Among the many new directives and executive orders already issued by the Trump administration is a little-noticed order to halt a scheduled cut in mortgage insurance fees levied by the FHA.
Earlier in January, the Obama administration announced it would cut the FHA’s insurance premium by a quarter of a percentage point to 0.60 percent, effective on Jan. 27.
The fact that this all seems like a tiny technical issue is perhaps part of the reason why the media has paid so little attention to it. However, the Trump administration’s move suggests the Administration may actually be willing to go against the grain on the Federal-government’s long-term — but failed — commitment to subsidizing home-buying and blowing up housing asset bubbles.
Why Care About FHA Insurance Premiums?
FHA insurance is an important issue because the program subsidizes banks, real estate agents, and some home buyers by making loans cheaper. The FHA programs lessens to risk to lenders who make loans to riskier borrowers.
As Bloomberg has explained, “The FHA sells insurance to protect against defaults and doesn’t issue mortgages. It is a popular program among first-time home buyers because it allows borrowers to make a down payment of as low as 3.5 percent with a credit score of 580, on a scale of 300 to 850.”
Lenders don’t like to make loans to borrowers unless they have good credit and can put down enough of a downpayment to ensure they have some “skin in the game.” If borrowers put very little into the house at the time of purchase, they’re more likely to default. So, when borrowers have poor credit and can only bring a very small downpayment to the table, lenders usually require the borrower to purchase mortgage insurance to cover the lender in case the borrower defaults.
However, in a private marketplace, some especially unattractive borrowers won’t even qualify for mortgage insurance — at least not at the same low rates — and thus will be unable to buy a home as cheaply.
Subsidies Drive up Home Prices
Enter the Federal Housing Administration (FHA) and its mortgage insurance program. Since everyone knows the federal government will bail out the FHA and pay its premiums — even if the FHA insures a bunch of high-risk loans that end up in default — banks use FHA loans to provide insurance on their riskiest lenders. This means more loans get made, more lenders collect more mortgage payments, and more Realtors collect their commissions. But, it also means more loans get made to high-risk borrowers. This drives up home prices because the presence of the FHA expands the pool of homebuyers even down to people who have virtually no money for downpayments and have bad credit histories.
In other words, there would be fewer buyers and less demand — and thus less home price inflation — if the FHA did not exist. As happens any time a government provides cheaper loans so more people can buy something — as with higher education — the subsidy only drives prices higher.
Proponents of the program of course claim that the program increases homeownership rates. Given that homeownership rates are now back where they were 50 years ago, it’s hard to see the program’s “success.”
By putting the brakes on the scheduled cut to the FHA fees, the Trump administration is in effect reducing the number of loans made to the riskiest borrowers, and it is making the FHA less likely to become insolvent and in need of a government bailout.
Nor is the prospect of an FHA bailout something beyond the realm of possibility. The FHA was, in fact, bailed out in 2013 after the agency’s reserves were exhausted in the wake of a rash of foreclosures following the 2008 financial crisis.
The Trump Administration’s move also lessens the longtime Federal preference for policies that favor spending and punish savings. Policies that encourage homebuyers to buy and spend right now — as does a policy of easy money through cheap FHA premiums — pushes consumers away from saving up for downpayments. The net effect is to encourage riskier loans for more homeowners with little invested in their homes. When an economic shock does come, these people are more likely to end up underwater.
Not surprisingly, the real estate industry has protested the move. Naturally, the real estate industry wants more home sales no matter how risky and bailout-prone the home loans might be. If Congress is willing to subsidize the Realtors and bankers in the form of artificially cheap mortgage insurance, these industries don’t see a problem.
But don’t look for the NAR to admit that rock-bottom FHA fees are a subsidy. The view of many opponents of the Trump Administration’s move is that FHA mortgage insurance is a “right” and not something underwritten by the taxpayer.
Is a Subsidy Cut a “Tax Increase”?
This can be the only explanation for a bizarro article at The Intercept titled “On His First Day in Office, Trump Raises Taxes on Middle-Class Homebuyers.” Even for The Intercept, calling a fee increase on a government subsidy program a “tax” is quite a stretch. If we accept this definition of “tax,” then we’d have to define any increase in the interest rate for student loans as a tax. And thus, anyone who is for cuts in the student loan subsidy is therefore in favor of a “tax increase.” In other words, what’s up is down, and what’s down is up.
In the real world, though, cutbacks in the FHA program are in effect a tax cut for people who actually save their money and can thus afford to put down more than a tiny token down payment. And, it’s a tax cut for the taxpayer who is off the hook for covering the next bailout of FHA. Moreover, it’s a tax cut for the private mortgage insurance industry — and thus all its employees and customers — since FHA has for years been crowding the PMI industry out of much of the market through FHA intervention in the marketplace.
So, yes, this will indeed increase costs for people who want to buy a home with lousy credit and no money for a downpayment. It will also increase costs for commercial lenders who have themselves been bailed out, and who want to make sure the FHA will be there to bail them out the next time things go south. But that’s a long way from anything that can be defined as a “tax increase.”