FHA Mortgage Rates Hit New Lows, Insurance Premiums Rise

Posted on Oct 26, 2012

FHA mortgage rates have dropped sharply since the start of the year, making new, all-time lows nearly weekly. Despite falling FHA mortgage rates, though, the annual cost of an FHA mortgage is mostly unchanged, the result of rising FHA mortgage insurance premiums.

The "effective interest rate" of an FHA-insured mortgage belies today's low rate environment.

You see, the FHA doesn't make mortgages. It insures the banks that do. The FHA makes mortgage guidelines by which a loan must abide to get FHA-insured and when banks underwrite home loans to those guidelines, the FHA offers default protection to the bank.

The FHA is an insurer of loans NOT a lender.

As an insurer, the FHA is subject to some of the same risks as, say, a home insurance company. The amount of premiums it collects must be higher than the amount of claims paid or the FHA risks bankruptcy. Where the FHA differs from traditional insurers, though, is that, as a federal agency, it is required by law to maintain $2 in reserves for every $100 insured.

In November 2011, an audit showed that FHA held just $0.24 per $100 insured.

It's no great surprise, therefore, that the FHA has raised its mortgage insurance premiums 4 times in the last 4 years. As the number of default claims increased between 2007 and 2011, the FHA risked running out of money. When claims outpace premiums, insurers raise premiums.

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