FHA Back in Business?

In a his testimony given on April 5^th 2006 before the United States House Committee on Financial Services, HUD’s Assistant Secretary for Housing, Brian D. Montgomery proposed changes to existing rules (as stated in the bill, House 4804 Senate 2123 titled "FHA Modernization Act of 2006") that would allow FHA lending to be more competitive in today’s market.

Montgomery stated that in the last few years, FHA has been falling behind for reasons ranging from “outdated business practices to cumbersome program requirements”.

Montgomery noted that:

1. In Florida, FHA loan volume has dropped from 2354 in 2000 to 621 in 2005.
2. In California, FHA loan volume has dropped from 2207 in 2000 to just 34 in 2005.
3. In California, FHA insured 127,000 loans in 1999 but only 5000 in 2005.
4. In 2005, 43% of first-time homebuyers purchased their homes with 0% down. Additionally, the majority of first time buyers that did put money down, the majority put 2% or less. Since FHA currently requires at least a 3% down payment, these buyers were not eligible for FHA loans.

The proposed changes to FHA rules would:

1. Eliminate the 3% down payment minimum.
2. Increase loan limits to 87 – 100% of GSE (Government Sponsored Enterprise) conforming loan limits in high cost areas, and 48 – 65% of GSE in low cost areas.
3. Allows FHA to set loan limits based on “median home price” in each area.
4. Allows FHA to set loan insurance premiums commensurate with the loan risk (down payment size… or lack thereof) and the applicant’s credit history.
5. Eliminate existing provisions that complicate FHA loans for condominiums. This would allow Condos to be treated like single family homes.
6. Extend the maximum mortgage term to 40 years.
7. Eliminate any existing limit on the amount a lender can recoup from a defaulted loan.

Based on Montgomery’s testimony, support for the proposed Bill seems unclear.

On one hand, if the proposed changes were implemented, the number of sub-prime loans should be greatly decreased as applicants with either poor credit histories or low incomes would surely get a better deal through FHA than through one of the various “predatory” lenders. This would certainly provide a measure of stability to lower income areas that typically have high percentage of sub-prime loans and subsequently, higher degree of defaulted loans.

On the other hand, could it be that FHA is trying to become competitive with the current, irrational expectation of lending?

Zero down, interest only and 40 year loan terms are all inventions that are designed to artificially allow borrowers (especially low income borrowers) to afford houses priced at today’s outrageous levels. The proposed changes seem to ignore the possibility that the primary reason FHA has lost ground in the last five years is because housing has become seriously out of whack. Does our government really want to get in the business of underwriting thousands of loans that have zero to negative equity on day one of the loan?