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The Federal Housing Administration (FHA) is raising its mortgage insurance premiums (MIP) and changing MIP cancellation policies. These changes may impact first-time home buyers, but they are needed to mitigate risk and strengthen the solvency of the mortgage insurance fund.

FHA faces financial problems stemming from losses on reverse mortgages and forward loans sustained during the housing crisis and low home values, causing a shortfall in its reserves. There is talk that FHA may need a government bailout of $943 million in tax payer funds.

Traditionally, FHA loans should make up between 10 and 15 percent of the market. In 2012, due to the economic downturn and absence of a robust private lending market, FHA insured over 25 percent of all homes purchased in that year. The National Association of REALTORS® (NAR) says had FHA not stepped in to fill the market void, many families would have been unable to purchase homes, housing values could have dropped an additional 25 percent, and the country would be much further from a recovery.

Facing multibillion dollar losses, FHA has taken a number of steps to shore up funds. Beginning April 1, 2013, FHA’s annual mortgage insurance premium for all new loans that are less than or equal to $625,500 and with a loan-to-value (LTV) ratio greater than 95 percent will be 1.35 percent of the loan amount. The loan to value ratio is calculated as the percentage of the value of the house that is paid for by the loan.

FHA will also require most borrowers to continue paying annual premiums for the life of their mortgage loan. Effective June 3, 2013 FHA will require borrowers who take out a new FHA loan with an LTV ratio of greater than 90 percent to pay the MIP until the end of the mortgage loan term or for the first 30 years, whichever comes first. With an LTV equal to or less than 90 percent, the MIP will be assessed until the end of the mortgage term, or for the first 11 years, whichever occurs first. Previously, once the loan was paid down to 78 percent of the original value of the house or after five years, whichever came later, the borrower would no longer be required to pay the MIP.

FHA insured loan limits are currently calculated at 125 percent of the local area median home price, up to a maximum of $729,750 in highest cost markets like Silicon Valley. The limits are temporary and set to expire at the end of 2013 to 115 percent of local area median home prices with a cap of $625,500. There are discussions in Washington of lowering this amount further, however nothing has been established yet.

In Silicon Valley, where home prices are some of the highest in the nation, many buyers are borrowing at the top of the FHA limits. The MIP can amount to hundreds of dollars each month, in addition to their regular mortgage payment. For instance, buyers with a $600,000 FHA-backed mortgage who put 8 percent down will pay at the 1.35 percent rate, which comes out to well over $600 per month in mortgage premiums. Whereas previously, this additional payment would have been eliminated once the LTV ratio hit 78 percent or five years, whichever was later, now this payment will be assessed for the life of the loan.

FHA also will require lenders to manually underwrite loans for which borrowers have a credit score below 620 and a total debt-to-income (DTI) ratio greater than 43 percent. Also announced, but not yet approved, is a proposal by FHA to increase the minimum down payment requirement for mortgages with original principal balances above $625,500 from 3.5 to 5 percent.

A higher down payment requirement could impact millions of first-time home buyers. Many first-time home buyers rely on FHA-insured loans because they can require a down payment as low as 3.5 percent. In 2012, more than four out of every 10 first-time buyers purchased their homes with an FHA-insured mortgage. It remains to be seen whether these numbers will go down with the new higher rates and requirement that mortgage insurance be paid for the life of the loan.

NAR supports legislation that strengthens FHA’s fiscal solvency and that balances the need to protect the fund from tax payer risk with the need to continue providing access to safe and affordable mortgage financing. While these changes may be necessary in the short-term to help stabilize the FHA fund, NAR’s position is that higher fees make it difficult for first-time buyers to purchase a home, as well as repeat buyers who are relocating from less expensive to higher cost areas. NAR has encouraged FHA to reconsider the need for these changes when the fund returns to full capitalization.

On January 1 both the U.S. Senate and House passed H.R. 8 legislation to avert the “fiscal cliff.” The bill was signed by President Barack Obama.

Below is a National Association of REALTORS® summary of real estate related provisions in the bill:

Real Estate Tax Extenders
• Mortgage Cancellation Relief is extended for one year to Jan. 1, 2014.

• Deduction for Mortgage Insurance Premiums for filers making below $110,000 is extended through 2013 and made retroactive to cover 2012.

• 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties is extended through 2013 and made retroactive to cover 2012.

• 10 percent tax credit (up to $500) for homeowners for energy improvements to existing homes is extended through 2013 and made retroactive to cover 2012.

Permanent Repeal of Pease Limitations for 99% of Taxpayers
Under the agreement, so called “Pease Limitations” that reduce the value of itemized deductions are permanently repealed for most taxpayers but will be reinstituted for high income filers. These limitations will only apply to individuals earning more than $250,000 and joint filers earning above $300,000. These thresholds have been increased and are indexed for inflation and will rise over time. Under the formula, the amount of adjusted gross income above the threshold is multiplied by three percent. That amount is then used to reduce the total value of the filer’s itemized deductions. The total amount of reduction cannot exceed 80 percent of the filer’s itemized deductions.

These limits were first enacted in 1990 (named for the Ohio Congressman Don Pease who came up with the idea) and continued throughout the Clinton years. They were gradually phased out as a result of the 2001 tax cuts and were completely eliminated in 2010-2012. Had we gone over the fiscal cliff, Pease limitations would have been reinstituted on all filers starting at $174,450 of adjusted gross income.

Capital Gains
Capital Gains rate stays at 15 percent for those in the top rate of $400,000 (individual) and $450,000 (joint) return. After that, any gains above those amounts will be taxed at 20 percent. The $250,000/$500,000 exclusion for sale of principle residence remains in place.

Estate Tax
The first $5 million dollars in individual estates and $10 million for family estates are now exempted from the estate tax. After that the rate will be 40 percent, up from 35 percent. The exemption amounts are indexed for inflation.

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