WASHINGTON — Federal Housing Administration borrowers have been refinancing faster than expected and the run off is creating a drag on efforts to build up the capital reserves of the agency's mortgage insurance fund.
Borrowers appear to be responding to declining interest rates, but fewer are taking advantage of FHA's streamline refinancing program, instead choosing to refinance into other loan products.
"FHA is not getting many of those loans back like they used to," said Brian Chappelle, co-founder of Potomac Partners.
FHA used to have a loan retention rate around 55% before the agency implemented a life of loan policy in 2013 that requires borrowers to pay an 85-basis point annual premium for the entire term of the mortgage. Previously, the annual premium expired when the borrower's loan-to-value reached 78%.
The result is that borrowers have increasingly chosen to refinance away from FHA products to avoid the life of loan premium. From June 2013 through April of this year, 2.4 million borrowers prepaid their FHA loans and only 650,000 refinanced back into an FHA-insured loan. The retention rate has fallen to 28%, according to FHA data.
"FHA has lost several billions of revenue because of the excessive run-off," Chappelle said. "All it is doing is encouraging prepayments and discouraging retention. The real troubling thing is the loans that prepay are the best loans and they don't come back."
A HUD spokesperson did not respond to requests for comment.
Some industry observers are worried that too many FHA borrowers are refinancing after two or three years and ditching their FHA loan because they don't want to get stuck paying annual premiums for 15 to 30 years.
"Requiring the annual mortgage insurance premium for the life of the loan will encourage strong borrowers to refinance out of the FHA portfolio, weakening the quality of FHA's books of business in the future," the National Association of Realtors warned in an April 7 letter to FHA. "Now that the housing market has recovered, NAR urges the FHA to reinstate cancellation of annual premium premiums for all borrowers that reach 78% LTV assuming the borrower has paid the annual premium for at least five years."
FHA also charges a 1.75% upfront premium that can be rolled into the loan balance at closing.
So far, the life of loan policy has not generated revenues for FHA because it takes a few years to reach a 78% LTV ratio, even with good house appreciation.
FHA borrowers that refinance tend to have better credit scores and more equity due to house price appreciation over the past few years. That gives them the opportunity to refinance into Fannie Mae, Freddie Mac or other loan products.
Over a six-month period ending March 31, nearly 456,780 FHA borrowers prepaid their loans, which was 99,723 more than FHA's auditors predicted.
"Prepayment speeds reversed course...and are now once again higher than predicted," the FHA said in its quarterly report dated June 9.
But some industry representatives downplayed concerns about the runoff/retention issue, seeing other market forces at work.
"Several large institutions are doing everything possible to de-emphasize FHA originations and they are offering alternatives," said David Stevens, the president of the Mortgage Bankers Association.
Some big lenders don't want the representation and warranty and False Claims Act risk that comes with the FHA program.
"A lot of the new purchase business is still going to FHA — albeit less now that many banks have created alternatives," Stevens said.
Stevens also pointed out that FHA auditors always assume a lot of run-off in the annual actuarial report and low replenishment rates.
"I am not sure any actual runoff they are seeing now is going to negatively impact them [FHA] too much, because they already assume very low replenishment rates, " Stevens said.
The new FHA loans being originated today are "better credit quality than in the past. It is hard to forecast," he said.
The annual FHA actuarial report is conducted by independent auditors. In November, they reported the FHA mortgage insurance fund reached a 2.07% capital ratio, marking the first time since the financial crisis that the agency exceeded its statutory capital minimum of 2%.
Meanwhile, there is a lot of speculation about when and if FHA will revamp its mortgage insurance premium structure before the Obama administration's term ends in January.
"I don't see any real reason for reducing premiums right now with interest rates so low," Stevens said.
"Some argue it could hurt liquidity in the market," he said. "Ginnie Mae investors are already nervous because it would cause faster prepayments."
But Isaac Boltanksy, a policy analyst, recently raised the odds of a FHA premium cut in 2016 to 60% from 30%.
"Some contacts believe a cut will be announced before the November election to ensure the maximum political benefit while other contacts argue that the FHA will likely wait to make an announcement until after the release of its actuarial report in mid-November," Boltansky said in a recent Compass Point Research & Trading report.
"Given the shift in commentary, we believe the odds now favor another 30 [basis point] cut in the annual FHA MIP and/or a 50-bps cut in the up-front MIP effective in 2017, but the decision is not yet certain and our sense is that changes to" the agency's life of loan policy "remain unlikely."
Chappelle argues that the FHA should raise the upfront premium, lower the annual premium and eliminate life of loan. If FHA raised the upfront to 3% from 1.75%, "that would increase the borrower's payment on a $200,000 house by $12 a month. By doing that you can lower the annual premium 30-bps to 55-bps and eliminate life of loan," he said.
But FHA principal deputy assistant secretary Edward Golding has made it very clear that "FHA is not competing for market share," according to Stevens. The Department of Housing and Urban Development wants to make sure FHA is financially healthy and ready for bad times when the housing market needs a government backstop.
"I think there is a possibility for a premium reduction. They may do it before the end of the Obama administration. It probably would be pretty small," Stevens said.
