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Trouble in FHA Land! April 9, 2008

Posted by shaferfinancial in Uncategorized.
Tags: , , , ,

Well you knew it was going to happen.  FHA is reporting that it will go into the RED this year for the first time ever in its 74 year history.  No doubt we the tax payers will be picking up the bill (as much as $1.8 Billion) soon.  Now FHA has always paid its own way in the past, so what is going on?

Well, its really the same old story.  First, a quick review of how this program works.  FHA a quasi government entity insures loans for folks with low FICO scores and little down payment money.  In short FHA loans only require the buyer of real estate to put down 3% plus a funding fee meant to cover potential losses and of course closing costs.  This was a solid program for first time home buyers and lower income folks.  However, starting in 2000 it was not the best deal around.  At that point sub-prime mortgages were actually less expensive and allowed for 100% financing sometimes even financing closing costs.  There was no funding fee for subprime mortgages.  So folks with little money and poor credit scores switched from FHA funding to sub-prime mortgages from 2000-2006.  However, there was one part of the FHA program that was popular; the seller financed down payment assistance program.  In 2000 this part of the program represented only 2% of all FHA loans but blossomed to over a third of the program by 2007. 

Here is how it works.  The seller pumps up the sales price of the home, say 5%.  A third party program comes in and makes a gift of the 3% down payment requirement and closing costs.  At closing the seller then refunds back to the company the additional 5% that the seller added to the purchase price.  Pretty nifty, huh!  The buyer gets a FHA loan without having to come up with any money!

Well, turns out that people involved in the seller financed dp assistance programs are foreclosing at 4 times the rate of the other FHA folks.  So the funding fee’s designed to cover the historical foreclosure rate for the FHA program is not enough to cover the program.

Of course consumer advocates defend this program.  And a perfectly good program that is self financing is looking for a bailout because of these no downpayment folks.  And what did it take to accomplish these loans?  Well a appraisal that is higher than the agreed upon price!

Starting in the 1990’s there was alot of pressure put on lenders to start lending to minority folks at the same rates as white folks.  There was also much pressure to lend in area’s with depressed real estate.  Finally, there was pressure to increase the percentage of home ownership in this country.  Now all of these ideas are morally correct ideas.  We should not discriminate, we should try to increase home ownership, and we should not red-line.

But, the way it was done is to lower credit requirements, reserve requirements and down payment requirements.  We now understand where those requirements should not go.  It is among folks who put little or no money into purchasing real estate and had credit problems and had little or no reserves where the foreclosure problems reside.  It is that simple folks. 

Now, unfortunately, the pendulum has swung the other way.  People with reasonably good credit and a little cash are being held out of the market or at the very least have to pay much more to get into the market.  Interestingly, FHA loans are on the upswing with the sub-prime market gone.  But with a third of them going to the Seller financed DP Assistance Program we are only adding to the government bailout that is going to be required.

Oh, I am sure we will hear about all these folks who were victimized by being able to buy real estate with no money and poor credit!



1. BawldGuy Talking - April 9, 2008

Whenever government programs fly in the face of the physics of economics, we all lose. Solving problems by defying gravity without even a parachute ends badly every time it’s tried.

2. Alleen - April 14, 2008

I just received an offer to purchase my house from some buyers that want to use this “charity donation” method of downpayment. I took me some time to figure out what this was all about. They do not have any cash saved to buy a house. So their mortgage will be for about 5% higher than the value of the home and they have nothing to pay for repairs the house needs. I don’t get it. People are crazy.

3. Carl Pruitt - April 15, 2008

There is another reason that FHA is going to lose money. The study on the the loans using down payment assistance programs is seriously flawed. The cities used in the study led the country in fraud cases. This was not accounted for in the study. There might have been completely different results had the study analyzed data from different cities.

The net effect of the FHA down payment program is no different than the community lending programs with conventional loans, with one notable exception. It basically amounts to the same 100% financing as a MyCommunity Fannie Mae conventional mortgage except that the home must be appraised – using an appraisal that gets reviewed every way to Sunday.

100% financing is the very least of the factors involved. As time goes on we will find a huge proportion of the FHA loans that end up in foreclosure will turn out to be the result of fraudulent deals where house flippers collude with a few mortgage brokers, appraisers, and real estate agents to doctor the files to make sow’s ears look like purses.

4. Carl Pruitt - April 15, 2008

The net effect of the FHA down payment program is no different than the community lending programs with conventional loans, with one notable exception. It basically amounts to the same 100% financing as a MyCommunity Fannie Mae conventional mortgage except that the home must be appraised – using an appraisal that gets reviewed every way to Sunday *for at least 3% more than the loan amount. This does not happen with 100% conventional mortgages which must only appraise for the loan amount. The standard down payment assistance is 3% of the sales price plus $250 to $500. It is very rarely 5%.

5. shaferfinancial - April 15, 2008

Carl, 3% or 5% matters little, although I have personally seen deals at 5%. My Community programs required at least average credit scores where as FHA loans don’t. That is the difference. I have not seen the foreclosure rate for the My Community Program, something that would be interesting to find out. The bottom line is that we are going to bail out FHA for the first time because of the seller dp program’s foreclosure rate. I have no problem with the basic FHA program which requires 3% down payments from the buyers. Although the foreclosure rate is higher than conforming loans, it is still within the confines of the cost of the loan charged to consumers. It has a proud history. The point is, and most mortgage programs are coming to this conclusion, that folks tend to stick with their loans in larger numbers when they have some money in the deal. The other point is that FICO scores matter and are pretty good at predicting how folks will behave in tough times.
I think the bottom line is that we now know how far we can go with respect with getting people into homes. Low FICO’s and no down payment is asking for problems!

6. shellie purdy - June 17, 2008

why is my bank having trouble getting my FHA loan funded?

7. shaferfinancial - June 18, 2008

Hard to tell with no information about the loan. Generally, many bank loan officers have little experience with FHA, so this might be the problem. Experienced mortgage brokers tend to do better with outside the box loan applications. Sorry, I couldn’t be more help!

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