I was shocked when President Trump cancelled a planned rate cut for FHA mortgage insurance. My first thought was, why is he picking on homebuyers? The program has sufficient funds to cover losses if a large number of people default. If the insurance works with lower premiums why not lower them? I can’t explain why someone would want to cancel a rate cut so many people were happy about, but I will share my perspective on how it affects homebuyers and sellers.
For background: Here is a link to an article that explains the basics of FHA loans and mortgage insurance. HUD Suspends the Planned FHA Mortgage Insurance Premium Cut
Here is how I see this cancellation affecting homebuyers and sellers. Most Buyers start their home search with a budget. They know what they can afford to pay monthly as a house payment. If they put less than twenty percent down that house payment includes mortgage insurance. Mortgage insurance does not give them any value but it has to be accounted for to make the loan work. So almost every Buyer has a number that their monthly principal, interest, taxes, and insurance can’t be greater than. When someone has a downpayment less than 20% of the home’s price then they also have to pay mortgage insurance every month. So their monthly payment includes principal, interest, taxes, insurance, and mortgage insurance. Add Homeowners Association fees if there are any but don’t worry about them for this example.
So when a Buyer goes to talk with a lender and see what they can afford they start with that monthly payment that both the lender and the borrower are comfortable with. Then they use current interest rates, local taxes, insurance averages, and the mortgage insurance rate to determine what that monthly payment equals in a loan amount. They add that amount to the Buyer’s downpayment and they know what purchase price the Buyer can afford. So as property tax, interest, and/or mortgage insurance rates are lower, Buyers can afford larger principal payments. That translates to Buyers having larger house budgets and being able to pay higher prices for homes.
For many Buyers with low incomes or in cities with expensive housing, any interest or mortgage insurance rate change means those Buyers can’t afford homes even at the lowest end of the market. So if they want to buy a home then they have to find a lower priced housing market nearby or move jobs to a place where they can afford to buy a home. For Buyers who aren’t at the very bottom of the market but who are shopping by monthly payment, they will either stretch beyond a payment they feel comfortable with but can still technically afford to get a house that they like or lower their house budget and likely also their expectations.
Since mortgage interest rates are likely to rise over the next year, this FHA mortgage interest rate change would have helped offset that for some Buyers and allow them to keep their same house budgets and stay looking for the same priced houses. It would have helped keep buying houses affordable for more people.
This change also affects Sellers. If by raising the cost of a monthly house payment some Buyers are removed from the market, then it takes some demand out of the market. If other Buyers are lowering their budgets then it also helps to keep prices down. Since many homes that FHA borrowers buy are sold by owner occupants who are planning to move up into nicer homes, then lower demand means their homes might sell for lower prices or take longer to sell. That will dampen the market in higher price ranges.
So this rate change that was going to help more Buyers afford houses and other Buyers to afford slightly more expensive houses has been cancelled. The hopeful Buyers who were shopping with a quote that included the forthcoming insurance rate change will have to revise their budgets. Hopefully they can all still find houses they can afford to buy before interest rates go up and change their affordability scenario again.
One group this rate change will benefit is real estate investors who have rental property. Those with tenants who were about to buy a home but now cannot afford one will get to keep their tenants. It will also keep some of the “starter house” competition out of the lower end of the housing market, which will make it easier for investors to buy those properties. Another group it will benefit are Buyers with money. Buyers with enough money even to qualify for conventional loans or those with enough to put down at least 20% for their downpayments will have less competition.
What really gets to me about this is that FHA borrowers are often some of the most vulnerable Buyers. They may be first time homebuyers and they may also be the first in their family to buy a house. They are typically not the Buyers whose family is giving them a significant contribution toward the purchase. They also often have lower credit scores or more late payment histories than Buyers using conventional loans. To me they need to buy homes so they can get out of the renting cycle and start to build wealth. Often a monthly house payment will be less than they pay in rent in a market like Nashville. So their credit will likely improve once they become homeowners. For these reasons I am most bothered by the cancellation of the FHA mortgage insurance rate cut.
