages will likely remain below 4% in 2013, though much depends on the borrower’s qualifications.