The FHA has been the lender of last resort throughout the housing bubble crash. They insured loans which didn’t properly price in risk during a declining market. No private lender would have made such loans, particularly as the super-low interest rates engineered by the federal reserve. The FHA has tried to raise its cost of money to cover the risk by increasing the insurance fees which drives up the effective interest rate, but their onerous fees have fallen short of covering the upcoming losses.
In the FHA’s defense, the loans they underwrote were of high quality, and although they reached pretty low for FICO scores, the documentation and underwriting was sufficient to protect the taxpayer from unqualified borrowers. What the FHA couldn’t protect the taxpayer from is the losses associated with falling prices.
As a business model, subprime lending works in an environment of rising prices. Even when the default rates are high, if prices are rising, the losses on those defaults is minimal. However, when prices are falling, high default rates make for very large default losses, and the business model is untenable. FHA is facing a similar problem, but for different reasons.
FHA had good underwriting, but the tiny down payments and falling prices have trapped all of their borrowers underwater. Over time, people want to move. The FHA will need to approve many short sales from underwater borrowers in 2007-2011 vintage loans, particularly from the earlier vintages that are severely underwater. Of course, that assumes the owner bothers with the short sale process. With no equity, it’s easy for an FHA borrower to simply stop paying and move on. To them, the house was no different than a rental. Their down payment was not much larger than a security deposit, and they recover that with just a few months of squatting before they go.
The problem isn’t that FHA borrowers are subprime borrowers, although some are sprinkled into the mix. The real problem is that prices went down, and the only viable choices for FHA borrowers are short sale or strategic default. Either ones means the FHA insurance fund takes a hit, and if enough borrowers need or want to move, the FHA will face serious losses. I think a bailout is inevitable.
By Tami Luhby @CNNMoney July 9, 2012: 5:11 AM ET
NEW YORK (CNNMoney) — The mortgage market appears to finally be stabilizing — as long as you ignore loans backed by the Federal Housing Administration.
Increasingly, FHA-insured loans are falling into foreclosure or serious delinquency, moving in the opposite direction of loans guaranteed by Fannie Mae and Freddie Mac or those held by banks, which are all showing signs of improvement.
Does anyone really believe bank-held mortgages delinquency rates are down 39%? Based on the charts of shadow inventory, the number of 90-day delinquent loans hasn’t declined much at all over the last year. We know the banks have not been foreclosing in earnest, and they have billions in non-performing HELOCs and second mortgages on their books. I don’t see how they could have reduced their delinquency rates that much. Perhaps the include the loan modifications which temporarily cure the loans?
And taxpayers could ultimately be on the hook for FHA’s growing number of troubled mortgages. The agency’s finances are already on shaky ground, and additional losses from loans going sour could prompt the need for a federal bailout, experts said.
“We can’t escape this one,” said Joseph Gyourko, a real estate professor at the University of Pennsylvania’s Wharton School. “This is an arm of the U.S. government.”
The share of government-guaranteed loans, a majority of which are backed by FHA, that were 90 days or more delinquent soared nearly 27% during the year ending March 31. Foreclosures jumped nearly 17%, according to a report published recently by federal regulators.
This is a catastrophe for politicians who were hoping to avoid an FHA bailout. The Obama administration will ignore this problem until after the election if the Republicans let him.
At the same time, bank loans saw a dramatic improvement, with delinquencies shrinking by 39% and foreclosures declining by nearly 10%. Fannie and Freddie’s portfolio also improved as delinquencies dropped by nearly 15% and foreclosures slid by more than 6%, the quarterly report issued by the Office of the Comptroller of the Currency said.
I still don’t get the math. If delinquencies are down, and foreclosures are down, how did all these bad loans get cured? The people who squatted for the last three years didn’t suddenly come up with the money. It doesn’t add up unless the banks are counting bogus loan modifications.
FHA has also had a tougher time successfully modifying loans. More than 48% of government-guaranteed mortgages re-defaulted 12 months after modification, compared to 36.2% of loans overall, the report said.
FHA’s risky borrowers:
FHA doesn’t make loans, but it backstops lenders if borrowers stop paying. With this guarantee in place, banks are more likely to offer mortgages to borrowers with lower credit scores or incomes.
Housing experts have been warning for years that many FHA-insured loans are not sustainable, especially in these troubled times. That’s particularly concerning because FHA’s share of the market has swelled in recent years as lenders pulled back on providing mortgages that weren’t backed by the government.
Orange County is also a hotbed of FHA loans.
One of the main critiques of FHA loans is that they require very low downpayments — a minimum of 3.5%. In an environment where home prices are declining, borrowers can quickly slip underwater and owe more than their property is worth.
Actually, it’s worse than that. At 3.5% down, the borrower is effectively underwater the day they move in. Ordinarily, the buyer is the most aggressive bidder in the market, so they may have bid up the price too high. Plus, it takes a 6% commission and about 2% in closing costs to get out. In the real world, anyone who puts less than 10% down is effectively underwater from the start.
“These are very risky loans,” said Ed Pinto, resident fellow at the American Enterprise Institute, a conservative think tank. And loans made in the past three years are “moving into the beginning of the peak delinquency period and they are very big books of business.”
Unless the economy improves significantly over the next few years, FHA will experience even more delinquencies, said Guy Cecala, publisher of Inside Mortgage Finance, an industry publication.
Unless prices go up and the economy improves, the FHA will experience more delinquencies. A certain number of people lose their jobs, need to relocate, or otherwise must sell their houses each year. In a rising market, these sales get absorbed without much problem, the borrower pays off the loan, and nobody is harmed. However, in a weak economy, more people default due to their job situation, and the falling prices prevent them from getting out whole.
Little room for failure:
The dramatic jump in delinquencies comes despite the agency’s efforts to improve the quality of the loans it insures.
Over the past several years, soaring defaults have been eating away at FHA’s emergency reserves, which cover losses on the mortgages it insures. In fiscal 2009, the reserve fund dropped to 0.53% of FHA’s insurance guarantees, well below the 2% ratio mandated by Congress. By late last year, it had fallen to 0.24%.
FHA pledged to shore up its standards and its finances in 2009. The agency has since increased its insurance premiums, established minimum credit scores for borrowers, required larger downpayments from those with credit scores below 580 and banned sellers from assisting borrowers with the downpayment. It also created an office of risk management and cracked down on lenders with questionable underwriting processes.
Despite the emergency fund’s diminishing reserves, FHA maintains that its efforts are working. The loans insured starting in 2009 are much higher quality and should lower delinquency levels over time, an FHA official said.
The steps the FHA took are appropriate, and their loans should perform better over time. Increasing the insurance premiums will help cover the losses, and eliminating down payment assistance eliminated the largest source of delinquent borrowers from the pool. Unfotunately, it these measures will prove to be too little too late.
“We expect the new books will continue with their better performance, primarily because of the steps that were put in place,” he said. “And we are benefiting from having more high-credit borrowers.“
Was the FHA limit has been kept at $729,750 while the conforming limit for GSE loans was dropped to $625,000 was to get more high wage earners into the FHA program? If so, it was a smart move. The high wage earners paying more than 1% of their huge mortgages into the FHA insurance fund will really help — assuming prices don’t crash causing big losses among those borrowers.
Still, FHA watchers warn that the agency doesn’t have much of a cushion against these rising delinquencies and foreclosures. And if the losses grow too great, the agency could need a taxpayer-funded bailout.
The FHA says that its reserves should be restored by 2014 barring a second recession, but outside experts aren’t so sure.
“They are doing very badly … there’s no two ways about it,” said Andrew Caplin, a New York University economics professor who has studied the agency. “Over the next five years, there won’t be enough of an economic recovery to fix FHA’s finances. Not a chance.”
What form would an FHA bailout take?
Even if the FHA requires a bailout, it probably won’t result in the loss of taxpayer funds. The government will likely make the FHA a bridge loan at 0% interest against future premiums. This will make the FHA solvent while they earn their way back to health. Once prices start rising, the default losses will decline, and eventually, the fund will have more coming in than going out. If the government has to make the FHA a bailout loan, which seems likely, the premiums will have to remain high for a little longer to pay off the loan. In the end, the taxpayer will not end up losing money, but future FHA borrowers will be paying the losses on bubble era loans for quite some time.
From FHA to Ponzi
Many, perhaps most, first-time homebuyers use FHA loans because the down payment requirements are so low. Many people enter the housing market using an FHA loan, wait until house prices rise 20%, then they trade up or refinance to get into conventional financing. However, during the housing bubble, many Ponzis entered the housing market with an FHA loan, then took hundreds of thousands in free money and blew it. The former owner of today’s featured property used a low down payment loan to get into the market in 2000 and managed to borrow another $335,000 in free money. I’ll bet he reapplies for an FHA loan when he qualifies again.
- This property was purchased with a $402,871 first mortgage. The sales price is conjecture based on the transfer tax paid, but they likely actually paid $415,000 and used a 3% FHA down payment of about 12,000.
- On 3/5/2002 they refinanced with a $327,000 first mortgage and obtained a $100,000 HELOC.
- On 12/22/2003 they refinanced with a $455,000 first mortgage.
- On 8/11/2004 they obtained a $150,000 HELOC.
- On 3/29/2007 they refinanced with a $736,000 first mortgage.
Apparently, that free money got too expensive, and they couldn’t afford the payments. They defaulted and lost the house.
Mission Viejo Overview
Median home price is $420,000. Based on a rental parity value of $579,000, this market is under valued.
Monthly payment affordability has been improving over the last 2 month(s). Momentum suggests improving affordability.
Resale prices on a $/SF basis increased from $237/SF to $240/SF.
Resale prices have been falling for 12 month(s). Price momentum suggests falling prices over the next three months.
Median rental rates increased $37 last month from $2,327 to $2,365.
Rents have been rising for 12 month(s). Price momentum suggests rising rents over the next three months.
Market rating = 7
$536,750 …….. Asking Price
$403,000 ………. Purchase Price
9/28/2000 ………. Purchase Date
$133,750 ………. Gross Gain (Loss)
($32,240) ………… Commissions and Costs at 8%
$101,510 ………. Net Gain (Loss)
33.2% ………. Gross Percent Change
25.2% ………. Net Percent Change
2.4% ………… Annual Appreciation
Cost of Home Ownership
$536,750 …….. Asking Price
$107,350 ………… 20% Down Conventional
3.67% …………. Mortgage Interest Rate
30 ……………… Number of Years
$429,400 …….. Mortgage
$104,653 ………. Income Requirement
$1,969 ………… Monthly Mortgage Payment
$465 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$134 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$135 ………… Homeowners Association Fees
$2,704 ………. Monthly Cash Outlays
($311) ………. Tax Savings
($656) ………. Equity Hidden in Payment
$129 ………….. Lost Income to Down Payment
$87 ………….. Maintenance and Replacement Reserves
$1,953 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,868 ………… Furnishing and Move In at 1% + $1,500
$6,868 ………… Closing Costs at 1% + $1,500
$4,294 ………… Interest Points
$107,350 ………… Down Payment
$125,379 ………. Total Cash Costs
$29,900 ………. Emergency Cash Reserves
$155,279 ………. Total Savings Needed
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