Fannie and Freddie's Pricing Pushing Borrowers Into FHA; FHA Pushing Back

If you're buying or refinancing a home today, the decision of FHA versus conforming isn't as straightforward as it used to be.

Choosing the high-LTV loan with the best mortgage rate a few years ago usually meant going with Fannie or Freddie. In the not-too-distant past, FHA mortgages came with a 1.75% upfront mortgage insurance premium, which could be financed, plus a .50% to .55% annual premium. You only had to put 3% down. On the other hand, Fannie and Freddie offered 97% financing too, with no upfront mortgage insurance premiums but higher annual ones, about 1% per year. Buyers had other options, too -- conventional lenders offered "piggy back" purchase money second mortgages that allowed buyers to borrow 95% of the purchase price and pay no mortgage insurance. And back then, many people could pretty much count on their home value rising fast enough that they could dump the conventional mortgage insurance or second mortgage pretty quickly. With FHA, you pay MIP for at lfor at least 5 years no matter how much your property appreciates.

In 2005, FHA mortgages only accounted for 5.8% of mortgage lending.

Then, things changed. The government-sponsored enterprises (GSEs) ended up being taken over by the government. In an effort to increase the quality of their loans, and increase the interest rates to riskier borrowers, they instigated risk-based pricing. Those with lower credit ratings, higher LTVs, and riskier properties like condos or manufactured houses paid more for mortgages -- in some cases a lot more. Suddenly, FHA looked pretty good -- it charges borrowers the same whether they have a credit score of 600 or 800.�� In 2009, FHA's market share rocketed to 35%.�� And with subprime lenders and Alt-A lenders fleeing the industry like scalded cats, those with borderline credit stampeded to FHA for loans.

The government doesn't want your business any more.

The pendulum is swinging back. FHA increased its down payment requirement to 3.5% (10% for those with scores < 580), its upfront MIP to 2.25%, and is seeking leave to up its annual mortgage insurance premiums to about 1%. Its commissioner David Stevens said in effect that FHA needs to increase its MIP so that insurers of conventional mortgages can compete for business. The reason is that with the GSEs piling on the risk-based pricing adjustments, the addition of mortgage insurance to that is a deal-breaker for borrowers. So they flock to FHA. Now FHA intends to become more expensive to push buyers back to the GSEs, build its reserves, and lower its market share.