FHA Mortgages to Cost More

Lets strangle the real estate market some more.

The FHA mortgage is the only game in town. FHA is considering ways to reduce its foreclosure rate. But FHA walks a fine line here. That’s because the main reason we even have the FHA mortgage is to encourage low income home ownership.

While an FHA mortgage is designed for low income and / or first time buyers it has become a major player in the home loan business. Just a few years ago, in 2006 to be exact, the FHA mortgage amounted to only 3% of the total mortgage loans made. Now they are 30% of the Everett real estate market and growing. If it were not for FHA mortgage financing there would be no real estate market as there would be no liquidity to finance a sale. The Obama administration has no stomach for increasing the down payment requirements for FHA mortgages and with good reason. The recovering real estate market could take another stumble and bring the entire economy down again if this isn’t handled exactly right.

There have already been major changes in how the FHA mortgage is underwritten.

Early last year the supposed “FHA Down Payment Assistance Plans” were eliminated. These plans were a sleazily way to get around the 3% down payment.  It has been proven that unless a home buyer has “skin” in the game they are much more likely to default than someone who put their own money into the purchase. It used to be that the majority of FHA foreclosures were traceable back to these Zero Down Plans. Currently there are two major reasons for defaults. They are job loss and upside down property values.

I think that increasing the minimums for FHA financing is not the right thing to do. If you look at the loans currently being underwritten there are few defaults. It is the older loans underwritten under the old rules that are causing the problems. The FHA mortgages that are defaulting are not the recent ones they are the ones written between 2005 and 2008 during the height of the market boom. Some recent home loans may be in trouble if the home value has fallen or the buyer has lost their job. But those types of defaults, those losses, are what FHA mortgages were designed to accept.

Last spring FHA increased its minimum down payment from 3% to 3.5%. It also increased its Up Front Mortgage Insurance (UFMIP) from 1.5% of the loan amount to 1.75% of the loan amount. They also increased their monthly mortgage insurance premium. They also raised the minimum credit score from 560 to 640. All this was done during the worst downturn since the early 1970’s. Many industry experts think this made the recession deeper than it had to be.

I think the way to approach this is to modify how the 3.5% down payment is allocated. I think the 1.75% UFMIP should be paid out of the down payment. That way the insurance fund is fully financed. It would matter little in the overall transaction if the down payment is 1.75% as opposed to 3.5%. You can also increase the monthly mortgage insurance without greatly hurting the buyers purchasing power.

Any way you handle it the FHA mortgage must remain stable or we risk another serious downturn in the whole economy.