Demand for houses by owner occupants has been anemic for nearly three years after four years of steep and unprecedented declines. Despite the refrain of increased demand from the bottom-calling glee club, the data clearly shows any increase in sales volume and demand this year is entirely due to cash investors, largely hedge funds buying low-end properties in beaten down markets.
The decline in purchase applications is caused by two factors: potential buyers do not have the down payment, and potential borrowers cannot qualify for the loan.
During the housing bubble, debt was cheap and plentiful, so many Americans stopped saving in favor of taking on copious amounts of debt. The Great Recession depleted the savings of the few Americans who had savings to begin with. The crash in house prices took away any equity people had stored in their houses. As a result of all these factors, Americans are broke and unable to come up with a down payment. Making matters worse, since house prices are still elevated near peak levels in many markets, a 20% down payment is a much larger hurdle to overcome. This forces most potential buyers today to consider FHA financing despite its high cost.
Lenders have two debt-to-income hurdles a borrower must jump. The first is the front-end ratio that limits how much the borrower can finance to buy a home, usually 31% of gross income. The second is the back-end ratio that limits how much total debt the borrower can reasonably service when factoring in car payments, credit cards, student loans and other revolving credit lines. Also due to the debt binge during the housing bubble, many Americans loaded up on other consumer debt to the point they cannot qualify for a mortgage today because their back-end ratios are too high. The deleveraging process has been slow and painful as the banks are loathe to write off the Ponzi loans they underwrote during the bubble.
Another factor holding back purchase originations is the lack of equity in existing home stock due to the collapse of house prices. Without equity from a bubble-era purchase, the move-up market is dead. Until prices begin moving up on a sustained basis from a protracted bottoming period (something many markets have not experienced), there will not be a sufficiently large cohort with move-up equity to sustain sales volumes. The recovery in purchase origination sales volumes will be hindered by the super-slow recovery in the move-up market.
Millions of potential buyers lost houses during the last several years, mostly from imprudent borrowing, but also from unemployment. Those that lost their homes to foreclosure cannot qualify for a new mortgage because both the GSEs and the FHA have waiting periods after a foreclosure before they will approve insurance on a new mortgage. So even if those who lost their homes had a sufficient down payment (they don’t), and if they had a high enough FICO score (they don’t have that either), they would be barred from obtaining a mortgage due to the waiting period. In what can only be described as a desperate and poorly thought out move, the FHA is considering removing the waiting period for an FHA loan to qualify more borrowers and stimulate demand.
Dan Green — September 10, 2012
Between 2006-2011, the FHA’s share of the purchase mortgage market increased 5-fold.
For 2012 and beyond, that share should increase.
The FHA is contemplating new, looser mortgage guidelines that would waive its standard “waiting period” after a significant derogatory credit event. Home buyers with recent bankruptcy, foreclosure or short sale may be cleared to buy homes immediately.
So what’s wrong with this idea? I first wrote about this problem back in April of 2010 when the GSEs did something similar: Fannie Mae Encourages Strategic Default by Reducing Punishment Time for New Loan. This policy will strongly encourage strategic default. The resulting walkaways will increase delinquency and foreclosure rates, lower home values, and cause billions of dollars in losses for the US taxpayer.
The whole point of a waiting period is to deter strategic default. Many borrowers are choosing not to strategically default because they know it would take five to seven years to get another home loan. If the FHA waives this waiting period entirely, that is one less reason for underwater homeowners to tough things out.
Take careful note how this changes the equation for those considering strategic default. Here is what happens if they stopped paying today:
Strategic default is a huge benefit to the underwater borrower because the waiting time to get back into the market will be all but eliminated. If they had to wait a full seven years, they might be better served to wait it out and let the market come back to them — or so they might convince themselves. If they only have to wait a brief period while their FICO scores improve, it isn’t very likely they will miss a huge market rally, and the punishment for their bad borrower behavior fails to be the deterrent it was intended to be.
Do you get the sense that the people at FHA did not think this through? Did they forget why they had a waiting period to begin with? Are they so desperate for new buyers to clean up their mess that they are willing to encourage much more strategic default? This seems really stupid to me.
FHA : Loans For Borrowers With 500 FICO Or Better
The Federal Housing Administration (FHA) is not a mortgage lender; the FHA does not make loans. Rather, it insures loans for banks that do.
The FHA publishes a compendium of rules known as “FHA mortgage guidelines” and so long as a mortgage meets of the rules’ minimum standards, the FHA will insure the loan-issuing bank against default.
A better name for an FHA mortgage, then, might be FHA-insured mortgage; it’s a more accurate reflection of the relationship between the FHA and mortgage lender nationwide.
For purchase transactions, FHA mortgage guidelines are fairly straight-forward :
- Monthly debt should not exceed 45% of household income, without excellent cause
- Downpayment must be 3.5% of purchase price or appraised value, whichever is lower
- Credit scores of 580 or higher get “maximum financing”; Scores under 500 disallowed
Do those standards seem too tough to you? For all the complaints about onerous lending standards keeping qualified borrowers out of their homes, these standards seem as loose as subprime was back in the bubble. If a borrower cannot meet those standards, does it seem likely they have the necessary financial discipline to sustain home ownership? I doubt it.
In addition, mortgage loan sizes may not exceed local FHA loan limits.
In most areas nationwide, including Palo Alto County, Iowa; Price George’s County, Maryland; and Miami County, Ohio, for example, local FHA loan limits are $271,050.
In other “high-cost” areas including Los Angeles County, California; Monroe County, Florida; and Eagle County, Colorado, the local FHA loan limit is $729,750.
I wonder how the people in Palo Alto County, Iowa, who are capped at $271,050, feel about subsidizing the mortgages of borrowers in Palo Alto, California, who can borrow $729,750. What justification does this policy really have? Also, isn’t a policy that allows larger loans in “high cost” areas also responsible for making housing costs higher there? I think we all know it does. If the government were truly concerned with making prices affordable, they would reduce these caps and force borrowers who want to buy a “high cost” property to borrow from a private lender in the jumbo market and put 20% or more down.
FHA Mortgage Guidelines Change With The Economy
Mortgage guidelines are a living, breathing thing. As the housing market moves, and as credit conditions necessitate, mortgage guidelines morph. This is true for FHA mortgage guidelines, just as it is for Fannie Mae- and Freddie Mac-type loans and VA loans, for example.
Guideline changes can be small; increasing maximum debt-to-income ratios from 43% to 45%, for example. Or, they can be big. The HARP 2.0 program is a good example of this. Other times, changes are major — broad enough in scope that they reverberate throughout the housing market as a whole.
In recent posts, I have lamented the difficulty in forecasting market prices due to the whims of government bureaucrats and bank executives who can cause huge changes in market prices and sale volumes with changes in policy. Today’s post is another example of one of those impossible-to-forecast policy changes with potential to really change things.
The FHA may make a major guideline change soon.
Within 75 days, the FHA is expected to change its purchase mortgage guidelines to allow home buyers with major derogatory credit events in their recent history to skip the traditional “waiting period” for an FHA-backed mortgage.
FHA : “Ignore” Foreclosures, Bankruptcy, Short Sales?
Major derogatory events include foreclosure, short sale, and Chapter 7 bankruptcy. The mandatory waiting period of each of the aforementioned events are as follows, assuming credit has been re-established by the borrower :
- Foreclosure : Must wait 3 years before eligible for FHA-insured financing
- Short Sale In Default : Must wait 3 years before eligible for FHA-insured financing
- Chapter 7 Bankruptcy : Must wait 2 years before eligible for FHA-insured financing
Under the FHA’s expected new plan, these waiting periods will be waived in full.
This one policy change will do more to increase demand than anything else the government has come up with. It directly addresses the biggest obstacle to increases sales volumes in the market — lack of qualified borrowers. If this change does occur, demand will pick up substantially. Potential buyers must still have a sufficient down payment — currently a paltry 3.5% — and they must have a FICO score high enough to meet FHA standards — currently a ridiculously low 580 — but those two unchallenging requirements are the only factors limiting demand.
Soon, FHA-insured loans may be available to home buyers who may have been recently foreclosed upon; for whom a short sale was necessary; or for whom a Chapter 7 bankruptcy was discharged yesterday.
The FHA’s new waiver on foreclosures, short sales and bankruptcies would add to the national pool of home buyers, creating buy-side demand for housing and upward pressure for home values nationwide.
The policy will also dramatically increase shadow inventory as millions of underwater loan owners default to take advantage of the change in policy. However, the banks don’t seem too concerned about shadow inventory as they merely plan to liquidate over time to the same people who just defaulted; after all, those potential buyers don’t have to wait, and they shouldn’t have to, right?
The FHA has grown its market share since the start of the decade on a combination of sound mortgage guidelines, low mortgage rates for borrowers, and a minimum downpayment option of just 3.5%. With its expected “waiting period” waiver, the FHA figures to grow its market share, and the pool of potential buyers nationwide.
Home prices have made slow, steady gains since October 2011 and those gains may accelerate with new FHA policies.
Wishful thinking. However, this new policy will have an impact. It may or may not positively impact pricing, that depends mostly on how well lenders manage their liquidations on the supply side. It should cause sales volumes to rise which may help the housing market find that elusive “escape velocity” the bottom callers are praying for.
During the housing bubble, the more irresponsible the borrower was, the more that borrower was rewarded. That simple truth has sown the seeds of moral hazard which will likely ensure another housing bubble. The former owner of today’s featured property was about as irresponsible as a borrower can be. He more than tripled his mortgage in a six-year span, he squatted for over four years, and he stiffed a private party (probably a friend) for $100,000 in the process. His reward? He got to spend over $400,000 in free money, and if the FHA makes the changes they are planning today, the US taxpayer will back a new loan to this guy. That doesn’t seem like the best use of my tax dollars.
Recording Date: 05/24/2011
Document Type: Notice of Sale
Recording Date: 03/19/2010
Document Type: Notice of Sale
Recording Date: 12/17/2009
Document Type: Notice of Default
Recording Date: 04/16/2009
Document Type: Notice of Rescission
Recording Date: 08/25/2008
Document Type: Notice of Sale
Recording Date: 05/22/2008
Document Type: Notice of Default
He quit paying the mortgage in February of 2008 at the latest, and the house was not foreclosed on until 10/28/2011. After $416,000 in HELOC booty, this borrower was allowed to squat for about four years.
I suspect he will want another one of those.
[idx-listing mlsnumber="I12113352" showpricehistory="true"]
$410,000 …….. Asking Price
$230,000 ………. Purchase Price
11/4/1998 ………. Purchase Date
$180,000 ………. Gross Gain (Loss)
($18,400) ………… Commissions and Costs at 8%
$161,600 ………. Net Gain (Loss)
78.3% ………. Gross Percent Change
70.3% ………. Net Percent Change
4.2% ………… Annual Appreciation
Cost of Home Ownership
$410,000 …….. Asking Price
$14,350 ………… 3.5% Down FHA Financing
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$395,650 …….. Mortgage
$102,706 ………. Income Requirement
$1,783 ………… Monthly Mortgage Payment
$355 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$103 ………… Homeowners Insurance at 0.3%
$412 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,653 ………. Monthly Cash Outlays
($266) ………. Tax Savings
($619) ………. Equity Hidden in Payment
$16 ………….. Lost Income to Down Payment
$123 ………….. Maintenance and Replacement Reserves
$1,907 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,600 ………… Furnishing and Move In at 1% + $1,500
$5,600 ………… Closing Costs at 1% + $1,500
$3,957 ………… Interest Points
$14,350 ………… Down Payment
$29,507 ………. Total Cash Costs
$29,200 ………. Emergency Cash Reserves
$58,707 ………. Total Savings Needed