Our current housing finance system is a mess. It’s laden with moral hazard, and likely to implode with enormous losses to be absorbed at taxpayer expense. All our current policies are geared toward saving our banking system from financial ruin and making loan owners comfortable with their fate. As with any policy initiatives that distort the natural market, the current system is loaded with unintended incentives that permit people to game the system for their personal advantage. Today we look at how using an FHA loan to game the system provides advantages that offset the high cost of the FHA insurance.
In Monday’s post, Loan modification defaults soar 24%, can-kicking fails, I found a very astute observation from an industry insider working in loss mitigation. It provides a helpful overview of just how messed up our system really is, and it points the way to how people can use FHA loans to their advantage.
Schizlor says:
FHA just recently revised their modification guidelines to basically throw out any relevant ratios (Housing Ratio, Total DTI) Essentially we all see this as a sign of, “For the love of god just get some payments coming in on these mods”. We see clearly that their liquidity is drying up and they are getting crushed by claim payments, particularly on short sales where they’ve insured the full balance of the mortgage and are taking enormous losses. They’ve basically decided, as you stated above, that these squatters making some payment is better than none at all. The crazy thing is, it’s just like the housing bubble, where anyone who could fog a mirror was offered a loan. Now FHA is offering anyone who can fog a mirror, a mortgage modification, completely irrespective of their ability to pay (for instance, giving people with a 70% housing ratio a mod, instead of foreclosing on them because they clearly cannot afford even the reduced payment)
They are now extending and pretending, within the extend and pretend program itself. FHA’s insolvency is a 100% certainty.
17% of FHA loans were delinquent in September. A bailout is coming. There is a recent article in the LA Times that made the laughable contention that the FHA will not require a bailout. Given that the FHA is giving loans to Ponzis to reenter the housing market, I think it’s safe to assume an FHA bailout is coming, and it will be much larger than government officials contend.
And I can tell you from firsthand experience (I work in Loss Mitigation) that your assertions have been, and continue to be, dead on with regards to modifications and their abject failure. Banks never intended to help anyone, they are using loss mitigation as a way to restrain supply of foreclosed homes from the market, and squeeze blood from a stone. Anecdotally I can tell you (I do short sales myself) that 85% of the people who submit for a short sale, have been through MULTIPLE attempts at modifying their mortgage. They want to game the system, and the banks are happy to let them play their game, because being left to hold the bag is the greater of two evils. Were the banks in any position to liquidate the potential foreclosures without crashing the market, these people would have been out on their ass years ago.
The government has stepped into the morass to make loan modifications an entitlement, as if saddling a borrower with a debt 30% to 50% greater than the house is worth is a compassionate thing to do. The only reason banks went along is because it was in their best interest to do so — for now. Once prices get back near the peak, I suspect lenders will try to undermine the loan modification entitlement system because if there is collateral backing their loan, foreclosure is preferable to a loan modification.
What’s more disturbing to me, is the amount of people allowed to short sell their home, who purchased the property after 2009. We have people who closed in 2011 asking for a short sale. We’ve even had people state on the application, that their reason for default was, “Property value is below what I paid”. Strategic Default has now become the order of the day, thanks to permissive extend-and-pretend policies.
The banks deserve the problems with strategic default their actions created. In my opinion, strategic default is a moral imperative to prevent future housing bubbles. Lenders have conditioned an entire generation of borrowers to believe loan modifications are an entitlement and strategic default is a viable option when prices go south.
All in all, things IMO are getting worse, not better. If people who bought in 2011 are allowed to short sell on a whim, why not everyone going forward? The minute you have no equity, default. It’s the governments (taxpayer’s) job to ensure private property owners have positive equity in their homes in today’s America.
If anyone in this day and age doubts the existence of “Moral Hazard”, come to my office. I’ll show you the application for a short sale from a man who bought his home in December of 2011, and said he needs a short sale because, “Property values have declined and the home is not worth what I paid for it last year”. The fact that someone could make that claim with a straight face in 2012 shows you how far this situation has deteriorated, and it continues to get worse by the day.
Keep up the good work IR
FHA loans as a stoploss
Back in 2006 when I started publicly warning people not to buy homes due to the impending crash, I pointed out to people that there is no stoploss protection in event of a major decline in prices. Leverage works both ways, and the people who were making huge money on small investments were enjoying stellar returns. However, if prices go the other way, the losses are even more brutal.
Another commonly leveraged investment is stocks. People in a margin account can buy twice as much stock as they can afford by borrowing money from their broker. In the event stock prices collapse, the broker will close out an investor’s position before the account goes negative to preserve their original loan capital. There is no such stoploss protection in residential real estate. If house prices go down, people lose money until prices stop going down. They can easily lose many times their original down payment investment.
Well, at least that used to be true…
Now in an era of short sales as an entitlement, borrowers and speculators have no downside risk beyond their initial down payment. As Schizlor points out above, if values go down, people simply petition for a short sale, and the lender absorbs the loss. And when that loan is an FHA loan, the lender simply passes the loss on to the US taxpayer.
The incentive here is clear. Everyone should put the minimum possible down payment on a property to minimize their own exposure. If prices go down, they can petition for a loan modification, a short sale, or simply strategically default with no financial repercussions.
FHA loans as a tool to maximize return on investment
There is a strong secondary incentive to put the minimum down when buying real estate. When you calculate return on investment, the denominator is your investment. The smaller this number is, the higher the return. A 3.5% down payment provides six times the return of a 20% down payment. It;s not the great deal zero-down speculators had going during the bubble, but it’s not bad.
FHA loans are best if you might have to move
Shevy and I always tell people they should rent rather than buy if they think they might need to move in three to five years. Our reasoning is simple, since commissions and closing costs are about 8% of the sales price, it takes at least two years if not longer for houses to appreciate enough to get back the down payment. If a buyer needs to move during that time, their down payment is at risk. This is true irrespective of the financing used, but why should a buyer risk their own money when the FHA will assume more than half this risk for them? Given the uncertainties about future home prices, and the potential to need to move, a buyer is well served by passing off as much risk as possible to the FHA and the US taxpayer.
Other FHA Loan benefits
One of our regular commenters, Perspcctive, mentioned these additional advantages in yesterday’s post:
Perspective says:
There are additional benefits to going with an FHA. There are many programs to help you if your income declines, including forbearance. There’s also a streamline refi that allows a quick refi with no appraisal or income checks. The MI is expensive on a 30-year loan (1.25% soon to be 1.35%), but worth the cost if you’re a marginal buyer maximizing your purchasing power and stretching your budget (and therefore can reasonably anticipate using many FHA homeowner aids).
Perspective says:
An additional benefit I failed to mention, is that the FHA has a policy of not seeking deficiency judgments (when they’re available). So if you refi into an FHA in CA, there’s an added benefit. However, starting in 2013, CA law allows a “continuous purchase money” character to remain. i.e. If the refi after 2012 refinances only the remaining principal from the purchase mortgage, no deficiency is available. If any cash is taken in a cash-out refi, then that amount is subject to a deficiency judgment.
This system needs to be changed
The above is the best advice I can give a buyer in today’s market — and that pains me. It’s terrible that our system encourages both bankers and buyers to pass their losses on to the US taxpayer. As one of them, it’s infuriating to see how our government’s policies to coddle the banks has created a system where both bankers and borrowers can pass their bad bets on to all of us. Unfortunately, that’s the reality of life. Despite the high cost of FHA insurance, I will probably get one of these loans when I finally buy a home. Why not?
I don’t like putting the US taxpayer at risk, but our government encourages it, so I might as well take advantage.
So should you.
Thanks for the reverse mortgage money
I hate reverse mortgages. It’s a way for banks to make huge fees and interest payments and give seniors very little in exchange. It warms my heart to see bankers lose their asses on these deals. The former owner of today’s featured property got a $300,000 reverse mortgage on 12/18/2007. I hope she took all her cash as a lump sum.
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Proprietary OC Housing News home purchase analysis
3047 South VIA SERENA Unit P Laguna Woods, CA 92637
$135,000 …….. Asking Price
$75,000 ………. Purchase Price
6/6/1995 ………. Purchase Date
$60,000 ………. Gross Gain (Loss)
($6,000) ………… Commissions and Costs at 8%
============================================
$54,000 ………. Net Gain (Loss)
============================================
80.0% ………. Gross Percent Change
72.0% ………. Net Percent Change
3.3% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$135,000 …….. Asking Price
$4,725 ………… 3.5% Down FHA Financing
3.45% …………. Mortgage Interest Rate
30 ……………… Number of Years
$130,275 …….. Mortgage
$55,270 ………. Income Requirement
$581 ………… Monthly Mortgage Payment
$117 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$34 ………… Homeowners Insurance at 0.3%
$136 ………… Private Mortgage Insurance
$560 ………… Homeowners Association Fees
============================================
$1,428 ………. Monthly Cash Outlays
($49) ………. Tax Savings
($207) ………. Equity Hidden in Payment
$5 ………….. Lost Income to Down Payment
$37 ………….. Maintenance and Replacement Reserves
============================================
$1,214 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$2,850 ………… Furnishing and Move In at 1% + $1,500
$2,850 ………… Closing Costs at 1% + $1,500
$1,303 ………… Interest Points
$4,725 ………… Down Payment
============================================
$11,728 ………. Total Cash Costs
$18,600 ………. Emergency Cash Reserves
============================================
$30,328 ………. Total Savings Needed
The property above is available for sale on the MLS.
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33 Responses to “How to game the system with FHA loans for maximum advantage”
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FHA is becoming an entitlement program, in the beginning it was just a program for people purchasing their first expensive home. Then it replaced sub-prime leading about 5 years ago. However, many politicians want to keep FHA conforming limits and be able purchase multiple homes spread over several years. It’s now the government 3.5% downpayment program open to people with minimal standards.
But I think you are right. I’ve been a fool saving my 20%. Especially, when all the all the other FHA borrowers will simply stop paying and ask for a modification when the market turns down.
I think you are better off buying now and continue saving for a 20% down payment on a different home. If prices go up, you will have equity from the home you bought to help you move up. If prices do down, you haven’t lost much. If you keep saving, even if you keep the home, you can refinance when you hit 20% equity and get rid of the FHA insurance that way.
In a 30-year FHA loan, you must pay MIP for five years regardless of LTV. Of course, you could refi out of the FHA loan to get out of mortgage insurance.
Also, FHA is considering extending MIP payment periods beyond 78% LTV. Something to keep in mind…
Check out:
http://portal.hud.gov/hudportal/documents/huddoc?id=F12MMIFundRepCong111612.pdf
pages 53-55.
“d. Proactive Strategies to Further Improve Recoveries
…. First, beginning in 2013, FHA will
launch a large-scale proactive marketing campaign to promote modification and short-sale strategies for delinquent borrowers. This effort is expected to increase utilization of
these programs, which will permit more borrowers to become aware of and take
advantage of these opportunities, while reducing foreclosures and decreasing associated
losses for FHA. In addition, FHA will also pursue more creative strategies to dispose of
REO properties in geographies where traditional asset disposition methods yield net
negative recoveries for FHA.
a. Revised Premium Cancellation Policy
….Therefore, beginning with new loans endorsed after the policy change
becomes effective later in FY 2013, FHA will once again collect premiums on FHA loans
for the entire period during which they are insured, permitting FHA to retain significant
revenue that is currently being forfeited prematurely.
”
I wonder what the more “creative strategies” will be.
And now MIP will be for the life of the loan, not just 5 years?
Credit: http://www.findmywayhome.com/home-mortgage-news/fha-mortgage-insurance-permanent-2013/
I also wonder what their “creative strategies” will be.
Trying to sustain the premium for longer than five years will prompt a lot of people to refinance. I’m sure it looks good on their actuarial tables, but in reality, those fees won’t materialize.
Is it too late to take part in this game? If interest rates increase in 5 years then you would be stuck with a low interest rate loan that has MIP payments for life or refiance and take the potentially higher interest rates and no MIP payments? Seems like the Feds and HeliBen are fishing.
Ops – Their first inexpensive home
Yeah, I think you right.
Being bullish on real estate is becoming fashionable.
Fiserv Projects Home Price Growth into 2017
The latest numbers from the Fiserv Case-Shiller Indexes show that the housing market may finally be on solid footing again.
Average U.S. home prices increased by 1.2 percent in Q2 2012 from the same quarter last year. The year-over-year increase is the first since 2006 when excluding 2010, which was influenced by the federal homebuyer’s tax credit.
The indices indicate that from the second quarter of 2012 to the same quarter in 2013, home prices will increase 0.3 percent and will continue to increase as the year progresses. Fiserv projects that housing prices will grow annually at a rate of 3.3 percent from mid-2012 through Q2 2017.
The cities hardest hit by the housing bubble burst have seen the biggest increase. Phoenix saw an uptick of 14.5 percent, Detroit saw an increase of 11.6 percent, and Miami saw home prices rise by 6.9 percent.
“The real estate market in the spring and summer of 2012 was the strongest since the peak of the bubble. There is now strong evidence for a slow, sustainable recovery on both the supply side and the demand side,” said David Stiff, chief economist, Fiserv in a statement. “On the demand side, existing home sales increased to their highest levels since 2007, save for the sale spikes caused by the home buyer tax credit. At the same time, supply is decreasing…In many markets, limited inventories are holding back sales activity as potential buyers are unable to find properties to purchase, pushing up home prices as buyers compete for a dwindling supply of homes for sale,” he continued.
The housing sector isn’t in the clear just yet. Analysts expect for sales activity and price appreciation to stall because of the impending fiscal cliff. Fiserv Case-Shiller expects that the battle over the fiscal cliff will restrain the housing market and anticipates that next summer’s market will likely be weaker than this year’s.
“In some markets, investor demand for housing will start to fade before first-time and trade-up buyer demand has ramped up enough to take its place. This will be most evident in markets with large foreclosure inventories,” Stiff added. “Currently, investors are snapping up foreclosed properties almost as quickly as they are being listed for sale, but the pool of investors is limited and, as prices rise, the potential returns on residential real estate diminish. Consequently, Fiserv Case-Shiller projects a small, short-term price decline for many markets that recently experienced double-digit appreciation.”
When nearly ‘everybody’ is positioned on the same side of a boat, it will typically capsize.
Ordinarily I would agree with you, but with the federal reserve operating the bilge pumps at full capacity, they can bail out the water as fast as the sinking ship takes it on.
el O is an avid boater so don’t question him on this.
P.S. It looks like the NB Boat Parade may get cancelled or pared down. Apparently, the residents are none too happy about higher dock fees coming down the pike. They are threatening to boycott the parade.
Well, a 50ft -10wide dock fee would go up from $100 per yr to about $263, so the increase won’t put a ding in ANYONES wallet down there. Probably just the Ivy-Leaguers who’re getting all riled-up
Deleveraging Continues: Consumer Debt Continues to Fall with Mortgages Leading the Way
Consumer debt declined in the third quarter, largely due to decreasing mortgage debt throughout the nation, according to the latest Quarterly Report on Household Debt and Credit released by the Federal Reserve Bank of New York.
After decreasing by $74 billion in the third quarter, consumer debt now stands at about $11.31 trillion. This is 0.7 percent below last quarter and continues a downward trend of almost four years.
Mortgage balances make up the bulk of household debt but are on the decline as well. After a 1.5 percent decline over the third quarter, Americans hold $8.03 trillion in mortgage debt.
Home equity lines of credit also declined, falling by $16 billion or 2.7 percent over the quarter.
While mortgage debt is declining, other categories of debt rose 2.3 percent over the same quarter.
Mortgage delinquencies, however, are also declining, and foreclosures are slowing.
In the third quarter, 5.9 percent of mortgages were 90 or more days delinquent, down from 6.3 percent in the second quarter.
Delinquency rates for home equity lines of credit did not improve over the quarter, but neither did they decline. They remained constant at about 4.9 percent.
Foreclosures slowed by about 5.5 percent over the third quarter with about 242,000 new foreclosures showing up on credit reports during the three-month period.
At the same time, originations rose to $521 billion, according to the Fed.
The improvement in mortgage delinquencies is consistent with the broader trend of improving debt delinquencies overall, which declined from 9 percent in the second quarter to 8.9 percent in the third.
Wouldn’t a significant chunk of the mortgage debt reduction simply be from the mortgage rate reductions experienced in Q3? If so, consumers didn’t actually reduce their debt… the Fed reduced their debt. Consumers in turn increased the debt that they were in control of. Consumers continue to leverage themselves into oblivion.
Housing Recovery Is Leaving Behind First-Time Buyers
Current homeowners are finally moving up, and distressed sales are making up less of the overall market—all signs of much-needed improvement in housing.
Current homeowners accounted for 54 percent of October’s non-distressed market, up from 50 percent in June, according to a new survey by Campbell/Inside Mortgage Finance.
This as the share of non-distressed sales surged to 64.7 percent, up from 55.7 percent as recently as February.
Unfortunately, first-time home buyers are seeing just the opposite, largely left out of this surge in sales and prices. Their share of the market, usually up in the 40 percent range historically, fell to 34.7 percent in October, the lowest in the Campbell/IMF survey’s three-year history.
The National Association of Realtors put their share even lower, at 31 percent.
Either way, they are the only group of buyers that have not seen their share of non-distressed home purchases rise over the past five months. The mortgage of choice for these buyers, FHA-insured loans, are increasingly tough to obtain. (Read More: Yes, Housing Starts Surge, but Rentals Are the Drivers)
“Financing of first-time homebuyers with low down payments threatens to become a significant problem in the U.S. housing market,” wrote Thomas Popik, research director for Campbell Surveys. “Fifty percent of first-time homebuyers use FHA financing, but FHA insurance premiums are increasing and underwriting is becoming more strict. Private mortgage insurance has started to fill the gap, but the long-term status of private mortgage insurance is in question pending the publication of the Qualified Residential Mortgage regulation resulting from Dodd-Frank.”
Even IR has warmed up to the realtor mantra “buy now or be priced out forever”. The world has truly been turned upside down!
Foolish (ahem, suicidal) monetary policy is sending false signals to the market and EVERYONE is misinterpreting.
I wouldn’t say I’ve gone quite that far. The cost of ownership is just now making an apparent bottom as falling interest rates have offset the increasing home prices. I think houses will be relatively affordable for quite some time, but I also believe the federal reserve and the banking cartel will enjoy continued success at reflating the housing bubble.
I never thought we’d be in a place where I’d actually say to hell with fiscal prudence, might as well buy now and continue saving 20% for a move-up if I can get me one of them FHA loans too!
I never thought I would write a post like today’s. If you can’t beat them, join them.
REALITY BATS LAST.
Real estate will continue to fall priced in real money, gold.
Dow is continuing its secular bear trend to 1:1 ratio to an ounce of gold.
These market forces exist just as gravity exists. Malinvestment and leverage will be wiped out as the market seeks equilibrium.
Cash (gold) is king. The economic contraction continues. The can kicking is guaranteeing more pain and greater contraction.
It’s because there is no longer a punishment for default. It’s just bad credit for a couple of years.
There is no reward for saving 20% except for not paying PMI.
Conforming Loan Limits remain constant for 2013:
http://www.fhfa.gov/webfiles/24718/LoanLimitsFor2013112912Final.pdf
The next big debate in housing will be to raise the conforming limits to bail out the banks on their high-end loans. With 3% interest rates on the horizon, much larger sums will be financable, and raising the conforming limit is the only way to get around the 20% down requirement.
There is an article where Congress wants to increase the G-Fees (Fannie and Freddie) to pay the costs of extra high skilled visa processing So now the G-fee is treated like a tax.
I just wonder if Congress get so greedy that over tax it (like FHA) and pop the next bubble. But then a again no one will foreclose on your house.
When you add the 3.5% dp to the 1.35% insurance fee, the borrower is really putting just under 5% down. I believe the GSE’s are lending at 5% dp’s in many if not most areas now, so it would really pay to comparison shop the two products.
The one advantage to a GSE loan with MI insurance is that you can cancel the insurance early without refinancing. This could be huge, especially if rates go up and you don’t want to refi into a higher rate. Refinancing will also cost a minimum $2,500 in fees, or a higher interest rate if you do a “no cost” refi. Besides how are you going to refi out if you started with 3.5% equity and prices drop just a little leaving you with no equity?
The positives for sticking with FHA would be the opportunity to streamline refi if rates continue to go lower (as Perspective astutely pointed out), or conversely, if rates spike up, an FHA loan is assumable which could be huge if you have a sub-4% rate locked in and want to sell your house.
Excellent points. Assumability will be huge looking forward.
The upfront MIP is currently 1.75%. Ouch! You can accept a slightly higher rate to offset that cost. The UFMIP can be financed though, so that cash is not required at closing – i.e. it doesn’t add to the 3.5% down requirement.
30-year GSE loans require two years’ seasoning before you can terminate MI with an appraisal proving you’re below 78% LTV. Shorter term have different rules. 15-year FHA loans require no seasoning before you can terminate MI early with an appraisal.
e.g. I just refinanced into an FHA 15-year loan with MI scheduled for 40 months. Next year, any combination of cash + higher appraisal could be used to terminate MI within just a few months of origination. We’re paying 60 bps MI, so I’m not going to spend a bunch of cash trying to terminate it early; but if I see comps selling for much higher prices, I’d have to consider it…
FHA is now going into Mixed Use Buildings
Regulatory Break for Mixed-Use Projects
By JOE GOSE Published: November 27, 2012
When the real estate investment manager Jamestown Properties began renovating a massive old Sears warehouse in Atlanta last year, it had a good idea of what it wanted to create: a bustling urban hub with 440,000 square feet of offices, 330,000 square feet of shops and 259 residential units.
The composition of the residential piece, however, remained a question. Would it be all rentals or a mix of condominiums and rentals? If a mix, what blend would perform best in a sluggish housing market characterized by scarce mortgage financing for condo buyers?
Now, thanks to a recent Federal Housing Administration rule change aimed at supporting mixed-use properties, condos are getting more serious consideration in the $200 million development, known as Ponce City Market.
“We continue to assess the right mix of what those units should be,” said Katharine Kelley, director of Jamestown’s development and construction division. “But the new F.H.A. ruling strengthens the attractiveness of condos as an option, because it increases the field of potential condo buyers.”
Enacted in September, the rule change opens the door to government-insured mortgages for condos in mixed-use buildings with commercial footprints of up to 35 percent, up from the previous 25 percent limit. Exceptions may be granted for projects in which as much as half of the space is commercial. Developers hope this, along with other F.H.A. changes, will help revive condo sales just as the overall housing market is improving.
The F.H.A., created in 1934, insures mortgages and offers programs that focus largely on first-time home buyers. Its support allows lenders to offer favorable mortgage terms, with down payments as low as 3.5 percent.
Because the agency and the government-sponsored entities Fannie Mae and Freddie Mac now back 95 percent of residential mortgages — roughly double their share before the financial crisis — certification from one of them is considered critical to the success of residential developments.
That is the case even though Fannie Mae and Freddie Mac are in conservatorship and an independent audit of the F.H.A. has projected a $16.3 billion loss for the fiscal year ended Sept. 30, leading to speculation that the agency will need a taxpayer bailout.
“We have to think three steps ahead as to how the condo buyer is going to get their financing,” Ms. Kelley said.
The F.H.A.’s mixed-use change is part of a broader shift in condo policy. In September, the agency increased the number of units that investors can own in a development to 50 percent from 10 percent, provided that the other half are owner-occupied, and it relaxed personal liability rules related to condo association boards and officers.
Developers and others say that in addition to strengthening home sales, the changes represent a vote of confidence in the creation of sustainable, pedestrian-oriented neighborhoods, which are more likely to have projects that incorporate mixed-use buildings.
The trend toward such development has grown in recent years, as younger and older people alike have migrated to urban centers to be close to jobs, cultural amenities and entertainment, said Peter D. Cummings, chairman of Ram, a Florida-based mixed-use developer focused on the Southeast and Michigan.
That “back to the city” movement is now spilling into the suburbs, said John K. McIlwain, senior resident fellow at the Urban Land Institute, a nonprofit research organization.
“We’ve learned that this mixing of development makes for a better urban design, so towns and cities are designing codes to encourage it, and the market is showing interest,” he said. “We’re going to see a lot more mixed use, whether it’s in the urban central city or suburban town centers.”
The F.H.A.’s mixed-use rules date to its inception and the growth of federal housing initiatives, according to the Chicago-based Congress for the New Urbanism, which promotes pedestrian-oriented, mixed-use neighborhoods. The rules stemmed from fears that one component of a mixed-use development could fail and place strain on others to maintain the property, a concern revived by the housing crash in 2007.
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