Facing losses from defaulting borrowers so serious that it must reduce risk or beg for a Congressional bail out, the Federal Housing Administration is transforming itself from a lender of last resort serving mid to lower income borrowers into a more expensive lender with a safer, more upscale portfolio.
FHA’s market share zoomed from three percent in 2006 to more than 30 percent today as lenders have dropped out of the market, leaving only FHA to provide for middle income and entry level buyers. The demise of no-down payment loans and down payment assistance programs made the FHA’s 3.5 percent down loans the best deal left for cash-strapped buyers.
Now two factors are reshaping FHA again, pointing it away from riskier lower income and entry levels buyers to the upscale market that it is more expensive for buyers and available to upper end buyers who previously were shut out of the program by loan limits.
First, FHA’s success brought with it thousands of defaults and the agency’s FHA loan-guarantee fund has slipped below the congressionally mandated 2 percent level. To control risk, FHA required participating lenders to assume liability for FHA-insured loans they originate and to have at least $1 million in net worth. Additionally, the agency has proposed to:
- Raise the required minimum down payment from 3.5 percent to 5 percent;
- Lower the maximum seller contribution from 6 percent to 3 percent;
- Establish a required minimum credit score;
- Eliminate the ability to finance the Up Front Mortgage Insurance Premium (UFMIP) into the loan;
- Raise the cost of FHA mortgage insurance (higher premiums)
These and other steps were discussed at House hearings last week, including requiring higher credit scores to qualify borrowers, In fact, a House bill, the FHA Taxpayer Protection Act of 2009, would increase the minimum down payment required to obtain an FHA loan to 5% from 3.5% and raise the up-front insurance premium from 1.75% to as much as 3%
“Nothing is off the table,” FHA Commissioner Dave Stevens said at the National Association of Realtors’ annual conference last month. “I will consider everything, and I’ve already made several risk changes to manage the portfolio.”
These steps, if implemented, will reduce FHA’s market share and also make FHA financing significantly more expensive for borrowers. Rather than returning its traditional role as lender to entry-level homeowners unable to get financing elsewhere, the FHA’s efforts to reduce risk are putting it in direct competition with private lenders for lower risk, higher income borrowers.
Another development may make FHA financing more accessible to middle to upper income buyers. The stimulus package passed last February temporarily raised the limits on FHA loans in higher-cost markets. Now key members of the House want to make the higher loan limits permanent, which would allow FHA to insure as large as $729,750 in the nation’s most expensive housing markets. Previously, FHA loans had been capped nationally at $362,000. House Finance Chair Barney Frank would like to see limits increased to around $800,000.
However, higher loan limits could throw a monkey wrench into the efforts to reduce risk. On low-down payment FHA loans, larger loans have higher default rates than smaller ones. The likely reason for this is that prices of more expensive homes fluctuate more, and the more sophisticated borrowers who take out larger loans are more likely to walk away if the equity in their homes disappears.
HUD Secretary Donovan opposes the push to permanently increase loan limits, but they are widely popular with real estate agents and builders, who are fresh from an