If you own a home or if you’re thinking about buying one, a recent White House decision will have an impact on your mortgage.
Early in 2017 President Trump issued an executive order reversing a rate cut on Federal Housing Administration (FHA) mortgage loans for homebuyers.
First-time, younger homebuyers generally take advantage of FHA-backed loans, which are designed to make homes more affordable.
Trump’s move isn’t surprising. Obama’s FHA rate cut and fee reduction created controversy among lenders and mortgage consultants. Though the cut was meant to save homebuyers money and lead to more mortgages overall, it would also have taken a bite out of the FHA’s capital reserves—possibly leading the housing market to crash, according to conservatives who back the reversal.
How will this decision affect homeowners and aspiring homeowners? The president of the National Association of Realtors estimates as many as 850,000 homeowners will see their mortgage costs rise, and 40,000 new homebuyers will be affected by higher closing costs and less attractive loan rates. Here’s what you need to know.
How do FHA loans work?
The FHA is part of the federal Department of Housing and Urban Development (HUD). When the FHA was founded in 1934, its goal was to stabilize the economy after the Great Depression by increasing opportunities for affordable homeownership. The FHA would step in when private lenders weren’t able to give credit to homebuyers.
FHA loans, made by private lenders and insured by the FHA, help would-be owners save on down payments and closing costs. First-time buyers, low-income buyers, and buyers with poor to fair credit are the main FHA loan recipients.
According to HUD, FHA-backed loans made up 16.6 percent of loans for single-family homes in 2016. In the same year, those loans added up to 1.26 million FHA-backed purchase loans and refinances for single-family homes alone.
The appeal of the FHA loans is their low down payment, as low as 3.5 percent for some buyers. Borrowers can also get mortgages despite suboptimal credit scores. The average credit score of an FHA borrower in 2016 was 679, considered a “fair” credit score for purchasing a home. But even borrowers with credit in the 500s and with past debts sent to collections can get FHA loans. Other lending agencies, like Fannie Mae and Freddie Mac, have stricter credit regulations.
What did Obama’s FHA rate cut mean for homebuyers?
Even with savings on the down payment, many FHA loan holders feel the impact of monthly mortgage insurance payments and added premiums. The FHA rate reduction saved one million borrowers, on average, $500 a year.
Fees were cut by a quarter of a percentage point (0.25 percentage points) of the total borrowed amount. A homeowner with a $190,000 loan, for instance—the average FHA-backed loan for 2016 – could see monthly payments drop by $40 per month. That monthly discount adds up to $480 per year in savings, and borrowers with pricier homes or heftier loans would save even more.
The FHA cuts were also intended to get more borrowers to qualify for the home-buying market. Lenders have strict debt-to-income ratios when it comes to homeowner’s insurance. With lower premiums to pay, younger potential homeowners with lower incomes and less established credit could meet lender requirements. In 2015 the FHA saw an estimated 75,000 borrowers with credit scores below 680 qualify for mortgages, thanks to FHA-backed loans.
The planned results? More affordable mortgages for a wider range of buyers, and a robust housing market.
Why did Trump reverse the FHA rate cut?
Many administration officials, even before Trump took office, were concerned about the rate cuts’ potential effect on the FHA mortgage insurance fund.
The FHA is required to have a capital reserve ratio—a percentage of the total deposits of customers—of at least 2 percent. The ratio finally reached a healthy 2.32 percent in 2016, making many government officials optimistic that the FHA could afford to reduce rates. Others worried if the rates dropped too low, the nation could lose money and end up with another housing crash.
Trump’s reversal of the planned rate cut means the rates will stay unchanged and the FHA’s capital reserve ratio will continue to rise.
What does Trump’s FHA reversal mean for homebuyers?
Both homebuyers and homeowners who have FHA loans will still be contributing at the original rate—0.85 percent of their mortgage amount each year (the annual rate dropped to 0.6 percent with the cuts). The higher costs may keep first-time buyers out of the market.
Say you have a $200,000 mortgage, close to the national average of $190,000. You’ll be paying $500 more a year (or $40 more a month) than you would have with the rate reduction.
Mortgage holders already paying the reduced rates will still see their mortgages climb by an average of $40 a month or $500 a year. Those in high-cost areas, like large cities, may be paying even more.
If you own a home or are about to buy one, plan on budgeting more for monthly mortgage payments. Fortunately, $500 a year usually isn’t huge savings compared to the cost of a home. Your expenses will increase, but probably not by much.
You could have a harder time securing a mortgage, however, if you’re in the market for a house. Without the lower rate, you’ll need a better debt-to-income ratio to be approved to borrow. Plan on paying the original 0.85 percent of your mortgage annually if you’re getting an FHA-backed loan.
The Trump administration has hinted at the possibility the reversal won’t be permanent, so Obama’s lower rates for FHA loans may be reinstated— but don’t count on it. Make sure to save plenty of money before taking out an FHA mortgage loan.
The new increase in FHA loan will make young and older homebuyers alike pay, on average, $500 more a year (or $40 a month) than with the reduction during Obama’s administration. And those looking to buy a home but have less than stellar credit will likely find it more difficult.