In a recent report, Citigroup Global Market analysts examined the current Federal Housing Administration/Department of Veterans Affairs mortgage rates and their impact on prepayment speeds.
According to the Mortgage Bankers Association, the FHA/VA mortgage rates have been below corresponding conventional mortgage rates by roughly 50 basis points. However, despite the relatively low rates available on FHA/VA loans through mid-January, the MBA Government Fixed-Rate Application Index had increased in line with the corresponding Conventional Index relative to November levels.
Different FHA lending programs
In the report, analysts asked whether structural features of the FHA/VA programs could explain the slow response.
They discussed the different programs in their report, including the FHA 203(b) program that targets new home buyers and allows 97% LTV loans. A mortgage insurance premium is required for these high-LTV loans. This upfront fee includes 1.5 points and a 50 basis point annual fee. Once a loan has reached a 78% LTV and at least five years have passed, the MIP payments are no longer required.
VA loans are available to both active duty soldiers and veterans, including National Guard and Reserve members. The VA guarantees a part of the loan's principal that allows the issuance of high-LTV loans up to 100%. The VA program requires a fee in the form of an upfront cost, though it is typically financed by adding it to the loan amount. VA loans could be refinanced, although a cash-out refi could not exceed a 90% LTV ratio and have a maximum 2% fee, compared to only a 0.5% fee for rate-reduction-only refinancings
There are also the Rural Housing Service and less common FHA programs such as the 203(k) that allows mortgagors to borrow additional money to pay for repairs, and the 203(h) that is a more lenient program for disaster victims.
Lack of incentive
Citigroup noted that despite the economic incentive for FHA/VA borrowers to refinance, these borrowers might not be affected by FHA/VA rates since they are primarily considering conventional products. There are also other nonfinancial factors dampening the response of FHA/VA borrowers regarding the comparatively low rates, including the new affordability products, niche programs that many lenders offer, seasonal factors (the FHA/VA mortgage rate drop happened during the winter holidays) and media impact (most of the media coverage on lower rates focuses on conventionals).
Researchers said that since housing turnover is less likely to be influenced by FHA/VA rates, they believe that discount GNMAs will change in line with conventionals. Although cash-out refinancings might be affected by recent changes in FHA/VA LTV limits, the changes might only make FHA/VA loans competitive with - and not necessarily preferable to - conventionals.
Analysts believe any rise in GNMA refis versus conventionals will happen slowly in the next few months. By contrast, they do not expect that much of a lag in any resulting rise in buyouts, mentioning that January buyout prepayments likely already reflect the lower FHA/VA rates.
"In fact, we would guess that buyouts in February speeds are down versus January, given the recent backup in rates and the efficiency of the buyout process," wrote analysts.
They examined the effect on 5.5s, 6.0s and 6.5s, saying that January speeds of GNMA 5.5s seem to have risen only very slightly versus conventionals due to a very near-term rise in buyouts, and this should become less going forward with the recent rate back up. They concluded that they expect the biggest increases - on the order of 2% to 3% CPR, eventually - in Ginnie speeds versus corresponding conventionals in 6s and 6.5s.
They believe that the recent lowering of FHA/VA rates will have a significant impact on 30-year conventionals.
FHA 30-year rates (with 1.5 extra points and at least five years of a 50 basis point mortgage insurance premium, regardless of LTV considerations) are still not competitive with conventional mortgages that don't require private mortgage insurance. Also, the lowering of FHA/VA rates will not impact 30-year conventional prepayment speeds, said analysts.
VA loans now have a lower rate compared to conventional mortgages, but that represents only a small advantage. VA loans are only available to a comparatively small number of borrowers.
But for the 15-year product, the possibility of some impact exists. The FHA annual MIP fee is not required for 15-year loans with an LTV of less than 90%, which means the only added cost of a 15-year FHA loan is the 1.5 upfront point. Since FHA/VA 15-year loans are also roughly 50 basis points less than conventional 15-year rates, FHA 15-year loans are competitive with conventional 15-year product. But the additional hassles and the lack of awareness will likely limit the number of borrowers who might take advantage of these loans.
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