Think Rising Rates Will Hurt FHA Fund? Think Again

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WASHINGTON — The financial performance of the Federal Housing Administration's mortgage insurance fund is expected to steadily improve over the next few years despite rising mortgage rates.

The FHA actuarial report released this week shows rising rates will slow insurance written on single-family loans to $170 billion in fiscal year 2016, which started Oct. 1, down from $193 billion in fiscal 2015. These figures exclude reverse mortgages.

Projections call for "positive near-term house price growth at the national level and a near-term rapid rise in mortgage rates," the report said.

Independent auditors at Integrated Financial Engineering in Rockville, Md., prepare the report, using economic forecasts provided by Moody's Analytics.

Moody's projects that mortgage rates will "steadily rise" to 5.09% in fiscal year 2016, 6.07% in 2017 and 6.24% in 2018.

"We then expect FHA [insurance] volume to revert to the $190 billion range for [fiscal year] 2019 and beyond given Moody's baseline scenario for the economy and the housing market," the FHA report says.

It seems rising mortgage rates benefit the insurance fund because it results in fewer refinancings by existing FHA borrowers. When rates rise, borrowers want to keep their lower-cost mortgages and that means they pay their FHA mortgage insurance premiums over a longer period of time.

The actuarial report shows the fund, which covers the FHA's forward and reverse mortgage programs, has a capital ratio of 2.07%. It was the first time since 2009 that the FHA exceeded its statutory minimum capital requirement of 2%.

On its own, the FHA forward portfolio has a capital ratio of 1.6% and reserves of $17 billion.

"The FHA predicts the forward portfolio needs an additional $4 billion to meet a 2% requirement and $13 billion to withstand the level of losses sustained in the last crisis," Ed Mills, policy analyst with FBR Capital Markets in Arlington, Va., wrote in a Nov. 16 report. "FHA predicts the forward portfolio can reach both goals in the next one or two years."

Mark Zandi, the chief economist at Moody's Analytics, said he thinks that will happen sooner rather than later. "I expect the capital ratio for the forward program to rise above 2% next year," he wrote in an email in response to a reporter's query.

Brian Montgomery, an FHA commissioner during the Bush administration in the mid-2000s, described the report as upbeat.

The combined programs "exceeded the 2% minimum requirement a year sooner than projected in last year's actuarial report," he said.

And the fund jumped to $23.8 billion in fiscal year 2015 from $4.8 billion the previous year.

"If I were [at the FHA today], I would be pretty happy," Montgomery said in an interview. "And in some ways it shows what [FHA officials] are doing is working."

The FHA is returning to its traditional role of helping first-time homebuyers with a few blemishes on their credit record, said Montgomery, who is vice chairman of the Collingwood Group, a Washington consulting firm.

"Anything FHA can do to find that balance between risk and open the aperture a little bit on credit scores is a move in the right direction," Montgomery said.

But a policy analyst who spoke privately said the FHA will need to maintain its current mortgage insurance structure if it wants to increase lending to riskier borrowers. "You can't target lower-credit-score borrowers and cut your premiums," he said.

The FHA reduced its 1.35% annual premium by 50 basis points in early February. But Edward Golding, the agency's deputy principal assistant secretary, told reporters Monday that he does not have any plans at this point to further reduce premiums.

Mills contends that the FHA "could propose changes on the margin, possibly reducing the up-front premium paid or making changes to current standards, possibly eliminating the life-of-loan requirement for a subset of loans."

The FHA currently charges a 1.75% up-front premium — the highest in the history of the FHA program. The agency also has a life-of-the-loan policy, which requires borrowers to pay the annual premium for the entire term of the loan. The annual premium used to terminate when the loan-to-value ratio hit 78%.

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