By Guy Benjamin

AS READERS MAY RECALL, the Federal Housing Administration announced a potential deficit to the single-family mortgage insurance fund of $16 billion late last year.

FHA announced several changes last week intended to shore up this program. The solvency of the insurance fund is mandated by Congress and is thought to be vital to the ongoing recovery of the housing market.

Primarily, FHA is increasing mortgage insurance fees and requiring borrowers in most cases to pay insurance fees for the life of the loan. In a big move for the reverse mortgage sector, FHA has announced the elimination of the standard fixed-rate reverse mortgage and will now offer only the fixed-rate option with the saver product, a program with sharply reduced loan amounts. The agency also plans to step up enforcement efforts on FHA-approved lenders that aggressively market to borrowers with previous foreclosures.

Lastly, FHA is committed to structuring a new housing counseling initiative for borrowers who meet certain criteria — for example, those borrowers with previous foreclosures.

The changes to the mortgage insurance fee structure will have the greatest impact on borrowers. The typical home buyer who is using FHA financing will put the minimum down payment required, which is 3.5 percent. Borrowers in this category will now pay a monthly mortgage insurance fee equal to 1.35 percent of the amount being borrowed. On a $300,000 loan that means a monthly payment of $337.50. That’s only $25 a month more than the current structure, but the biggest change is that these borrowers will now be required to pay this fee for the entire life of the loan.

This change is actually a return to the original mortgage insurance structure. FHA had always collected premiums for the life of the loan, but in an effort to become more competitive with private mortgage insurers (PMI), the agency began automatically canceling collection of premiums once the loan balance reached 78 percent of its original balance. FHA estimates they have foregone billions of dollars in premiums since enacting the change, so now they are going back to the original structure.

The question now is, how will these changes affect the mortgage marketplace, and will home buyers now turn to conventional loan programs with PMI instead of FHA?

If we look at a similar 3-percent down payment, conventional loan, the PMI rate is .0880 percent — almost half a percent less than FHA. The monthly PMI payment is just $220 versus $337.50 for FHA.

On top of that, FHA also requires an upfront premium, normally financed into the loan, of 1.75 percent or $5,250. Lastly and most importantly, borrowers can cancel PMI once their loan balance and home values meet certain thresholds. This could save a borrower tens of thousands of dollars over the life of the loan.

Clearly the conventional option is a better deal for the home buyer. But there is one catch: Private mortgage insurers are for-profit entities. They don’t have the backing of the federal government. They have to stay solvent and maintain reserves in order to stay in business. The qualifying criteria is therefore much tougher across the board. In almost every aspect, borrowers applying for PMI must meet a higher standard.

It will be pretty interesting to see how this shakes out as the housing market continues to recover. It seems reasonable to me to assume that the highest-quality borrowers will gravitate toward conventional financing and away from FHA. What will this mean to FHA? Will the insurance fund then be further burdened by foreclosure rates typically associated with higher-risk borrowers?

Personally, I think we’ll see a significant percentage of borrowers who have been crushed in the bust and lost their homes in foreclosure using FHA to make a quick re-entry into the market. Will these borrowers prove to be good credit risks who were simply caught in a devastating economy, or will they prove to be just as bad credit risks as before? Time will tell.

Guy Benjamin (NMLS 887909) writes a weekly column for The Herald, offering general information on real estate matters. As it is impossible to address all possibilities and variations, he will try to answer individual questions by readers who contact him at 925-771-2454 or gbenjamin@lhfinancial.com.

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