How a Smaller FHA Hurts the Housing Market

The FHA has got some problems and that raises a question: Could such difficulties limit the availability of government-backed financing?

The GAO says that the FHA’s insurance portfolio expanded from $300 billion in 2007 to more than $1.1 trillion today. That’s a lot of growth but by itself a larger insurance program is not really a problem. What’s a problem is that FHA reserves have fallen substantially and to satisfy future claims it may be necessary to get additional funding from the Treasury Department.

Does this mean that FHA-insured mortgages may not be as available in the future as they are today?

You bet. FHA loans are already less available than they were five years ago and will be still-less available in the future. The FHA has tightened underwriting standards, raised the minimum down payment and sanctioned more than 1,500 once-approved lenders during the past few years. Seller-assisted down payments are long gone and the fixed-rate “standard” reverse mortgage will no longer be around after April 1.

As to borrowers with credit scores below 620, look for them to have a tough time getting FHA loans if their debt-to-income ratio is 43 percent or more. After April 1 such loans will require manual underwriting, something most lenders will avoid. Why? No money. Under Wall Street reform “qualified mortgages” cannot have fees and charges that exceed 3 percent of the loan amount so few lenders will want the cost, expense and potential liability associated with manual underwriting.

But selective FHA reductions are not necessarily bad. Since 2010 FHA loans by their year of origination (vintage) have produced surpluses. That means FHA rule changes have been paying off and no federal bailout has been required to date — though around October we should know if federal money will be needed to help with claims for this year.

Despite better results some still want to hobble the FHA.

“Lawmakers from both parties,” reports Bloomberg Businessweek, “have been anticipating the budget estimate for FHA as they gauge whether they should step in with legislation that would shrink the agency’s market share and shore up its bottom line.”

If FHA market share is artificially reduced — something that could be accomplished by Congress if it raised the minimum down payment from today’s 3.5 percent to something higher — then we ought to ask why it is that so many people now want to finance with an FHA loan. No one is forced to accept FHA terms, no lender is compelled to make FHA loans and in an open marketplace any lender is free to offer mortgages with better terms.

The reason FHA reserves are in trouble is because the value of real estate is still below where it was in April 2007 — 15.2 percent less according to the Federal Housing Finance Agency. The FHA insures mortgages and those mortgages are secured by real estate. Lower real estate values mean bigger claims because there is less real estate equity to pay-off lenders where homeowners default.

“Households collectively lost about $9.1 trillion (in constant 2011 dollars) in national home equity between 2005 and 2011, in part because of the decline in home prices,” reports the Government Accountability Office.

“Between 2006 and 2007,” says the GAO, “the steep decline in home values left homeowners collectively holding home mortgage debt in excess of the equity in their homes. This is the first time that aggregate home mortgage debt exceeded home equity since the data were kept in 1945. As of December 2011, national home equity was approximately $3.7 trillion less than total home mortgage debt.”

It could have been worse except that the FHA bailed out the housing sector and thus the entire economy. As FHA Commissioner Carol Galante explains, “Moody’s Analytics estimates that were it not for FHA’s presence during the crisis, house prices would have fallen 25 percent further than they did already.”

That’s more than a trillion dollars in additional economic losses that were prevented by the existence of the FHA program, a benefit that was obtained with no taxpayer dollars, no subsidies to Wall Street and no executive bonuses.

Making FHA loans artificially less-desirable on a large scale will create higher mortgage costs because of reduced competition in the marketplace. Until somebody can explain how borrowers will benefit from such a result efforts to hobble and handicap the FHA should be stopped.

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