Eleven seconds after the inauguration, most major media headlined something like “Trump’s first act as President is to cancel FHA mortgage insurance reduction.” Facebookers pounced on the new President for making it harder for “working people” to buy homes.
While both type statements contain facts, they cloak those in emotional political rhetoric. I’ll circle back to that, but since many of the people commenting seemed to lack understanding of the issues, I’ll provide a little background. (“Reader’s Digest” version. Let me know if you want the “War and Peace” version.)
The FHA does not issue loans, but instead insures mortgages and collects fees from borrowers to reimburse lenders in case of default. Borrowers can qualify for an FHA-backed mortgage, with down payments as small as 3.5%, even with a credit score as low as 580, which could signal a past bankruptcy or debts sent to collection. FHA Guidelines also allow higher debt-to-income ratios, does not test for residual income , and make concessions on housing quality not typical for conventional and VA loans.
As a result of lower lending requirements, many more people are able to buy homes than would otherwise be the case. That is in fact the purpose of FHA.
Good credit risk management involves ‘layering of risk.’
If someone has a lower credit score, the lender might want to have a higher down payment or lower debt-to-income. If something does happen, the borrower with equity will have more “skin in the game” a better ability to sell or refinance without loss. Multiple weaknesses strip away the layers and progressively increase the probability of loss.
Because FHA guidelines strip away multiple building blocks of credit quality, the default rate on these loans is significantly higher than on other types of loans. In fact, FHA loan defaults are traditionally more than double that of VA loans and nearly triple that for conventional. For loans made during 2007, the default FHA rate was a whopping 36%.
To compensate for increased risk, FHA collects an insurance premium and builds a capital reserve to cover the increased losses and collection costs. There are similar mortgage insurance programs for conventional and VA loans.
The issue is whether the capital reserves are adequate.
The FHA is required to have a capital reserve ratio of at least 2 percent. At the end of the last fiscal year, that ratio was 2.32 percent. On Jan. 9, the Obama administration said it would cut FHA premiums because of the mortgage insurance fund’s financial health. That came as a surprise, because just a few months before, administration officials had said that they weren’t planning to reduce FHA fees.
Note that the 2 percent requirement is not an actuarial calculation but a politically negotiated amount set by congress. I have no way of knowing whether the current 2.32 percent is enough and apparently, neither does the Trump administration…or Obama for that matter. FHA apparently didn’t think so three months ago, because administration officials had said that they weren’t planning to reduce FHA fees. Keep in mind that just three years ago, tax payers had to bail out FHA to the tune of nearly 2 billion dollars.
In the absence of any economic circumstances occurring recently that would warrant a reduction in the premium, I am mystified.
There is one significant event that occurred between October of 2016 and January 9th 2017.
Donald Trump was elected President of the United States of America.
Barrack Obama is far too clever to steal the furniture from the White House. Instead, he left President Trump a smoldering political turd under his desk in the oval office. Two weeks before inauguration he had FHA announce a surprise reduction in their mortgage insurance premium to take effect a week after the new President takes office.
Crafty politico that he is, Obama gives people a gift that the new administration has to pay for…one way or the other. If Donald Trump doesn’t act and it works out, Obama gets credit. If he doesn’t act and FHA needs another bail out, Trump takes the blame. If Trump acts, he gets blamed for dumping on the little people. Brilliant!
Even the media gets in the act. During the football playoff season, their headlines could just have easily have said,
Trump, sacks Obama’s attempt at FHA end run.
Much has been made of Donald Trump’s lack of political experience. Obama and Clinton are highly skilled, career politicians who have spent their adult lives exclusively in that arena. Mr. Trump is just a businessperson and that clearly shows up here. Don’t get me wrong, Obama was so slick that even an adept politician would have been dead meat on this one.
All President Trump could do was fall back on business disciplines. One of those in assuming responsibility for a new organization is to put the brakes on activities initiated by the outgoing administration. This provides the time and opportunity make proper evaluations and prudent decisions. It may not be politically correct, but it is text book Business. I did similar when I took over new operations in my business career. Most good business people do.
Do I feel for the people who will be adversely affected?
- First, nobody lost anything they already had. This was a postponement of something new.
- Secondly, the reduction could still happen if the analysis that should have gone on before demonstrates such is reasonable.
- Third, are people who have not paid previous debts, have not had the means or discipline to save for down payment, and who have insufficient income and reserves for unforeseen events best served by home ownership? Empathy for them as people is understandable, but most of us have gone through times in our lives when owning a home would not have been a good decision.
Any home owner who has had foreclosures on their street knows what that does to property values in the neighborhood. It isn’t just the government or “rich” taxpayers that take the hit for imprudent lending. It includes those people who worked hard, saved and scrimped along the way to earn their dream. I definitely feel for them.
As Mr. Obama leaves office, America loses a master politician, maybe the most skilled politician ever. Instead, we get someone who not only lacks political acumen, but disdains it. Instead, we are stuck with someone who is going to try to succeed using business skills and discipline.
 Residual income is that left after mortgage and other debt payments necessary for food, clothing, transportation, home maintenance, etc.