Nov042015

Lowering FHA insurance fees made housing less affordable

Lowering FHA insurance fees increased sales volumes and prices at the low end. Prices went up faster than incomes, so houses are less affordable.

no-house-for-youFurther, Last September I noted that High loan costs cause FHA originations to plunge; in fact, FHA financing is so expensive, it’s like taking out a 12.4% second mortgage! Something had to be done if the housing market were to sustain current pricing or build any momentum for the future.

Last November I reported that first-time homebuyer participation rates hit a three-decade low, a major problem for the long-term health of the housing market. I later predicted this would pressure would mount to lower FHA insurance fees to revive home sales. About a month later President Obama announced FHA insurance fees would be cut in half. I speculated that lowering FHA insurance fees would spur the housing market.

It did.

In fact, it’s stimulated the market for low-end properties so much that affordability is crumbling for properties financeable with FHA loans.

Obama’s bid for more affordable homes is lifting house prices

By Steve Goldstein, Published: Oct 22, 2015power_to_the_bankers

WASHINGTON (MarketWatch)—President Barack Obama was in Phoenix earlier this year to talk up something as hot as the desert sun—housing.

In a January speech, he announced a new Federal Housing Administration policy to lower the mortgage insurance premium enough to save the typical borrower $900 a year, assuming a $180,000 mortgage.

That FHA fee drop was aimed at helping middle-class families. “Over the next three years, these lower premiums will give hundreds of thousands more families the chance to own their own home, and it will help make owning a home more affordable for millions more households overall in the coming years,” Obama said.

This is completely wrong, but more on that later.

In fact, what’s happened—for those on the outside, trying to get in—is that owning a home has become less affordable, directly as a result of the FHA move.

CoreLogic tracks house prices nationally. What Sam Khater, deputy chief economist of CoreLogic has found, is that prices on lower-end homes immediately vaulted in price.

The FHA move certainly has helped stimulate demand. Year-to-date, FHA single-family endorsements for purchase have boomed by 24%.

Lowering the cost of FHA insurance makes it available to more borrowers, a form of credit expansion with a very predictable market impact.

supply-demand

But CoreLogic’s Khater says that is not what the housing market needs at this point.

“In today’s market where supply is so tight, it’s not helping the cause to artificially stimulate demand,” he said.

Khater says the market is overpriced, due to a chronic lack of supply. Supplies are low for a number of reasons—borrowers being upside down, or underwater, on their current mortgage; a lack of new construction, particularly for low-end homes; and the increased popularity of rentals.

cloud_inventory_viewActually, this is exactly what the housing market needs. The only way cloud inventory will come to market is if house prices go up.

Obviously, nobody in the government gives a shit about the burden this places on today’s buyers or future buyers for that matter. The priority is to save the banks, otherwise we wouldn’t have cloud inventory, and the banks would have been required to foreclose on their bad loans and liquidate the REO.

An extended period of low affordability and artificially high prices is something we all must endure to bail out the foolish buyers and bankers from the housing bubble. It is what it is — a travesty of justice and a ripoff.

Affordable housing

We all want affordable housing. There are numerous government programs designed to provide low-cost rental and ownership properties to people in all walks of life. Lenders, builders, realtors and buyers all benefit from affordable housing because affordability means an increase in transaction volumes and more money into the pockets of those dependent on the real estate market. The difficult problem with affordable housing is how to provide it without making it unaffordable. Finance is not the answer, so lowering the FHA insurance fee will ultimately fail as a measure to improve affordability as Obama suggested.

Most of those who worked in the mortgage business back during the bubble era really believed the “financial innovation” meme. I have contended that the entire idea of financial innovation is a fallacy. mortgage brewAt its core, the belief among financiers is that affordability products reach more customers and permit home ownership for a larger number of people. We took that idea to an extreme in the early 00s, and the result was an unsustainable increase in home ownership rates and home prices, both of which ultimately crashed.

If you look back to the lending practices which endured the crash of the last housing bubble in the late 80s, you see that the financing arena was dominated by 30-year conventionally amortizing loans with 20% down payments and conservative debt-to-income ratios, the only loan program with relatively low default rates even if prices decline. So what happens when a new “affordability” product is introduced into this stable system?

Let’s look at an example. Assume our would-be buyer makes $100,000 a year and could qualify for a $300,000 loan using conventional financing. He has saved $75,000 for a downpayment and costs. He is looking to buy a $375,000 home. In our stable system, he would find a home relative to his income. If he is making the median income, then he would be able to afford a median priced home.toxic_option_arm

Now let’s say that lenders “innovate” and start offering interest-only loans with a 10-year fixed term followed by an interest rate reset and a recast to a fully amortized loan on the remaining 20-year schedule (sound familiar?) Our buyer is conservative and does not want to purchase on these risky terms and take the risk on future interest rates or the need to refinance later because he may not be able to afford the higher payment in 10 years. However, other potential buyers will ignore these risks and embrace the new financial innovation because it allows them to buy a house they previously could not afford.

The same payment on an interest-only schedule now finances 15% more money, so other potential buyers in the marketplace who are making $100,000 can now finance around $345,000 instead of $300,000. When our conservative buyer goes out in the open market to bid on properties, he now finds himself being consistently outbid on properties. At this point, he has a choice to make: either embrace the new financial innovation and bid 15% higher for the same property, accept a lower quality property, or not buy a home. The affordability product did not make houses more affordable, it made them less so.

It’s the same with lowing the cost of FHA insurance. It does not and can not make houses more affordable because buyers quickly bid up prices to the new equilibrium price.

Lowering the FHA insurance rate did spur the low-end of the housing market as I predicted it would. The stimulus has now run its course, low-end house prices are higher, and the market rests at the new equilibrium price. However, houses are not more affordable; they are less so.

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