With the country facing a massive foreclosure crisis — and with that crisis likely to become worse during the coming year — the Bush Administration has tweaked Federal Housing Administration rules in a way that ought to be applauded.
For the past year there has been a considerable debate in Washington regarding FHA “modernization.” In essence modernization would:
- Reduce the down payment requirement from 3 percent to as little as nothing down;
- Increase the size of FHA mortgages, which now can only be as much as 87 percent of the conventional loan limit. Since this year’s conventional loan limit in the lower 48 states is $417,000, the largest FHA loan for a single-family home is $362,790; and
- Modify the FHA insurance premium from a flat rate for everyone to a risk-based system where different borrowers would pay different rates.
While FHA modernization passed in the House, it’s stalled in the Senate. The reasons? First, the FHA program is an insurance plan which already has a significant foreclosure rate. Loosen down payment standards and there will be even more claims, so many claims that insurance will run out and taxpayers will have to pay the bill. Thus there are worries by fiscal conservatives that a reduced down payment requirement would make the program too risky.
Second, a study by the Government Accountability Office estimates that under modernization 20 percent of all current FHA borrowers would not qualify for the program and 37 percent would face higher fees. The GAO findings concern liberals who would like the FHA program expanded to include more borrowers.
Diverse political opposition to the modernization plan makes it impossible to force a quickie reform bill through Congress. Given that reality, the Bush Administration has now adopted a middle-of-the road initiative to fight rising foreclosure numbers.
The Moral Hazard
For the past few months debate in Washington regarding the foreclosure meltdown has focused on the “moral hazard” of a mortgage bailout. In other words, while there’s a desire to help borrowers with toxic loans, there’s no interest in guaranteeing lender or investor profits.
The logic behind this view is that since lenders created and marketed toxic loans — and since they recorded big profits from such financing — they should have to live with any losses. It would be a “moral hazard” to shield lenders from losses because they would then have no incentive to create safer loan products. As to investors, they are supposed to know that markets have risks and profits are not guaranteed.
Hearings chaired in the past few months by Sen. Charles Schumer, D-N.Y., and Sen. Chris Dodd, D-Conn., have made clear that Congress would not accept a lender or investor bailout. The increasingly visible hearings have already forced government regulators to revise a number of lending standards, to propose new loan disclosures and to end efforts by hedge fund managers to limit mortgage modifications.
“The government,” says President Bush, “has got a role to play — but it is limited. A federal bailout of lenders would only encourage a recurrence of the problem. It’s not the government’s job to bail out speculators, or those who made the decision to buy a home they knew they could never afford.”
While there’s widespread and bipartisan agreement regarding a “no” to lender and investor bailouts, another form of “moral hazard” is more contentious: Could the strange and exotic mortgage products behind the foreclosure glut have been stopped at an earlier point? Where were federal regulators in 2004 when toxic loan products entered the marketplace in significant numbers? With presidential campaigns now heating up, this debate has just begun.
Threading The Needle
Given political and economic constraints, how could the FHA program be expanded to reach to the enormous number of homeowners who now face foreclosure? The Administration’s answer is a “new” loan product called FHASecure.
The FHASecure program is exactly like every other FHA program except for one feature: It allows homeowners with “nontraditional” ARMs to refinance with an FHA mortgage even if they have one or more late payments as a result of a toxic loan re-set. (In the world of mortgage lending, a “late” payment only shows up on a credit report if it is at least 30 days late.)
Despite almost-daily headlines about “subprime” meltdowns, FHASecure program is aimed more broadly. The HUD news release announcing the program does not even use the term subprime. While the FHASecure program potentially applies to any ARM, it is specifically directed toward loans with massive payment increases that are built in when toxic loans re-set, loans such as interest-only financing, 2/28 and 3/27 ARMs and option ARMs.
To qualify for the FHASecure program, homeowners must meet the following five criteria:
1. There must be a history of on-time mortgage payments before the borrower’s teaser rates expired and loans re-set. In other words, the FHA is cherry-picking the marketplace, it doesn’t want borrowers with weak credit, only those directly impacted by toxic loans. It also doesn’t want investors and speculators, it wants “homeowners” and “families.”
“FHASecure is designed for families who are good borrowers but were steered into high-cost loans with teaser rates,” said Assistant Secretary for Housing-FHA Commissioner Brian Montgomery. “These homeowners, many of whom are minorities, need a safe, affordable mortgage product that will help build wealth.”
A senior HUD official, speaking to reporters on a background basis, said that FHA would consider loan applications from borrowers who had missed six monthly payments or even more. While the intent here should be applauded, borrowers in states which allow quickie foreclosures will lose their homes if they get in trouble and then wait several months to refinance or sell. For instance, RealtyTrac research shows that the foreclosure process can take as few as 37 days in Georgia, meaning borrowers who fail to act at the first sign of mortgage trouble can lose their homes before the FHASecure program can kick-in.
2. Interest rates must have re-set or will re-set between June 2005 and December 2009. The standard here is not when the loan originates but when it re-sets. Given that there were relatively few toxic loans issued in 2002 and 2003, the FHASecure timeframe is very inclusive. Moreover, it anticipates problems with loans made today that will re-set within the next two years.
3. Borrowers need 3 percent cash or equity in the home. There has been a huge debate on Capitol Hill regarding a change in FHA down payment requirements under the modernization proposal, but not with the FHASecure program. The Bush Administration shrewdly stayed with the 3 percent standard, avoiding a political fight, and did not need congressional approval for the FHASecure program because it did not involve any major changes.
The 3 percent requirement will be a difficult barrier for many borrowers who would otherwise qualify for the program. Huge numbers of toxic loans were originated with little or nothing down. In many cases borrower equity has gotten worse as negative amortization has caused loan balances to grow while slowing markets have resulted in lower home prices. The result is that many recent borrowers are upside-down on their mortgages, they owe substantially more than the property is worth and thus have no equity that would allow them to qualify for the FHASecure program.
To establish home values the FHA will insist on actual appraisals by real appraisers. No automated appraisals, drive-by appraisals, tax assessments or broker opinions will be accepted.
A related barrier involving value concerns the FHA loan limit. Even in “high cost” areas, the maximum mortgage amount for a single-family home in the lower 48 states is $362,790. In areas such as California, Seattle, Portland, the New York metro region, the Washington, DC metro area and Boston, many troubled homeowners have loans substantially above the FHA loan limit. The FHASecure program will not help such borrowers unless they can come up with significant amounts of cash for closing.
4. Borrowers will need a sustained history of employment. Unlike private-sector lenders, the FHA has stubbornly — and correctly — stuck to traditional lending standards. You say you have a job? Great. We’ll need to verify that. In writing. There’s no change here from the usual FHA requirements.
5. Borrowers must show sufficient income to make the mortgage payment. While FHA rates are typically several percentage points below interest levels for subprime financing, FHA loans are not free or cheap. Borrowers must be able to pay interest plus a 0.5 percent insurance premium. For many borrowers, the FHASecure program will mean higher monthly payments than they paid during the toxic loan “start” periods.
Whether troubled borrowers will have the income necessary to meet baseline FHA standards is unclear. While the FHA has very liberal qualification standards, it requires applicants to verify income. This may be a huge problem for borrowers who obtained loans with “stated-income” mortgage applications, applications where borrowers could estimate income and lenders generally would not check the numbers.
In any given year there are foreclosures as a result of illness, accidents, job losses and the death of a spouse. The FHASecure program recognizes that the current foreclosure crisis is not a byproduct of the usual causes of default, but rather the use of “nontraditional” loan formats which have usually high levels of failure.
Figures from RealtyTrac show that foreclosure filings in July were up 93 percent when compared with a year earlier. Not all of those facing foreclosure — perhaps 2 million homeowners in 2007 — will actually lose their homes because some owners will be able to sell or refinance their properties, bring mortgages current or modify financing with help from their lender.
Seen in the context of a massive need for mortgage relief, the FHASecure program will benefit a large number of homeowners but not all of those who need help. A senior HUD official estimates that 240,000 homeowners a year will benefit by the program — 60,000 facing foreclosure and 180,000 who want to refinance out of toxic loans. This is an increase of 140,000 loans because HUD had earlier estimated that 100,000 borrowers would refinance this year under the FHA program. Over several years the new FHA effort may well save 500,000 homeowners from foreclosure and the pain of steep re-sets.
“The FHASecure program is a balanced effort to save an impressive number of homeowners from foreclosure,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation’s leading foreclosure marketplace. “It will not help everyone, but there’s no responsible program that can unravel all the damage done by toxic mortgages.
“What we’re really looking at is a major effort to end the toxic loan era,” Saccacio continued. “The next steps will involve better loan disclosures, tougher lender regulation, increased consumer education, changes in the tax rules and far more lender responsibility to do right for borrowers.”
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.