FHA is a victim of its own success

My first home was financed with a FHA mortgage. I had applied for a conventional loan but was turned down because I didn’t have the required 10 percent down payment.  That’s when my banker suggested we try FHA. Two months later, I was moving into my first home. I kept that house and FHA mortgage for nearly 20 years and have been an ardent supporter of FHA loans ever since.

FHA has strong advocates among the real estate industry. Builders, lenders and Realtors love FHA because the low down payment mortgage program helps more buyers buy homes and that generates sales, profits and commissions. FHA has been helping credit challenged buyers since its formation under HUD, Housing and Urban Development, back in 1934. During all that time, the agency has been financially solvent. That’s about to change.

FHA loans are popular with borrowers who only have a small down payment and often less than perfect credit. The basic qualification for a FHA loan is that the borrower has at least 3.5 percent for a down payment, two years of job history and a minimum credit score of 580. While FHA insures loans, different lenders who actually fund and service the loans have “overlays” (additional qualification criteria) for their FHA borrowers. For instance, FHA’s minimum credit score requirement is 580 but Bank of America’s FHA overlay requires borrowers to have a minimum credit score of 640. That’s still 100 points less than what would be required for a conventional loan.

For many years in California, FHA loans have not been a popular financing vehicle. Their loan limits were too low in our high-priced California real estate market and, besides, there were a number of subprime lenders and loan programs readily available. That’s changed. FHA today is our government’s sponsored subprime loan program on steroids making loans up to $729,750. According to trade publication Inside Mortgage Finance, FHA will insure nearly 16 percent of all home purchases in 2012, 30 percent of all new home purchases and roughly half of the home purchase mortgages taken out by blacks and Latinos. The agency now insures $1 trillion worth of homes and 8 million loans.

FHA has been credited with helping pull up the housing market by providing an alternative to more credit cautious Fannie Mae and Freddie Mac, who insure conventional loans. A million first-time borrowers would have been locked out of the housing market if not for FHA and the agency is financing a million more “Boomerang” buyers, folks who lost their home in a foreclosure, short sale or bankruptcy and are now returning to the housing market.  So we all agree on the huge success FHA has had in the past few years making loans. That’s part of the problem.

Just when the housing market started showing positive sale gains and returning consumer confidence, FHA filed its latest annual report showing it’s got a big empty hole in its cash reserves. The financial audit shows the agency’s capital cushion plummeted to a minus $16.3 billion for fiscal 2012. That’s puts the agency $34.5 billion short of the legal capital requirement. If FHA was a federally regulated bank, it would be shut down by federal regulators. That’s bad enough, but what’s worse is the agency’s mounting fiscal problems could spell trouble for the fragile housing market and the economy in general.

If FHA cannot stop the hemorrhaging, Congress has little choice but to write a check to ensure that FHA can meet its financial obligations. After all, what’s another few billion? Taxpayers have already forked over $180 billion and still counting to Fannie and Freddie. But fixing FHA requires more than plugging a fiscal hole. It requires fundamental reforms.

More than one in six FHA loans are 30 days or more delinquent. That’s not due to declining property values. Most of the delinquent loans were made after the housing bubble burst. FHA needs to knowingly stop lending money to borrowers who cannot afford to make their payments and have no skin in the game. FHA loans are commonly used in conjunction with other state sponsored zero down payment loan programs. The delinquency rate on these special programs is one in five.

FHA needs to get out of the reverse mortgage business. Several major lenders including Wells Fargo and B of A have already pulled the plug on their reverse mortgages business and so should FHA. According to the most recent FHA audit, 11,791 reverse mortgage claims have been tendered to FHA this year already amounting to a loss of $2.5 billion. Seniors are defaulting on their reverse mortgage in record numbers after bilking taxpayers out of billions.

The Obama Administration has been using FHA to help manipulate the housing market’s recovery. That’s a worthy goal but at what cost and who is going to pay for it? FHA should not be used as a political tool to satisfy affordable housing advocates. The agency should back off from its aggressive pursuit of making loans to anyone who can fog a mirror and return to their original charter of helping first-time buyers buy affordable housing.

FHA has become the financing soup de jour to homeowners who have defaulted on a previous mortgage. Financing boomerang buyers two years after a bankruptcy and three years after a foreclosure is being reflected in their increasing delinquency portfolio.

Saving FHA from itself is necessary for the long-term solvency of the organization. It should return to its roots and step back from markets that can be better served by private lenders with less risk to taxpayers.

Ken Calhoon is a real estate broker in El Dorado County. He can be reached through his website at kencalhoon.com.