Sep172012
FHA waived 3-year waiting period and prompted millions of strategic defaults
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.
FHA May Waive Its 3-Year Foreclosure Waiting Period
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:
- They could save 12 to 36 months worth of housing payments with the amend-pretend-extend dance.
- After they go through the foreclosure, they could rent for a couple years at a cost less than the previous payment they quit making years ago.
- After three years of squatting and a short period of inexpensive renting while their FICO score recovers, they could buy a comparable substitute for their former home and pay less for it.
- In the end, they would have the same house with a much smaller mortgage and plenty of equity.
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.
High-end foreclosures are rare, but growing
Elvira Grau, a party planner who appeared on The Real Housewives of New Jersey, has lost her $3 million home in Cresskill, Bergen County, to foreclosure.
It’s one of a growing number of high-end foreclosures – a sign that housing distress is not limited to lower-income neighborhoods.
Grau and her husband, James, own Space Odyssey, a former warehouse in Englewood they bought in 2005 and turned into a 26,000-square-foot entertainment venue. Elvira Grau appeared on The Real Housewives in 2010, planning a party for one of the show’s stars, Teresa Giudice. But the Graus were apparently not able to keep up the $17,500 monthly payments.
Million-dollar-plus foreclosures like the Graus’ are rare, but are on the rise, according to RealtyTrac, a California company that follows the foreclosure market. Although the numbers of foreclosures on properties with mortgages over $1 million are still tiny – less than 2 percent of all foreclosures nationwide – they have more than doubled since 2007, RealtyTrac said.
For buyers of luxury homes, the rising number of foreclosures in this price range offers the potential for better deals, since such dwellings generally sell at discounts that could total hundreds of thousands of dollars.
As in the case of the Graus, several observers said, high-end foreclosures often involve business owners.
But whether it’s a $200,000 house or a $2 million house, the basic story is the same. During the housing boom, households took on too much debt, in the form of mortgages or home-equity loans. Often, the mortgages were exotic loans with low initial payments that were followed by higher costs later.
When families faced job losses or other setbacks as the economy fell into recession, many couldn’t keep up with the mortgage payments, said Daren Blomquist, a RealtyTrac vice president.
High-end homeowners in trouble have taken longer to fall into foreclosure because they typically had more of “a financial cushion to fall back on to keep making their mortgage payments,” Blomquist said. “They’ve been able to hold out longer.”
HAMP is proving a dismal failure
The 1 millionth Home Affordable Modification Program trial or permanent workout failed in July, according to the latest Treasury Department data released Thursday.
A total of 770,834 borrowers failed to finish either a three-month trial or were determined to not qualify for the program from June 2010 through July 2012.
Another 229,185 permanent modifications redefaulted after making the first three monthly payments during the trial process, according to the report.
Since it launched in March 2009, a total of more than 1 million mortgages made it through the trial stage, but just over 825,000 active permanent modifications remain active today. And the monthly amount of newly reported workouts dropped to just 16,767 in July since average roughly 25,000 per month at the end of last year.
Even with a recent expansion, for which there is no official estimate yet, the amount of total modifications will fall well short of the original 3 million to 4 million originally promised.
More than one-third of the HAMP failed trials and permanent mods end up being modified through another proprietary program. But roughly 16% of the trials end up going through foreclosure, according to the Treasury.
The Special Inspector General for the Troubled Asset Relief Program said less than $3 billion of the $29.9 billion set aside for HAMP was actually spent as of June 30.
Treasury Assistant Secretary for Financial Stability Tim Massad continued to say Thursday that the program established guidelines around which servicers built their own programs. But Mitt Romney has challenged them as part of his presidential campaign and vowed to end “the alphabet soup” when he takes office.
The Treasury also found that more servicers were improving their performance under HAMP. It gave back witheld incentive payments last year to Bank of America , JPMorgan Chase, and Wells Fargo.
In the second quarter, the Treasury disagreed with less than 2% of all participating servicer decisions in HAMP. At the start of last year, some servicers such as Ocwen Financial Corp. and One West Bank had disagreement rates near 7%.
“By shining a spotlight on individual servicer performance in key areas, and requiring improvements through our compliance process, the nation’s largest mortgage servicers are fixing their processes while being held publicly accountable,” Massad said.
I can’t think of a business model that has a 33% failure rate.
There certainly isn’t a lending model that survives with that kind of track record. Even the payday loan lenders have better performance than that.
Fewer home buyers are first-timers
Despite low interest rates, low prices and slowly rising sales, first-time homeowners accounted for just 34% of all buyers in July, according to data released Wednesday by the National Association of Realtors. While that figure has inched up slightly from the month and year prior, the association says first-time home buyers account for 40% of purchasers under normal conditions.
The reluctance of newcomers to enter the market may be further adding to housing’s woes. After all, first-time buyers are vital to boosting sales, especially during downturns, since when they buy a home, they aren’t also selling a previous home to finance the purchase.
Their recent absence is largely due to the current challenges of saving up enough for a down payment: In a survey released in June by Trulia, an online real estate marketplace, 47% of all adults who aren’t homeowners and who wish to buy a home said that the down payment is the biggest obstacle to entering the housing market. Most mortgages require at least a 10% down payment, and in some pricey markets, like New York and San Francisco, coming up with that cash can take years, says Jed Kolko, chief economist at Trulia. A poor credit history, which makes it difficult to qualify for a mortgage, was the second most common issue holding back would-be first timers, according to Trulia’s survey.
Many potential buyers are also facing higher unemployment rates than other groups. The unemployment rate among 25- to 34-year-olds stood at 8.2% in July, compared with 6.9% for 35- to 44-year-olds and 6.5% for 45- to 54-year-olds, according to the Bureau of Labor Statistics.
Separately, first-time buyers are competing against investors—who tend to have all-cash offers and who go after the same, lower-price homes, says Leonard Baron, real estate lecturer at San Diego State University. Sellers who are eager to unload their homes are more willing to work with investors, since the sale doesn’t hinge on a bank’s decision to approve them for a mortgage. More recently, experts say, tight inventory has made it even harder for first timers to compete.
Still trapped in the ‘fiat money + fiasco’ delusion, post y2k OC slumlords get royally ‘whacked’ (asset values flat to tanked + purchasing power of the income streams continue to decrease, NOT increase)… while those who chose to liquidate their rental portfolios and bought gold are literally live’n the dream’.
http://4.bp.blogspot.com/-Qb3MKFv6FtQ/UFX__bVMudI/AAAAAAAAY9s/beyYk-85G8I/s1600/purchasing_power_us_gold_etc.png
Interesting chart. Of course, I wouldn’t have enjoyed the ride in gold from 1980 to 2000…
True. You do have to be able to time the market. But what does the movement in gold from 1980 to 2000 have anything to do with investing in gold now? I would not have enjoyed the ride in re from 2006 to 2012. Does that mean I would never buy a house, or I think that re will not once again be a good investment. Well, I don’t, but that’s besides the point.
I think the point is that the historical performance of gold has been piss poor, worse than even real estate.
If the waiting period is eliminated, the only question for prospective strategic defaulters is, “How quickly will my credit score return to the minimum necessary?”
Yep. Plus, since FICO doesn’t concern themselves with policy or morality, they will evaluate people based on their performance. By and large, strategic defaulters are good credit risks. The FICO score recovery on the cohort identified as strategic defaulters will recover quickly as they will not be delinquent on other debt service payments. The waiting period was the only real punishment for a true strategic defaulter, and with that eliminated, many more will be encouraged to do the same.
Beware acting on what the GSEs or FHA are “thinking about” doing. They think about things (out loud) all the time. But the banks don’t have to listen to them (that is to say, they don’t have to be as generous as the GSEs say they should be). And the banks are still the originators, aren’t they?
No. This is not about opening the floodgates to underwater homeowners looking to escape their predicament. It is about big investors that are hungry (right now!) for bargain properties, and (down the road) long-term renters who can (someday in the distant future) buy the rentals at a tidy profit for the patient investor.
Caveat emptor. This smells of a trap.
This may be one of those idea balloons they float every once in a while. Perhaps someone will read a post like this and point out the unintended consequences of what they are considering. The waiting period should be maintained.
Do you think the banks may put overlays on FHA qualification and impose their own waiting period? They might. Some probably will, but some lender somewhere won’t, and that lender will grow their business. If there are buyback provisions on those originations, lenders will remain cautious.
Uh-oh… notable sell-off still underway—-last weeks QE3 launch bounce just about wiped-out across the board thus far in MBS price-land + the 10yr yld now sits @1.83 and the [email protected]. LOL
My father-in-law just asked me to help him purchase silver.
So QE3 prompted a bond selloff? I would have expected the opposite. Perhaps sellers are taking this as a signal to unload their positions as a last chance to dump them on the government.
If FHA does away with a waiting period, why not strategically default. There isn’t a consequence of significance other than perhaps 6 months or so waiting for the legal issues to play out. Heck, put a deposit on a new home 12 months out, lock in that lower price, squat, default, then re-buy FHA a brand new home. We’re living in times of zero responsibility for ones actions. Jump on in, the water’s fine!
I wouldn’t be surprised to see a resurgence of the buy-and-bail gambit. As you pointed out, if you lock in the price on a new home, you have 12 months to save for the down payment and recover your FICO score.
The only factor the borrower doesn’t have control of is how quickly the strategic default is processed by the lender. If the lender goes into amend-extend-pretend mode, the delinquent payments will persist, and the FICO score may be slow to recover.
Well, it looks like QE3 will keep blowing air back into the bubble which never fully deflated here in Oakland, CA, pricing me out of the market. I’m so flabbergasted at what’s going on in the housing market that it’s hard to read the news – or even this great blog – anymore. The banks, the Fed, the government, and loan-owners who got into this mess are apparently willing to do anything to avoid taking responsibility for the mess they caused.
Oh, and by the way, I find that ‘American Banker’ cover to be insulting – to pigs, which from everything I’ve read are sociable, friendly, and intelligent. Too bad they’re a symbol of greed. (In the NY Times 7/31/08, Nick Kristof, who grew up on a farm, wrote “Our cattle, sheep, chickens and goats certainly had individual personalities, but not such interesting ones that it bothered me that they might end up in a stew. Pigs were more troubling because of their unforgettable characters and obvious intelligence. To this day, when tucking into a pork chop, I always feel as if it is my intellectual equal.”)
Your comments on the pig were amusing.
“The banks, the Fed, the government, and loan-owners who got into this mess are apparently willing to do anything to avoid taking responsibility for the mess they caused.”
This galls me too. What’s worse is that they are taking our money through bailouts and interest rate subsidies to keep us priced out of homes they could never afford.
Where is this information coming from? As a person who had to foreclose on our home because my daughter got cancer and we had tons of medical debt (i had to file a BK) in the process, I hope it is lifted! the strategic defaulters will not qualify anyways due to bad credit and no down payment.
And the same story just keeps repeating. This is getting to the point of the absurd.
I have a feeling that it is worse here on the east coast, because we got all that bailout money flowing through all of us that work or are tied to the NYC Finance Industry, that has kept the prices from dropping like they did in CA to start with.
I am looking for a house in one of the suburbs in NJ and the asking prices are outrageous, even for houses in borderline neighberhoods.
[…] treasury bonds and mortgage bonds, it is possible that mortgage rates may go even further down. FHA also may waive the 3-year waiting period after short sale/foreclosure. If that happens, in conjunction with even lower mortgage rate, the housing markets can easily go up […]
You make everybody who is foreclosed on seem guilty. Many of us were wrongfully foreclosed on while following programs by the banks, given no notice, no chance to reinstate the loan, nothing, so that the banks can get a GSE payoff on the whole loan balance on a foreclosure judgment, rather than work with the homeowners through programs in place. Then the banks spend that time falsely reporting those of us as having defaulted when we did not. You have no idea the harm that is to have a fraudulent foreclosure hitting your credit. This blacklists you from homes due to these waiting periods put in place, supposedly to keep homeowners from purposefully not paying their loans. You don’t mention the banks who purposefully trick homeowners into programs with the intent to not work with them, and to slam them with a foreclosure suit, that if they had the money to hire a lawyer, would show them victims of the bank and innocent of payment defaults, like my lawyer has done.
For people in my position it is mandatory FHA waive these waiting periods so we can recover from the wrongful foreclosures and get housing. Stop dreaming that one can rent somewhere; the same credit harm you get from wrong foreclosures, also keeps you from renting anywhere. Not everyone is trying to take advantage of the system, except it seems almost every bank is trying to take advantage of the GSE payoff on houses through judgment and wrongfully hitting hundreds or more with wrongful foreclosures.
wave the 3 year waiting period? awesome! It’s like section 8 housing for the middle class!! you just have to move a bit more often.
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