Upfront premiums for FHA-guaranteed loans could soon be reduced by more than half, but annual premiums on the government-sponsored mortgage insurance are expected to nearly double now that Congress has given FHA authority to revamp the way premiums are structured.

Faced with rising losses on FHA-guaranteed loans, the Department of Housing and Urban Development (HUD) hiked upfront premiums in April, raising them from 1.75 percent of the loan being insured to 2.25 percent.

Editor’s note: This story has been updated and corrected. FHA has pushed back the schedule for implementing changes to premium structuring from Sept. 7 to Oct. 4. Upfront premiums will be reduced to 1 percent, not 1.25 percent as stated in a previous version of this story.

Upfront premiums for FHA-guaranteed loans will soon be reduced by more than half, but annual premiums on the government-sponsored mortgage insurance will nearly double now that Congress has given FHA authority to revamp the way premiums are structured.

Faced with rising losses on FHA-guaranteed loans, the Department of Housing and Urban Development (HUD) hiked upfront premiums in April, raising them from 1.75 percent of the loan being insured to 2.25 percent.

Applications for FHA-guaranteed loans fell nearly 20 percent after the increase went into effect, according to a weekly survey conducted by the Mortgage Bankers Association.

But in detailing its plans in February, HUD promised it would roll back upfront premiums if Congress gave it the authority to raise annual premiums instead.

Legislation raising the statutory cap on annual premiums from 0.55 percent to 1.55 percent, HR 5981, passed the House on July 30 and was approved by the Senate by unanimous consent Wednesday.

The next day, Federal Housing Commissioner David Stevens announced that upfront premiums will be reduced to 1 percent, but that annual premiums won’t be increased all the way to the statutory limit just yet.

Stevens said HUD will follow the course laid out by the Obama administration in February, increasing annual premiums for FHA mortgage insurance to 0.85 percent for borrowers with loan-to-value ratios of up to 95 percent and to 0.9 percent for borrowers with higher LTVs.

The changes were originally scheduled to take effect Sept. 7, Stevens said in a letter to FHA lenders, but the implementation date was later pushed back to Oct. 4 to give lenders more time to update their systems. 

The way premiums are currently structured, a borrower taking out a $200,000 loan with the 3.5 percent minimum downpayment pays an upfront premium of about $4,500, plus $1,100 a year in annual premiums.

When HUD rolls back upfront premiums to 1 percent and increases annual premiums, that borrower would pay an upfront premium of about $2,000, plus $1,800 a year in annual premiums. The $700 increase in annual premiums would translate into an additional $58 a month on their mortgage payment.

The Mortgage Bankers Association welcomed that prospect.

"We are encouraged that FHA Commissioner Stevens has indicated he may not need to raise premiums to the maximum, and we believe that that a small increase in the annual premium, coupled with a decrease in FHA’s upfront premium, will help stabilize FHA while lowering closing costs for many borrowers," MBA Chairman Robert Story said in a statement.

The MBA also welcomed Senate passage of HR 5872, which increases FHA’s authority to insure multifamily loans by $5 billion for the remainder of the fiscal year.

The changes in FHA premium structure are one of several steps taken to stem losses.

An actuarial report revealed in November that FHA’s capital reserve ratio had fallen below the 2 percent minimum set by Congress, raising fears that the program would require a taxpayer bailout. HUD maintained that premiums collected on new loans should cover losses and that the program is unlikely to end up in the red except under the most dire circumstances.

But in December, HUD announced it would tighten underwriting standards on FHA-backed loans by increasing the amount of upfront cash homebuyers must bring to the table, raising minimum FICO scores for new borrowers, and reducing maximum seller concessions from 6 percent to 3 percent.

HUD published a notice in the Federal Register on July 15 outlining further details of those proposed changes, and is accepting public comments until Aug. 16. After reviewing the comments it receives, HUD will publish a final notice that will include the implementation date for the changes.

HUD and Congress had previously put in place a ban on seller-financed downpayment assistance on FHA loans, tightened underwriting guidelines for streamline and cash-out refinancings, updated FHA appraisal standards, and increased oversight of lenders.

In their latest quarterly report to Congress on the performance of FHA-guaranteed single-family home loans, HUD said this week that the credit quality of recent loans has improved, and claims have been lower than predicted by the actuarial report.

New 90-day delinquencies during the quarter ending June 30 were down 32 percent from the quarter ending Dec. 31, to 104,000, the report said, and FHA has received 19,310 fewer claims and paid $3.7 billion less than projected.

Average FICO scores, which were in the 630s during much of 2007 and early 2008, are now approaching 700, and less than 1 percent of new loans rely on downpayment assistance, compared with about one in four loans in 2007 and 2008 (downpayment assistance from charities is still permitted).

The report said FHA is on a pace to insure 1.7 million loans in the year ending Sept. 30, and may insure more than 1 million purchase loans for the first time since 1987.  

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