One of the biggest deterrents to FHA loans could soon become history.
Most buyers using FHA pay mortgage insurance as long as they have the loan. They must refinance into a conventional loan to get rid of it.
Many prospective homebuyers on platforms like Reddit, TikTok, and Instagram cite lifetime mortgage insurance as the top reason they opted for conventional loans.
But now, the leader of the U.S. Department of Housing and Urban Development (HUD) says she is open to removing the onerous FHA rule.
Top HUD official ‘willing to look at’ changing key FHA rule
On January 11, 2024, in front of the U.S. House of Representatives, HUD Secretary Marcia Fudge said she “willing to look at” altering rules around the permanent monthly FHA Mortgage Insurance Premium (MIP).
She was then asked whether FHA MIP could drop off when the homeowner hits a certain amount of equity – similar to private mortgage insurance (PMI) for conventional loans. Fudge said, “I would love to see it happen.”
See the 10-second clip from the meeting:
The admission by HUD’s top official is encouraging. And, it’s right in the center of the Biden Administration’s goal of “making homeownership more accessible and affordable for the nation’s working families, particularly households of color.”
Removing permanent mortgage insurance would repeal a de-facto penalty for FHA loan users, 29% of whom are minorities, according to the 2022 HUD Annual Report to Congress.
If implemented, this would be a sea change for homebuyers and usher in a new era for FHA loans.
Suddenly, many homebuyers wouldn’t need to wait months or years to qualify for a conventional loan.
And they could opt for FHA without worrying about the cost of a conventional refinance in the future.
When might the FHA ‘life-of-loan’ rule change?
It’s impossible to say whether any progress has started toward this goal or if it’s simply on Secretary Fudge’s wish list. Likely, only inner circles within HUD and the White House know.
If the change were in the works, HUD would keep it quiet until it was ready. It would not want to disrupt the housing market by announcing future policy that could change forms.
Many homebuyers would wait to buy a home until new rules were in effect, potentially slowing down homebuying and the economy.
This is how the White House played its hand with the recent monthly MIP reduction from 0.85% to 0.55% of the loan per year.
On February 22, 2023, the Biden Administration surprised-announced the reduction for new loans closing on or after March 20. Because purchase loans take at least a month to close, the announcement covered most loans in process.
We could see a similar strategy if FHA’s lifetime mortgage insurance were repealed: an announcement with no warning.
What would the change mean for FHA buyers?
FHA homebuyers would no longer have to worry about being locked into mortgage insurance for life.
Most FHA buyers put just 3.5% down, but you must put 10% down to get cancelable mortgage insurance. Even then, FHA MIP lasts 11 years.
You have to refinance into a conventional loan when you have 20% equity to remove it. Refinances cost thousands of dollars.
If FHA MIP were like conventional PMI, homeowners could potentially lower their monthly housing expense by getting a new appraisal when they reach 20% equity. Or, MIP would automatically drop off at 22% equity.
No one knows whether FHA would emulate conventional PMI rules or make up its own cancelation guidelines.
Assume someone buys a home with a $275,000 FHA loan. They live there for 10 years. They cancel FHA MIP after five years. The rule would save them about $6,500 in MIP over the remaining five years, or about $4,000 to $5,000 in refinance costs.
Would cancelable FHA MIP apply to existing FHA loans?
Unfortunately, existing FHA homeowners would probably remain under the rules in effect when they received their loan.
That’s not to say it’s impossible for FHA to make the rule retroactive, but it’s unlikely.
Past FHA mortgage insurance changes have applied only to new loans as of a certain date.
However, homeowners could likely use the FHA Streamline refinance loan to take advantage of the new policy.
FHA Streamline is an easier refinance, requiring:
- No appraisal
- No equity in the home
- No employment or income check
- No minimum credit score
- A partial refund of upfront MIP spent on the existing loan
You must have your current FHA loan for six months before using the Streamline program. And, you have to pay closing costs. While not a perfect solution, it could be a good way to obtain cancelable mortgage insurance even if the homeowner doesn’t qualify for a conventional loan.
What should prospective homebuyers do in light of the news?
It’s always a good idea to see if you qualify for a conventional loan along with FHA. You might discover that you don’t need to worry about FHA’s permanent mortgage insurance at all.
But if you only qualify for FHA, homebuyers should proceed as normal. It would not be wise to change plans based on an unconfirmed FHA change.
There’s more to lose by waiting as home prices march upward.
The best plan of action is to request pre-approval from a lender no matter which program you use.