If you are a first time homeowner with a variable rate mortgage then there’s a good chance that your payment will increase by the maximum amount this year because of rising interest rates. To help offset the burden on these already strapped homeowners, the FHA planned to reduce the mortgage insurance rate by 1/4 of one percent in hopes of avoiding an increase in loan defaults. That plan was made just earlier this month. The planned relief was minimal, perhaps $500 for an average borrower, but still welcome. Bloomberg reports “Some housing industry groups lauded the change, saying it could increase home buying by offsetting recent rises in mortgage rates”.
That was the deal until Trump took office and reversed the plan to help homeowners. The first official act of the new president of the United States was to eliminate this savings that some homeowners expected would make their home more affordable this year. Some homeowners were counting on this provision to make up for the recent spike in variable mortgage interest rates. The average affected homeowner will now pay about $500 more per year after the Trump order according to the FHA as reported by MarketWatch. That means some people will pay more in total mortgage payments than they had originally budgeted earlier this month.
Most first time home buyers are steered into variable rate mortgages because it is easier to qualify for the mortgage loan. Yet variable rates pose higher risks for borrowers on a tight budget. Some have called this a predatory lending practice yet it is legal and dominates this segment of the home-buying market.
Bloomberg reports that supporters of the reduction were disappointed that the Trump administration reversed course. It seems to be an action of political retaliation rather than a move justified by economics. The victims are the nation’s most vulnerable homeowners. Since the Obama administration raised the mortgage insurance rates after the housing crisis, the planned reduction moved the rate back closer to historic averages. It seemed logical to reduce the rate during an inflationary period when the default rate traditionally declines.
Not all homeowners are affected. Mortgage insurance – often called “PMI” – is typically paid by new homeowners in the first few years after their first home purchase. Mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, as well as private mortgage insurance companies. An average mortgage insurance rate on a $200,000 loan below 20% equity is $166 per month.
Those few first time buyers who are able to put down a 20% deposit are exempt from the mortgage insurance requirement. If house prices do not rise – as we saw in the last decade and is predicted ahead – then home buyers can wind up paying mortgage insurance for a much longer time than they expected. The cost of mortgage insurance substantially erodes the financial benefits of home ownership.
If you planned to benefit from the .25% lower insurance rate or if your mortgage company already estimated your 2017 escrow payment earlier this month based on the expected lower rate then the monthly payment must be recalculated and the monthly escrow amount will be about $40 higher. The monthly mortgage payment charged to customers is actually a compiled estimate of current and future insurance and tax costs plus principal and interest on the loan. So if you mortgage company calculated your rate expecting the lower mortgage insurance rate then you can expect to receive a revised higher bill in the mail soon.
I’ve already received a few questions on what can be done about it. Eventually, after enough equity builds up in the home, the mortgage insurance is not required. Unfortunately, if the real estate market weakens in 2017 as we expect, there may be no viable strategies. One adviser suggested increasing the monthly payment to build up equity and get rid of the mortgage insurance requirement more quickly. I don’t see that as viable for two reasons: 1) many of these borrowers are already financially stretched, and 2) even a modest drop in real estate market will have major effects on the amount of equity in these homes. The only viable approach seem to be “bite the bullet” for the first two years and work hard to build up 20% equity in your home after the next appraisal.
In some cases mortgage insurance payments are tax deductible. But this applies only if you itemize expenses and have an income below the thresholds. I estimate that only about half of affected homeowners meet this criteria. Additionally, President Trump has proposed eliminating these types of itemized tax deductions for the future.
Overall, I am concerned that this move feeds into a scenario for weakening residential real estate prices and further erosion of the homeowner base that I wrote about recently. This most recent news does not favor an improvement in the homeownership trend.
Follow-up note: Reader response to this article points out that the president’s action yesterday was cancellation of a planned decrease in mortgage insurance premiums not an actual increase. My response was based on consumer questions who perceived it as an actual increase. The reality is that the increase as due to rates and the timing of that increase is controlled by the rate reset provisions in the mortgage. Methods used to calculate the 2017 monthly mortgage payment may vary.
A monthly mortgage payment is typically a combination of principal and interest, plus an estimate of homeowners, flood and mortgage insurance, plus an estimate of taxes. Then, usually once a year, the mortgage company adjusts the monthly payment up or down based on the actual figures instead of the estimates.
If your 2017 escrow payment was calculated based on expectation of the lower insurance rate or if your variable rate is scheduled to reset, then your monthly payment will in fact increase. If your payment was based on the old insurance rate or rate will not reset, your monthly payment will be unaffected.
I did not investigate how many mortgage companies were already using the lower mortgage insurance rate in escrow calculations for 2017 but the local source indicate that recalculations would be necessary as a result of the presidential order.
Another reader questioned the accuracy of the $500 average impact estimated by Marketwatch and CBA News. I did not investigate the accuracy of this news source. Assuming the rate differential is 0.25% then the $500 annual impact implies that the average affected mortgage below the equity threshold is about $200,000. I have no other information on that point.
Mortgage insurance cost is estimated at .85% or $1700 per year on average $200K loan (I’m not clear whether some lower cost private programs are available or not). Many first time buyers use an adjustable rate mortgage to make their ‘buying power’ stretch further so they can afford a home. So when interest rates went up quickly, the FHA expected an increase in defaults. So to help reduce foreclosures (which is not good public policy and hurts us all) they offered to partially offset the large interest expense increase with an insurance decrease of $500. At least that was the plan until yesterday.