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FHA S.O.S?

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Posted On: 10/28/2009

Q: I've heard stories that the Federal Housing Authority program is in trouble. Is this true?

A: There are very few success stories in real estate of late, but one that comes pretty close concerns the FHA.

The FHA is a government-sponsored mortgage insurance program. Started in 1934, it has helped more than 35 million people finance real estate. At a time when many private-sector lenders have been shuttered, the FHA is now providing about 35 percent of all loan originations. If you think the real estate market has been difficult, imagine if a third of all loans were suddenly unavailable.

You can purchase real estate with as little as 3.5 percent down plus closing costs if you use the FHA program, instead of putting down 20 percent if you don't. In effect, the trade is little down for insurance. If the home is foreclosed the insurance is there to assure that the lender is paid off. Being insurance, of course, means there's a mortgage insurance premium, generally 1.75 percent up front plus .55 percent annually.

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In late August the Mortgage Bankers Association issued its delinquency and foreclosure report for the second quarter. The results were interesting: 3 percent of all prime loans were in the foreclosure process, while the rate for FHA loans was 2.98 percent. VA loans did best (2.07 percent) while subprime loans had the worst record (15.05 percent).

Yup, that's right - the foreclosure level for FHA loans was below the rate for prime mortgages and yes, government-backed loans were doing better than mortgages from the private sector.

The FHA program is not problem-free, however. There are three major concerns now associated with FHA financing.

First, FHA loans have a steep delinquency rate - 14.42 percent for FHA loans in the second quarter versus 6.41 percent for prime loans. Delinquencies are generally seen as a hint of foreclosures to come, but the FHA program has a very high "cure rate," meaning that it's able to save the homes of many people who are delinquent.

Second, insurance plans - whether private or federal - must have substantial reserves to cope with possible losses. HUD has a reserve fund for single-family FHA loans, but the size of that reserve has shrunk in the face of ongoing claims. In a one-year period the reserve went from $12.9 billion. However, with increased mortgage insurance premiums and the elimination of seller-assisted down payments, HUD Secretary Shaun Donovan predicts the program will generate roughly $1.7 billion in profits this year.

The catch is that the FHA has long been profitable. During the past eight fiscal years it has given almost $14 billion to the US Treasury. This is money that comes from borrower premiums and could go into the reserve fund, but instead it's sent to the Treasury Department.

The combination of strict underwriting standards, steady premium collections, big reserves and high cure rates has been successful - despite the billions of dollars which have been removed from the program, a woeful economy and rising unemployment levels.

Third, the FHA reverse mortgage program (as opposed to the single-family program) is generating huge losses. HUD asked Congress this year for $800 million to support the program, money that's needed because reverse mortgages tend to be relatively short loans that have growing principal balances because monthly payments are not required.

That means reverse mortgages made a few years ago, when prices in most markets were higher, are now being closed out as borrowers move, sell or pass away. Unfortunately, when home values fall, HUD can face massive claims from lenders - and that's precisely what's happening now with FHA-insured reverse loans.

The great unknown is what will happen to future home values and unemployment rates. If values continue to fall or if unemployment rates rise, then any mortgage insurance program is going to have problems because of the overall economic environment. That the FHA has done as well as it has in the midst of the worst economic crisis since the 1930s suggests that HUD has done a good job up to this point.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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