Oct192013

The pressure is on to expand lending

The housing market and the mortgage market has stalled.   With the elimination of most of affordability products and mortgage rates that can’t go too much lower price gains have stopped and lending has greatly decreased, see graph below from Confounded Interest.

Now the housing industry is trying to recycle old ideas to stimulate lending activity and home prices.  However with Dodd-Frank most of those affordability products will not qualify as Qualified Mortgages.  This has reduce the ability of banks to inflate home values.  However, there some ways to expand lending by broadening scope of FHA and the GSEs beyond principal residences.

 WHY THE FHA SHOULD BE OPENED TO INVESTORS

FHA mortgages are supposed to be a vanishing species but the use of such financing  is actually on the rise despite higher costs and tougher terms.

The overall FHA market share is down as cash buyers are now the largest market share.

The latest figures from HUD show that so far this year the FHA has insured 1.06 million “forward” loans — a figure that compares with 850,000 mortgages during  the same period in 2012. As to reverse loans, to this point just 44,282 have been originated versus 98,959 last year.

Why the use of FHA loans is increasing seems curious: In 2012 the up-front mortgage  insurance premium jumped from 1 percent to 1.75 percent while the annual mortgage insurance cost grew to 1.25 percent. For borrowers taking out an FHA-insured loan for more than $625,500 the annual fee is now 1.5 percent.

There was a rush to purchase or refinance with FHA before the mortgage insurance premiums increased in June.  Since June the number of FHA loan originations and refinances  have dropped off considerably.   That’s why the FHA initial bailout was announced because future mortgage insurance revenues were projected lower as fewer new loans were being originated at FHA.

It used to be that borrowers could cancel the annual insurance premium, but that policy has now been reversed for new FHA loans and the premium continues for the life of the loan. In effect, it is potentially a much-higher cost.

It  usually happens that sales do not increase when prices go up and yet we’re  seeing more FHA mortgages. The reason is that while the costs for new financing have increased it’s really cheap and easy to get FHA loans refinanced.’

How cheap? HUD reduced the up-front charge to refinance from 1 percent to .01 percent.

The result is that new FHA originations are down by about 20,000 loans so far this year when compared with 2012 while refinancing has increased by almost 220,000 mortgages.

According it new data even the refinances have dropped off in September.  FHA might have more total loans than in 2013 when compared to 2012, but the purchase loans will lower.  In addition, the new Qualified Mortgage rules will restrict FHA to 43% Debt to Income ratio in same cases and will reduce the number of potential FHA borrowers in 2014.

For most FHA borrowers refinancing is an opportunity to shake-off older and higher rates for interest levels which are far below historic averages.

However, rising FHA loan numbers hide a substantial problem: The FHA really needs new loans more than older ones. The reason is that each new mortgage brings in a hefty up-front fee that can be added to FHA reserves, reserves depleted by foreclosure claims from loans made between 2000 and 2008. How much extra? Some $20 billion between 2009 and 2012.

So what can the FHA do to pump up new loans? Why not open the FHA program to investors?  Especially for those who buy distressed properties.

The problem with FHA is that borrowers only put a small down payment.  When home values dropped borrowers that had little skin in the game simply walked away.  Changes in the tax law even encouraged this behavior.  Now the author is proposing to give investors FHA backed loans, and investors have even less motivation to keep their investment property if values dip again.  If there is another dip and FHA backed investor loans, I think there will be an even larger percentage of defaults for investor loans compared to owner occupied loans.

Every foreclosure, short sale and REO absorbed by investors reduces the inventory of distressed homes and thus  pressures home values higher. That’s good for everyone, but it is especially  good for mortgage-insurance programs such as the FHA. Rising home values are the surest way to stabilize FHA reserves because when homes can be sold for more than the mortgage debt there are no claims.

Real estate equity grew by $784 billion in the first quarter according to the Federal Reserve, and a good portion of that increase was the result of more real estate demand. Having more investors in the mix would simply mean more folks looking for property, not a bad idea when one considers that despite good news during the past year home values have yet to reach the peak seen in 2007.

The Real Estate grew because mortgage rates hit historical lows in 2013 and that increased home values by increasing affordability.  The increase real estate was due to financial leverage  not economy growth.  So, just like Irvine Renter demonstrated on Friday, real estate values are sensitive to mortgage rates.  If for some reason mortgage rates increased in 2014, then home values will probably decrease.

People have short memories (or just plain stupid), but low down payment non-owner occupied loans were tested and failed in the last bubble.   Downey Savings bank allowed investors to put a 0% down payment on a non-owner occupied house or 5% down payment if it was condo.  This bank no longer exist because of this loan product, investors simply walked away when the investment no longer appreciated in value.  In most cases the investment property didn’t    The number of defaults were over whelming and bank ran out of money.

 FHA was the test bed for easy and low downpayment first time buyer home purchases.  The standards were lose and losses started to accumulate where required ever growing mortgage insurance premiums.  Finally, a bailout is needed and I think it will take several years to calculate the final bailout total.  Now, if FHA expands no down payment to investors it’s going to end up like Downey Savings.

Mike