An FHA mortgage premium cut will only raise prices

With a new federal administration in place, some are calling for a reduction in the Federal Housing Administration's mortgage insurance premium as a way to "help" borrowers struggling with higher mortgage rates. But history tells us that such a move, particularly in today's housing market, would backfire—raising home prices, benefiting existing homeowners and real estate agents, and exposing taxpayers to greater risk.

This is a policy we've seen before, and it doesn't work. FHA cut its MIP in January 2015, reducing it by 50 basis points. At the time, FHA predicted this move would bring 250,000 new first-time homebuyers into the market over three years and save each FHA buyer $900 annually. Instead, the result was higher home prices in FHA-dominated neighborhoods, with prices increasing 2.5 percentage points faster than in comparable markets. Only 17,000 additional first-time buyers entered the market—far short of FHA's projection.

The real beneficiaries of this policy were existing homeowners, who gained from higher asset values, and real estate agents, who saw an estimated $2.8 billion windfall from increased commissions due to inflated home prices. Prospective homebuyers—the very people FHA claimed to help—were left no better off, forced to pay more for the same homes.

Fast forward to February 2023, when FHA again cut its MIP, and the results were predictably similar. Our updated study found that home prices once again rose proportionally in response, proving that when demand-side subsidies are introduced in a tight housing market, they get capitalized into higher prices—reducing affordability rather than increasing it.

Market conditions today are even less favorable for an MIP cut. As of December 2024, the supply of homes in the lowest price tier stands at just 2.5 months—one of the tightest markets on record. In January 2015, when the previous cut was implemented, supply stood at 3.9 months, and even then, affordability worsened. With today's even lower inventory, an MIP reduction would once again be absorbed into home prices, offering no real relief to buyers.

Cutting the MIP is effectively a wealth transfer from FHA's capital reserve fund—which is meant to protect taxpayers—to existing homeowners and real estate agents. The Mutual Mortgage Insurance Fund (MMIF), which backs FHA loans, currently boasts a capital reserve ratio of 11.5%, well above the statutory 2% minimum. While some argue this surplus justifies a premium cut, economic uncertainty, rising default risks, and potential losses from recent natural disasters all demand a more cautious approach.

Instead of a reckless giveaway, FHA should prioritize maintaining its financial stability. The 2% threshold has long been recognized as inadequate for catastrophic losses, and in an environment of economic uncertainty, FHA should be fortifying its reserves—not depleting them.

If FHA wants to truly help borrowers, it should focus on policies that improve long-term financial stability rather than inflating home prices. A far superior alternative to an MIP cut on 30-year loans would be reducing MIP rates on 20-year loans, aligning payments between 20- and 30-year terms.

This approach would encourage lower-income borrowers to build wealth faster, as they would pay off their loans sooner and accumulate home equity more rapidly. It would also reduce default risk, since shorter-term loans carry lower overall interest payments and help borrowers establish financial security more quickly.

Additionally, it would help stabilize neighborhoods, as homeowners with more equity are less likely to default or face foreclosure. Unlike an MIP cut on 30-year loans, this approach would not increase purchasing power in a tight housing market, avoiding the inflationary effect on home prices while ensuring more rapid equity buildup for FHA borrowers.

The lessons of 2015 and 2023 are clear: MIP cuts in tight housing markets do not help affordability. They inflate home prices, reward existing homeowners and real estate agents, and transfer wealth from FHA's reserve fund—backed by taxpayers—to private market participants.

Rather than repeating past mistakes, FHA should hold on to its reserves and explore solutions that actually help borrowers, reduce risk, and promote long-term financial security.

The Trump 2.0 FHA has an opportunity to chart a smarter path forward. Just as it did in 2017, when it rescinded an MIP cut hastily implemented in the final days of the Obama administration, it should stand firm against another misguided attempt to artificially boost housing demand at the expense of fiscal responsibility.