The Federal Housing Administration stepped into to fill the gap left behind by subprime lending in 2007, and now taxpayers could be paying the price as these loans fall into foreclosure at a dangerously high rate.
An independent audit of the FHA released by the U.S. Department of Housing and Urban Development in November found that the government-back fund that covers losses on bad loans has an economic value of negative $16.3 billion.
FHA’s Mutual Mortgage Insurance Fund (MMI Fund) is required to cover expected losses on its portfolio of loans, worth more than $1 trillion. But according to this latest study by independent acutaries, the fund’s $30.4 billion balance falls more than $16 billion short of covering those expected losses.
If this scenario plays out as predicted by the independent actuaries, the U.S. Treasury — and by extension the U.S. taxpayer — may be forced to bail out the FHA for the first time in its 78-year history. But the HUD report is quick to emphasize that this prediction may not come true, and that it is taking steps to shore up the FHA’s financial position and avoid further losses.
Many of those steps fall under the category of foreclosure avoidance for loans originated between 2007 and 2009, which are identified as the most problematic batch.
“Loans insured prior to 2010 continue to be the prime source of stress on the Fund, with fully $70 billion in future claim payments attributable to the 2007-2009 books of business alone,” writes HUD Secretary Shaun Donovan in his foreword to the report.
Foreclosure Rates Spike on 2007 to 2009 FHA Loans
A RealtyTrac analysis of loan origination and foreclosure data shows a spike in foreclosure rates on FHA-backed loans originated in 2007 and 2008 to above 4 percent — the two highest foreclosure rates of any vintage in the last 12 years. The foreclosure rate — percentage of loans in some stage of foreclosure — on 2009 loans is around 2 percent, but that is still more than twice the foreclosure rate on other loan types originated the same year. Given the dire predictions in the FHA report, it won’t be surprising to see the 2009 vintage foreclosure rate rise as more delinquent homeowners transition to foreclosure.
Why such high foreclosure rates for the 2007 to 2009 vintages? First, the sheer volume of FHA-backed loans increased dramatically in 2009, as the industry turned to these loans to fill the gap left by the exit of most subprime loan products. Meanwhile FHA loan requirements did not substantively change, the lessons from the subprime lending collapse still not fully understood.
The most damaging feature of those 2007 to 2009 FHA loans was the continued practice of seller-funded down payment assistance, which allowed sellers to funnel a down payment to the borrower through a nonprofit conduit. This resulted in the share of borrowers using their own money to make a down payment on an FHA-backed loan — which already has a low down payment requirement of just 3.5 percent — to fall below 50 percent, according to HUD.
The practice of seller-funded down payment assistance was outlawed by Congress in January 2009, and the HUD report attributes that change to much of the reason for vastly improved FHA loan performance in vintages after 2009.
Foreclosure Prevention Could Minimize FHA Losses
Still, many of those rotten loans remain in the FHA barrel, and HUD says it is taking aggressive steps to avoid starting foreclosures on those bad loans, even if the homeowner ends up losing the property in some other way. That’s because, according to the report “foreclosures are expensive, for families, communities and the MMI Fund. By reducing the likelihood that a loan ends in foreclosure and, in turn, becomes an FHA real estate owned (REO) property, costs to the Fund are decreased.”
The report outlines the following foreclosure prevention efforts it predicts will minimize losses on the bad loans.
- Sell pools of delinquent mortgages headed for foreclosure through the FHA’s Distressed Asset Stabilization Program, at least 10,000 per quarter over the next year. The idea here is that FHA gets the loans off its books, albeit it still at a loss since they are being sold at a discount. That discount gives the new loan holder the margin to offer the distressed homeowner a sizable reduction in monthly mortgage payments, which will hopefully help that homeowner avoid foreclosure.
- Improving loss mitigation so that struggling borrowers get payment relief directly through FHA.
- Expand short sales so that distressed homeowners have a more palatable way out of a bad situation. The FHA fund still takes a haircut with a short sale, but it is less costly in most cases than a full-fledged foreclosure.
- Streamline REO sales so that FHA gets the most bang for its buck in the sale of a foreclosed home.
This last point, of course, is not a foreclosure prevention initiative, but it is the only one of four that is not, which shows the priority of the FHA in trying to avoid foreclosure if at all possible. That aversion to foreclosure reflects the entire lending industry, which explains why foreclosure activity dropped to a five-year low in September even as many homeowners are still struggling.