Alexander Calder's Flamingo, in Front of the Ralph Metcalfe Federal Center, Home of the FHA in Chicago

FHA (Federal Housing Administration) insured loans are headed for a big change. For those unfamiliar with FHA mortgages, these loans are insured by the government, which allows for flexible approval guidelines. This insurance is paid for by the borrower as an upfront premium collected at close and as a smaller premium collected on a monthly basis. These premiums are then pooled with those from other FHA borrowers to form an insurance fund.

In times of normal demand, the aforementioned process works pretty well, but with the demise of sub-prime mortgage options and collapse of the housing market, FHA loans have steadily grown in popularity. The increased demand has put significant pressure on the capital reserves of the insurance fund. As a result, Congress approved a plan this week to shore up the agency’s insurance fund with a reconfiguration of the mortgage insurance paid by borrowers on loans originated after September 7th.

Under the new structure, FHA requires a borrower to pay an Upfront Mortgage Insurance Premium calculated at 1% of the loan amount. The good news is that this is down from the 2.25% currently required. The bad news, however, is that the monthly figure will increase from a factor of 0.55% annually to a factor of 0.90% annually.

What does this mean for the consumer?

Let’s look at an example: assume a $150,000 home purchase:

BEFORE September 7, 2010

• Upfront Premium (2.25%): $3,256.88
• Monthly payment including mortgage insurance: $793.93

ON OR AFTER September 7, 2010

• Upfront Premium (1.00%): $1,447.50
• Monthly payment including mortgage insurance: $826.93

NET CHANGES

• Upfront cost: Decreased by $1,809.38
• Monthly cost: Increased by $33.00

Overall, these changes should not affect many borrowers; it may place home ownership out of reach for buyers who currently just squeak by. On the practical side, I would recommend that anyone currently in the market for a home to talk to a lender as soon as possible to see how the new FHA loan requirements would affect them. This is especially important for pre-approved buyers as these changes could nullify their approval status or change the assumptions under which they should be shopping.

EDIT (13 Aug 2010): HUD has come out with an amendment to their earlier announcement. Based on the new information that they are distributing, the new date for the change will be October 4th, 2010.

We would like to thank Diorama Sky for kindly sharing today’s photo via the Creative Commons License.