WASHINGTON — Federal Housing Administration borrowers have been refinancing faster than expected and the runoff 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 the FHA's streamlined refinancing program, instead choosing to refinance into other loan products.
The FHA "is not getting many of those loans back like they used to," said Brian Chappelle, co-founder of Potomac Partners.
The agency had a loan retention rate of around 55% before it 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.
The FHA "has lost several billions of revenue because of the excessive runoff," 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 do not 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 the 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."
The 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 the FHA because it takes a few years to reach a 78% LTV ratio, even with good house appreciation.
FHA borrowers who 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 that ended March 31, nearly 456,780 FHA borrowers prepaid their loans, which was 99,723 more than the FHA's auditors predicted.
"Prepayment speeds reversed course ... and are now once again higher than predicted," the FHA said June 9 in its quarterly report.
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 the FHA — albeit less now that many banks have created alternatives," Stevens said.
Stevens also pointed out that FHA auditors always assume a lot of runoff 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 [the FHA] too much, because they already assume very low replenishment rates," Stevens said.
The new FHA loans being originated today have "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 that the FHA mortgage insurance fund had 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 whether the 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 an 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," the report said, "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 housing agency should raise the upfront premium, lower the annual premium and get rid of the life-of-loan policy. If the 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 Edward Golding, principal deputy assistant secretary at the agency, has made it very clear that the FHA "is not competing for market share," according to Stevens. The Department of Housing and Urban Development wants to make sure the 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," Stevens said. "They may do it before the end of the Obama administration. It probably would be pretty small."