Under Pressure, FHA Skews to Wealthier Home Buyers

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The Federal Housing Administration, the government insurer of home mortgages, is often credited with saving the home finance market during the worst of the latest housing crash.

When no one else would lend to lower-income borrowers, the FHA stepped in, its share of mortgage originations rising from around 3 percent during the height of the housing boom to close to 40 percent of the home purchase market at the height of the crash.

That was not without a very high price.

12 percent of FHA loans were delinquent at the end of the first quarter of 2012, with an additional 4 percent already in the foreclosure process; 16 percent of FHA loans are in some form of distress. That is far higher than the 11 percent of all loans nationally in distress, according to the most recent data from the Mortgage Bankers Association. The higher delinquency is expected, given that FHA, historically, serves borrowers with lower credit scores and lower down payments. A borrower needs just 3.5 percent down payment and a 580 credit score to qualify, according to FHA guidelines.

“FHA delinquencies are getting worse, and we attribute that mainly to the age of book. Loans tend to default in the first 3-4 years that they are out. Because so many of these FHA loans are fairly new, made since 2010, with the big run-up in FHA originations, 2009 - 2010, these loans now are running at their peak default period, which makes the FHA defaults look really high,” says Jay Brinkmann, chief economist at the Mortgage Bankers Association. But Brinkmann says loan quality is improving by origination year, and he claims more recent years will offset the bad years.

Still, the sheer volume of FHA loans originated during the worst of the housing crash could play against that hypothesis. When credit dried up in 2008, volume at the FHA soared, even as home prices plummeted. Given the low down payment structure at FHA, that inevitably put a significant share of FHA borrowers underwater very quickly, that is, owing more on their mortgages than their homes are worth. Of the 11 million underwater mortgages in the U.S. today, 1.7 million are FHA-insured, according to CoreLogic. Underwater borrowers are more prone to delinquency.

High loan losses have put the FHA in a precarious position financially. By law, it is supposed to maintain a 2 percent capital ratio, or assets against risks, but its most recent measure put that ratio at .24 percent. That is why the FHA is changing the way it serves the current mortgage market. It is now serving higher income borrowers to subsidize its mounting losses, according to a new report from George Washington University, which accuses the FHA of “mission creep.” In fiscal year 2011, 54 percent of FHA’s activity insured homes whose values were greater than 125 percent of their area’s median home price, according to the report. In high-cost markets, like Westchester, NY, 63 percent of FHA borrowers had incomes greater than 150 percent of the average median income.

“Partly in an effort to redeem its mounting and highly publicized delinquencies, it has expanded to a market – higher income borrowers – that it has not traditionally served,” notes the reports co-author, Robert Van Order, professor of finance at GW.

While the loan limit at Fannie Mae, Freddie Mac and the FHA was raised to a maximum $729,750 during the worst of the crash, they were all lowered to $625,500 in the fall of last year. Barely two months later, Congress reinstated FHA’s higher limit. “A rationale for the change was that it might help replenish FHA’s capital by increasing the volume of business,” according to the GW report.

FHA Acting Commissioner Carol Galante responded to the GW findings at the request of CNBC:

"The growth of borrowers with higher credit scores in FHA's portfolio is really about the broader constriction of credit. Because the private market has been so reluctant to lend -- and combined with loan limits set by Congress that exceed those of the GSEs -- FHA is still playing a critical, countercyclical role.

However, while we have not actively sought to expand our share of higher credit score business, we absolutely agree that as the economy recovers and the market normalizes, FHA's role should recede and its portfolio once again be focused on the underserved families FHA was created to serve."

This spring, FHA raised its upfront insurance premium to 1.75 percent of the loan from .75 percent for most loans and its annual premium by 0.10 of a percentage point for loans under $625,000. The increase was expected to bring in $125 billion through September 2013. The average FICO score for new loans is now 700, despite the minimum 580 allowed, but the lower down payments are still a problem.

“While the FHA may well be serving more higher-income borrowers now, that group is still less well-heeled than the group accessing Fannie/Freddie mortgages or portfolio loans at banks,” notes Guy Cecala of Inside Mortgage Finance, which in a recent survey found more than half of all first time home buyers using FHA loans. “If you combine FHA’s lower credit score with very high loan-to-value ratios, it’s not much of a surprise that FHA would have more problem loans and be more vulnerable to unemployment and other economic issues.”

FHA’s higher income borrowers are a relatively recent phenomenon, while its troubled book of business dates back more than five years. FHA officials claim its new business will offset losses from the old book, but with the economy and jobs market still in shaky recovery, the older loans will still take their toll.

“That’s going to be a drag on the agency’s performance for the foreseeable future,” adds Cecala.

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