Modest Changes Made to FHA

After a surge in delinquencies last year, The FHA announced stricter standards yesterday. The key changes include:

- The agency will increase up front mortgage premiums to 2.25% from 1.75%

- In order to qualify for the agency’s 3.5% downpayment program, borrowers must have a credit score of at least 580. Those with a lower score will have to pay at least 10%. However, this rule change will essentially have no bearing on the program since the average borrower score is around 700. A universal increase of the downpayment to at least 5% would have more appropriately addressed the negative equity situation challenging the program (note 14.36% of FHA loans were past due at the end of Q3 2009 vs. 9.64% for all loans)

- Maximum seller financing will be reduced to 3% of a home’s appraised price vs. a previous ceiling of 6% (will help remove the incentive to inflate appraisals)

- The FHA will more closely monitor the performance and compliance of participating lenders. This is in response to the Taylor Bean and Lend America disasters and the 15 lenders that are currently being investigated by the FHA for engaging in potentially fraudulent activities.

Overall, the changes seem like window dressing for the agency and are unlikely to have a major impact on participating lenders’ ability to provide credit to the FHA’s core constituency.

For those interested, the Wall Street Journal ran a good front page cover story ("Souring Mortgages, Weak Market Force FHA to Walk a Tightrope") rehashing many of the problems facing the FHA (which I have recounted in numerous posts). Although David Stevens, head of the FHA since July 2009, spends much of the article defending his organization, I think this quote is the most telling:

"We should not play this large a role," Mr. Stevens says. "It's not healthy for the mortgage-finance system, it's not healthy for the economy, and it's certainly not sustainable for the long term."

The chart below does a great job of zeroing in on the rising delinquencies and diminishing capital cushion affecting the FHA. Most fascinating to me is how quickly loans made in 2007 and 2008 are falling into arrears. Many of these loans were extended to at-risk borrowers who were refinanced into FHA-backed loans as a result of government foreclosure prevention programs. In effect, institutional investors were able to offset troubles in their own portfolio onto the government. With the redefault rates on many of these modified mortgages running in the 50-60% range, its highly likely the taxpayer will ultimately absorb the bulk of these losses. In affect, the FHA is serving as a backdoor recapitalization program for the nation's banking system.