One of the first actions of the new administration — to suspend indefinitely the scheduled Federal Housing Administration mortgage insurance premium cut — is good news.
While the premium cut may have saved the typical borrower around $40 per month at a time when rising mortgage rates were threatening to sideline first-time buyers, the decision to suspend it was correct. One can only hope that the suspension will be permanent as the move may represent a step away from easy access to credit in housing, which is driving up house prices faster than incomes are rising.
The median first-time buyer spends around $200,000 on a house with a downpayment of 3.5 percent. For this median buyer, the post-election rally in interest rates, which raised the 30-year mortgage rate by around 70 basis points, translates into a monthly payment increase of around $78 holding all else constant. But an improving economy can help offset these costs.
Given that the inflation-adjusted median household income grew by more than 5 percent in 2015 — which puts around $150 (after tax) per month more in the pockets of the median household — the adverse effects from the suspended FHA premium cut and the higher interest rates should largely be moot.
On the other hand, a 6 percent higher purchase price raises the monthly mortgage payment after taxes and insurance by $76 — almost the same as the increase caused by the higher interest rate. The difference is that the post-election mortgage rate spike was more or less a one-time thing. House prices on the other hand have been increasing far faster than income gains, at a pace of roughly 5 percent annually for the last three years, and will likely continue to do so.
Here is why. According to the National Association of Realtors, the supply of homes for sale has favored sellers for more than four years now, and the supply-demand imbalance is getting worse as the Realtors’ measure of housing supply is inching closer to its all-time low set in January 2005 — the height of the most recent housing boom.
But this is just an average of all price points. According to data from Zelman & Associates, the supply of homes is three times more constrained at the entry level, where first-time buyers generally buy, than in the luxury market. Basic economics teaches that prices rise when demand outweighs supply. It should come as little surprise that according to data from Trulia, the median list price for a starter home has increased by an average of 7.2 percent over the last four years, while the median list price for the premium market has increased by “only” 4.7 percent.
Data from the National Mortgage Risk Index published by the International Center on Housing Risk at the American Enterprise Institute confirm that first-time buyers have been devoting a rising share of their income to buy a house over the past four years, exposing them to greater risk of default should house prices or their incomes decline. On the other hand, repeat buyers, for whom rising prices provide the wherewithal for a downpayment on another home purchase, have managed to lower their debt-to-income ratios over the same period.
This unequal outcome, occurring well before the spike in interest rates, is a direct result of the supply-demand imbalance plaguing the market today, an imbalance that has been, and continues to be, fueled in large measure by easy access to credit.
Today, the imbalance continues to worsen, as more demand is stimulated by policies that increase leverage, such as the Federal Housing Finance Agency’s January 2017 conforming loan limits increase for mortgages, or the looser lending rules pre-programmed into the agencies’ automated underwriting systems that were used to help borrowers as a response to rising prices or interest rates. Making it worse are the increasing regulations restricting land use, which diminish housing supplies.
The FHA’s premium cut is another example of a policy that expands leverage. An analysis by AEI’s International Housing Risk Center found that the January 2015 FHA mortgage insurance premium cut not only failed to create the expected savings for borrowers but also did not expand homeownership as announced. The consequence was a rise in house prices: The median FHA buyer had to pay around $1,300 more for the exact same house.
Record-low housing inventories, especially at the lower-priced part of the market, and easy credit pose a grave threat to affordability. The suspended mortgage insurance premium cut would have done little to ameliorate the situation. It could even make it worse. Implementing the policy would only mean higher prices and greater risk for first-time buyers. The new administration should be applauded for its suspension of FHA’s insurance premium cut.