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I Love FHA, But...
by Robert Franco | 2007/08/14 |

I love FHA, but an article in the USA Today, Good Old FHA Loans Make a Comeback, irked me a bit. The gist of the article was that FHA applications were up considerably since December - 76.8%. Yet, the article states that "FHA is flawed and in need of some major improvements." With that contention, I must disagree.

When the FHA was created in 1934, it provided the only way many low- and middle-income families could afford a home. Over the years, it changed little.

But in recent years, private lenders have launched innovative mortgage products targeted at first-time home buyers and borrowers with impaired credit. In addition, private lenders can approve applications more quickly than the FHA.

Despite the rebound, FHA is flawed and in need of some major improvements, industry experts say. "FHA is definitely a step behind where the private markets have gone," says Keith Gumbinger, vice president of HSH Associates, which publishes loan information.

If we have learned anything this year from the "private lenders" that ventured into subprime lending, its that the subprime market is extremely risky and the business model chosen by the private market doesn't work. The Mortgage Lender Implode-O-Meter is currently reporting that 117 major U.S. lenders have "imploded" since late 2006. The fall out from the subprime bust has been astonishing, not just here, but around the world.

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An interesting Associate Press article in the International Herald Tribune, How the Mortgage Crisis Arose and Infected the World, points out just how off-the-mark the private lending market was.
The slide started innocuously in April after New Century Financial, a mortgage lender whose principle borrowers were Americans with less-than-stellar credit, filed for bankruptcy protection.


A month later, USB AG, the giant financial company, said its hedge fund business had lost 150 million Swiss francs in the first quarter largely on the back of investments it made in the U.S. subprime mortgage field. Then in July, Wall Street's Bear Stearns closed a pair of hedge funds after wrong-way bets on mortgage-backed securities caused them to collapse. Before the losses, the funds were worth a combined $20 billion.


Markets came to head late last month and early in August as concern mounted that those mortgage securities may not have been as firm as people thought. It was capped by the August 6 bankruptcy by Melville, N.Y.-based American Home Mortgage Investment Corp.


By then, banks worldwide were looking at their portfolios and finding sizable exposure and hedge funds were closing down in a bid to stave off investors who wanted to redeem their stakes, essentially, a modern day run on a bank.

On Thursday, France's biggest bank, BNP Paribas, froze US$2.2 billion held in three funds because their exposure to subprime prime mortgages in the U.S. solidified fears that risk was spreading worldwide.

Looking at the bigger picture it is hard to see why anyone would suggest that FHA should follow the lead of the private market. Yet the USA Today points out "a number of factors" that have held back FHA loans, as if that is a bad thing. On the contrary, adhering to the guidelines that have made the FHA program so successful since its inception in 1934 are what has kept it head and shoulders above the rest.

Low limits. The maximum loan amount allowed by FHA hasn't kept up with rising home prices in high-cost areas. The current FHA maximum for a single-family home is $362,790.

As a result, there are more FHA loans in Michigan than in California. In the first quarter, the median home price in San Francisco was $748,100, compared with $154,600 in Detroit, according to the National Association of Realtors.

FHA has mainly been there to help low income first time home-buyers achieve the "American Dream" of home ownership. If that is the case, why should they need to increase its lending limits beyond $362,790? Granted, the average price of a home in San Francisco is nearly $750,000, home prices in New York, Miami and a few other cities around the country are staggering as well. I certainly couldn't afford to live there; and I don't.

I live in a modest home, which I purchased for $76,000. If you can't afford a home because the FHA limit is only $362,790, you shouldn't be buying it. If the limit is increased, it would just means that there would be less money available for those who really need it.

Down payment. FHA requires a 3% loan down payment. Until the subprime market collapsed, many private lenders offered zero-down payment mortgages, even to first-time home buyers. Even now, some home buyers can get zero-down payment loans, but they usually need stellar credit.

When I bought my home, I put 20% down. It was tough, but I did it. Sure I could have bought a larger home if I was only required to put 3% down - or nothing at all. But, that would only have encouraged me to buy more home than I could really afford. The American Dream is home ownership - not a home featured on an episode of MTV Cribs.

Requiring a down-payment serves two very useful purposes: 1) it provides some security for the lender. In the event they have to foreclose, they are more likely to recoup their loss if there is some equity in the home. And, 2) it requires the homeowner to have a stake in their purchase. As your parents likely taught you, you take better care of the things you "earn," as opposed to something you were "given." Homeowners who have a substantial investment in their home are less likely to let it go into foreclosure - they will do everything they possibly can before it comes to that.

Basically, anyone who must rely on a special program to afford their first home probably shouldn't be looking for a home that exceeds the FHA limits. And, if they can't come up with a modest 3% down, they aren't ready to be a homeowner. As the subprime market has taught us, abandoning sound lending practices doesn't work.

Robert A. Franco


Categories: Subprime Lending

1394 words | 3049 views | 7 comments | log in or register to post a comment

The FHA money doesn't come from the...
The FHA money doesn't come from the government so increasing the FHA limits won't reduce the amounts available to others. The loan limits are geographically set. So they adjust to average pricing in regions. 
by Diane Cipa, General Manager, The Closing Specialists® | 2007/08/15 | log in or register to post a reply

Here is another interesting article...
Here is another interesting article that shows the impact of the US mortgage market on foreign countries.

Why a US Problem is Hurting Australia
"SO, my home loan repayments could rise because families 16,000km away in America have reneged on their mortgage payments? How does that work?"
by Robert Franco | 2007/08/15 | log in or register to post a reply

I agree that if the government is g...
I agree that if the government is going to be involved in the lending business, it should have some pretty conservative guidelines for lending money to ensure repayment.

I'm not so sure the government should be any more involved in competing with private lenders though than they should be involved in providing title insurance or competing with any other business. Government regulation is one thing, competing in the market with private companies is quite another.

I'm not sure, but I suspect that at the heart of this crisis is the fact that even the lenders aren't really lending their own money. I've never been able to get a clear explanation of how FreddieMac, FannieMae, the Federal Reserve and the lending business all work together to create the home lending industry, but it appears that since most of the lenders seem to have a government or quasi-government entity automatically purchasing the loans they originate regardless of how risky the are, there is less incentive to be careful with lending practices.

The lowering of the Federal Reserve rate also created a huge amount of available capital for lenders to lend, so of course, they came up with new ways to lend it to anyone they could.

If these lenders did not have anyone to purchase these loans and give them more money to lend, they would be reluctant to lend to risky borrowers since any losses would come directly out of their own pocket. The current system seems to encourage risky behavior on the part of lenders since they can apparently go for several years without having to pay the piper for bad loans until it turns into a crisis.

I would argue that pure market forces are not at work here since the governmental entities involved seem to factor as players in the market rather than just regulatory bodies. The irony of course is that now the Fed and other similar world banks are "pumping liquidity" into the market to head of this crisis when, in reality, the artificial liquidity created by lowering the Federal Reserve rate coupled with this creative lending practices created the problem in the first place.
by David Jenkins | 2007/08/15 | log in or register to post a reply

I realize that FHA doesn't actually...
I realize that FHA doesn't actually supply the funds for the loans, but they do insure them. There must be a limit to amount of liability they can take on in doing so. Still, there is no reason to expand the program by increasing their limit - or worse, to lower the 3% down-payment requirement. 
by Robert Franco | 2007/08/15 | log in or register to post a reply

The FHA is a fixed rate mortgage wi...
The FHA is a fixed rate mortgage with escrows for taxes and insurance required. The program tolerance for credit scores is nowhere near as low as subprime. They've been doing virtually 100% financing with the charity gift program for years and delinquencies are reasonable.

It's a solid program with VERY strict quality control. Any first payment or first year defaults are pounced on by auditors looking for patterns of fraud or abuse and believe me they prosecute bad actors and take no prisoners.

It's a good program and it's been time tested. They know what they are doing. Adjusting loan amounts to allow more people into the program is a good idea.
by Diane Cipa | 2007/08/15 | log in or register to post a reply

Unlike subprime, Alt-A and garbage ...
Unlike subprime, Alt-A and garbage 80/20 programs, the people who use the FHA program actually have to pay an insurance premium to fund it.

There is positive amortization so we have people creating equity.

This is one government program that has worked really well and should continue to do so for a very long time. We should be supporting it.

BTW - I wouldn't expect FHA underwriting gurus to be so stupid as to forego traditional title insurance. They have standards and don't listen to bull.

HUD has made some mistakes - especially when they loosened RESPA but they have a great track record with the FHA mortgage program and for that matter they also do a great job with Section 8 housing.
by Diane Cipa | 2007/08/15 | log in or register to post a reply

As an approved FHA appraiser for ov...
As an approved FHA appraiser for over 25 years, I am disgusted with the lowered standards for the condition of property for FHA loans. It appears that as long as the improvements are not falling down, the loan will be made. What happens to a property that needed work to begin with, and after 2-3 years with no improvements made, is forclosed on? What a mess FHA will have on their hands. I've seen it before, but it will be worse this time.  
by Diana Nytko | 2007/08/24 | log in or register to post a reply
Source of Title Blog

Robert A. FrancoThe focus of this blog will be on sharing my thoughts and concerns related to the small title agents and abstractors. The industry has changed dramatically over the past ten years and I believe that we are just seeing the beginning. As the evolution continues, what will become of the many small independent title professionals who have long been the cornerstone of the industry?

Robert A. Franco



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