Nov232013

Has FHA increased their fees so high they are now a predatory lender?

Just in case you didn’t know FHA is a government insurance program for lenders. FHA has front-end Mortgage Insurance and regular Mortgage Insurance and it’s paid by the borrower.  These rates have greatly increased since 2007. Now a new question is being asked.  Is FHA now one the lenders (really an insurance product) the government tried to band after the housing bust.

The FHA is a predatory lender

According to the FDIC’s Inspector General: “Predatory lending typically involves imposing unfair and abusive loan terms on borrowers, often through aggressive sales tactics; taking advantage of borrowers’ lack of understanding of complicated transactions; and outright deception.”

This happens all the time with payday loans, auto title subprime loans, and even student loans.  These types of loans charge a very high interest rates, because there is an extremely high level of default.  Students loans don’t have a high rate, but have large balances beyond what the student can expect to pay back.

The Federal Housing Administration’s (FHA’s) mortgage insurance practices qualify as predatory under this standard.

First, FHA mortgage insurance pricing grossly overcharges lower-risk borrowers. Hundreds of thousands of borrowers have been steered by mortgage lenders and real estate brokers to use FHA mortgage insurance rather than less expensive private alternatives. In FY 2013 alone, nearly 200,000 home purchasers with FHA-insured loans could have saved an estimated $710 million over the life of their loans, or nearly $4,000 in individual savings.

In a little defense of FHA the people they usually insure loans for don’t have enough credit or down payment to get obtain a private loan.  Not everyone that gets an FHA has bad credit, but it’s sometimes the lender of last resort for many borrowers.  Therefore FHA needs to charge higher insurance rates for these borrowers that are mostly likely to default.

Second, the FHA counts on a borrower’s lack of understanding of the complicated nature of FHA insurance as well as the expectation that the FHA would not intentionally permit borrowers to be steered into financially disadvantageous transactions. FHA’s premiums add up to about 10 percent of the initial mortgage amount over the average life of a loan. Since FHA does not price for credit risk, it needs to overcharge low-risk borrowers so it may subsidize the rates charged on high-risk borrowers.

FHA is in a bit of financial difficulty and will require a cash infusion (bailout) to shore up it’s reserve fund.  If you do what he suggested and charge it’s low-risk borrowers a lower fee, it would need a much larger bailout.  Basically, the low risk borrowers subsidized the high risk borrowers.  Well FHA is not completely subsidized , because the high risk borrowers are not subsidizing all the low risk borrowers costs or FHA wouldn’t need a bailout.

When Congress established the FHA in 1934, cross-subsidization between low-and high-risk borrowers was explicitly prohibited. Today, the FHA program is all about cross-subsidies; the average low-risk borrower with a $150,000 mortgage is overcharged about $9,000. This amount is much larger than the pricing difference between FHA and private mortgage insurance, since FHA benefits from many subsidies-not paying taxes, no need to earn a return on capital (if it had any capital), and taxpayers absorbing its administrative costs-which enable the organization to mask monumental losses on their high risk loans.

The reason that FHA”s mission has drifted it was used tool to prop up the housing market after the crash.  Private sources of lending disappeared and the FHA increased the type the borrowers it traditionally served.  It was open not just to first time buyers, but all buyers up to the conforming limit.

Third, these cross-subsidies allow the FHA to offer abusive loan insurance terms to hundreds of thousands of high-risk borrowers. For example, FHA’s underwriting standards permit borrowers with a 600 FICO credit score, 98 percent loan-to-value, and a 43 percent Debt to Income (DTI) to obtain an FHA insured loan, even though these borrowers have a one in four chance of foreclosure. Abusive terms such as these harm working class families and neighborhoods.

This is a typical subprime loan.  You can’t have lending business that have 1 in 4 failures.  If you did have a business like this you would need to charge mortgage rates that were similar to credit card rates.

The secretary of HUD should add a number of protections to HUD’s consumer bill of rights to prevent such predatory practices. First, he should require the FHA to provide private-government best-execution comparisons to FHA applicants so as to ensure low-risk borrowers do not needlessly overpay thousands of dollars when they obtain an insured mortgage loan. If the private market alternative is a better execution, prospective borrowers should be so informed. If Secretary Donovan fails to do this, Congress should consider adding it to pending FHA reform bills.

FHA is already in a financial situation they can’t walk back from.  They already have too many bad loans from years of subprime lending and need to generate more loans at higher mortgage insurance rates to pay for the bad loans.  If HUD were to adopt these practices, then the bailout amount would increase over what is currently required to bailout them out.

Finally, the secretary of HUD should require lenders to disclose to prospective borrowers a clear and conspicuous notice within both 72 hours of application and at closing, which sets forth the applicant’s Loan to Value, FICO score, and total debt-to-income ratio, as used in underwriting the applicant’s FHA loan. This disclosure shall also include the estimated cumulative foreclosure rate for loans insured by the secretary with similar risk characteristics to the applicant’s and the average estimated cumulative foreclosure rate for the most recent fiscal year as determined in the FHA’s annual actuarial study. Such a disclosure would provide a prospective borrower the most transparent information regarding their risk of foreclosure. If Secretary Donovan fails to do this, Congress should immediately enact the Protecting American Taxpayers and Homeowners Act (the PATH Act) which provides for this much needed consumer protection.

What would do more the return long term stability to FHA is get away from low downpayment loans.  There should be a minimum of 10%  as a benchmark that the borrower could at least make it to that level of responsibility.  That would better protect FHA from losses if the borrower couldn’t just simply walk away.  However, FHA is in a situation where it has to accept many high risk applicants to the keep the insurance premium revenue up.  Lastly, the low risk borrowers are getting better rates and lower insurance costs by Fannie and Freddie, so FHA now has a greater of mix of high risk borrowers. FHA is really now the subprime lender.

Mike