Borrowers are flocking back to the FHA, which has become the only option for those who lack hefty down payments or stellar credit.
The agency’s share of the mortgage market is up from 2 percent three years ago to nearly a 33% of the mortgages now made, its highest level in at least two decades, according to Inside Mortgage Finance, an industry trade publication. The FHA does not lend money directly. It provides mortgage insurance for borrowers working with FHA-approved lenders and uses the premiums to cover its losses.
At the same time, Congress has substantially increased the amount a homeowner can borrow on an FHA loan in pricey areas, thrusting the agency into markets it was previously shut out of, such as California, where plunging home prices have made people more vulnerable to foreclosure. Moreover, lawmakers last year put the FHA in charge of a program created to address the roots of the financial crisis by helping delinquent borrowers refinance into new mortgages.
The agency now faces this swell of loans that default almost immediately.
Under the FHA’s own rules, there’s a presumption of fraud or material misrepresentation if loans default after borrowers make no more than one payment. In those cases, the lenders are required by the FHA to investigate what went awry and notify the agency of any suspected fraud. But the agency’s efforts at pursuing abusive lenders have been hamstrung. Once, about 130 HUD investigators teamed with FBI agents in an FHA fraud unit, but this office was dismantled in 2003 after the FHA’s business dwindled in the housing boom.
At the same time, the FHA office responsible for approving and policing new lenders has not expanded even as the number of active lenders doing business with the FHA more than doubled to 2,300 in the past two years.
Although the FHA insures mortgages issued by lenders, it leaves these companies to conduct their own business. If a lender writes a lot of bad loans, that’s when the agency can eject it from the program. Experts in housing finance warn, however, that the FHA has inadequate staffing and technology to keep up.
With the surge in new loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans. In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency’s overall growth in new loans, according to a Washington Post analysis of federal data.
Many industry experts attribute the jump in these instant defaults to lax scrutiny of prospective borrowers.
If a loan “is going into default immediately, it clearly suggests impropriety and fraudulent activity,” said Kenneth Donohue, the inspector general of the Department of Housing and Urban Development, which includes the FHA.
The spike in quick defaults follows the pattern that preceded the collapse of the subprime market as some of the same flawed lending practices that contributed to the mortgage crisis are now eroding one of the main federal agencies charged with addressing it. During the subprime lending boom, many mortgage brokers and small lenders milked the market for commissions and fees by making as many loans as possible with little regard for whether they could be repaid. [McAuleys World: Borrowers secured NINJA and Liar Loans – the underlying problem that resulted in our financial collapse has never been corrected]
The Palm Hill Condominiums project near West Palm Beach, Fla., exemplifies the problem. The two-story stucco apartments built 28 years ago on former Everglades swampland were converted to condominiums three years ago. The complex had the same owner as an FHA-approved mortgage company Great Country Mortgage of Coral Gables, whose brokers pushed no-money-down, no-closing-cost loans to prospective buyers of the condos, according to Michael Tanner, who is identified on a company Web site as a senior loan officer.
Many of the borrowers were first-time home buyers and were unable to keep up their payments. Tanner said he complained to his company that extending loans without any money down lured borrowers who either didn’t understand or take seriously the payments they’d have to make. Great Country’s owner, Hector Hernandez Jr., could not be reached for comment.
Eighty percent of the Great Country loans at the project have defaulted, a dozen after no payment or one. With 64 percent of all its loans gone bad, Great Country has the highest default rate of any FHA lender, according to the agency’s database. It also has the highest instant default rate. [Yet Great Country Mortgage is Still an FHA Lender – I wonder where Great Country’s Political Contributions go]
In Reston, Access National Mortgage has watched its default rate climb. The lender is among a growing number that market FHA mortgages to borrowers through direct mail, telemarketing and the Internet. By the end of 2008, more than 5,200 of the agency’s defaults were on loans promoted with these techniques, a sevenfold increase in one year, accord to the review of federal data. [A single lender with 5,200 defaults in a single year – and the lender is still authorized to work with the FHA – this simply doesn’t pass the “smell test”]
Dean Hackemer, president of Access National Mortgage, noted that many of the lenders now running into trouble with FHA loans were previously selling subprime loans and related Alt-A mortgages, which required no documentation.
Refinanced Back Into Trouble
Among FHA loans with instant defaults, the upward trend is especially pronounced in refinanced deals. The number of refinancings that defaulted after zero payments or one have more than quadrupled since then end of 2007 and now represent two-fifths of all instant defaults.
The FHA is attractive to borrowers looking to refinance, in part because the agency allows for cash-out refinances, a practice Apgar called “particularly problematic.” It has become rare among conventional lenders, who fear that borrowers will take the cash and walk away from the loan.
The FHA also permits “streamlined” refinancing, in which established FHA borrowers get lower rates without verifying their income.
Karmen Carr, a housing finance consultant for the FHA, said some mortgage brokers have been known to game the system.
Some of the country’s largest and most established lenders are so concerned about this new threat to the credit market that they are not waiting for the FHA to tighten its requirements. Instead, they are imposing new rules on the brokers they work with. Wells Fargo and Bank of America, for instance, now require higher credit scores on certain FHA loan transactions and better on-time payment history. [Yet the Democrats ask “Why aren’t the Banks Lending”? – Is rejecting a bad credit risk an excuse or valid business decision?]
“We have some self-preservation methods,” said Joe Rogers, executive vice president at Wells Fargo.
Some experts who track FHA lending say the agency should not wait for lenders to take the lead on toughening the rules, especially given the mortgage industry’s poor track record for policing subprime and other risky home loans.
“Even if the market eventually gets these guys, they shouldn’t have to wait for the market to do it,” said Brian Chappelle, a former FHA official who is now a banking industry consultant. “The most frequent question I get asked by the groups I talk to is: ‘Is FHA going to implode?’ . . . They haven’t seen HUD do anything significant in the past two years to tighten up its lending.”
[In order to initiate an economic recovery the Country needs to find a floor on Mortgage Values – Investors will not pruchase Mortgage Securities until they can have confidence that appropriate Mortgage underwriting has been completed. Housing “demand” or demand for “Mortgage Backed Investment Securities” (which is what really triggered the housing crisis) will not rebound until the corruption is removed from the system. Attempting to “bailout” a corrupt system is a recipe for disaster]