An Open Letter To HUD About FHA Loans
A little back story.
On December 2, 2009, HUD Secretary Shaun Donovan appeared before the House Committee on Financial Services to discuss the current state of The Department Of Housing And Urban Development and more specifically the Federal Housing Administration, which regulates FHA loans. FHA loan use has increased greatly in the past few years, as family budgets have tightened and because conventional loans require 20% down payment, the FHA loans‘ 3.5% down payment becomes quite attractive. In exchange for this low down payment, borrowers have to pay a mortgage insurance premium (both an upfront fee and a monthly premium that is rolling into their mortgage payment). This insurance is what the FHA uses to back up homes that they insure against default (foreclosure). If the home is foreclosed on by the bank, the FHA steps in and pays the bank on their insurance for the loss. It’s much like car insurance, you don’t need it until something goes wrong.
I personally love FHA loans for my clients, because they offer them a chance to get into a home and still have some cash in reserves for the future (you should always have cash reserves when you buy a home – you never know what might happen the day after you move in). During Secretary Donovan’s recent visit to the House, however, he announced some proposed changes to FHA guidelines that could greatly affect the housing industry and its recovery.
Here’s a brief breakdown of FHA loan changes that have been talked about:
- Raise the minimum down payment from its current 3.5% to 5%.
- Establish a minimum credit score.
- Raise mortgage insurance premiums.
- Lower maximum seller paid contributions from 6% to 3%.
- End the ability to roll the upfront mortgage insurance premium cost into the loan.
Why are they proposing these changes? It all relates back the state of the housing market. As foreclosures increased, FHA had to start paying the banks on these mortgage insurance policies. As they did and the market slowed to a crawl, there wasn’t enough money flowing into FHA’s coffers. The FHA’s bank account was getting smaller and smaller. Federal law mandates that FHA must maintain a minimum of 2% reserves (of the loans they are insuring) in order to pay off possible insurance claims. Secretary Donovan’s bank statement? FHA was down to 0.53%. That’s 1.47% less than they need. So, as with anyone struggling to pay the bills, they look to other possibilities of generating revenue.
The recommendations and ideas (above) are all meant to help plug the hole and bring the coffers back to the levels they need to be. Something obviously needs done, because if FHA runs out of money, we get into a whole new mess, but are these recommendations going to fix the problem? In the short term, maybe. In the long term, I think we’d be opening up a can of worms we don’t want to mess with.
An Open Letter to HUD.
Dear Secretary Donovan,
I’ve seen some of the recent ideas floating around regarding FHA loans and I have to tell you, I’m a little concerned. I know you’ve got a tough job trying to keep the FHA and HUD afloat and relevant in today’s market, but I have some fears that you might not be looking at the bigger picture. The coffers are low, but how do we solve that?
This year, the government decided to extend and expand the First Time Home Buyers Tax Credit. I wasn’t a big fan of the plan, but hey, it’s law now, so I will continue to encourage my clients to take advantage of it. When the tax credit initially came into being in 2008, we all waited with baited breath for a huge rush of buyers to flood the market and eat up all the housing inventory. The first tax credit ($7,500 repayable) didn’t really motivate many people, but when it was reintroduced (as the $8,000 non-repayable) it did help. I don’t think it helped quite as much as everyone wanted it to (and depending of whose numbers you listen to, it changes from day to day), but people did take advantage of it.
Side note: When you “announced” the availability of a way to monetize the tax credit, you really did a lot of damage. It’s still one of the most common keyword searches on my website and many others.
The problem with the tax credit was that it got the phones to ring, but the consumer on the other end of the phone needed to still qualify for a loan. For many, they weren’t qualified; whether it was bad credit scores, high debt to income ratios, or lack of down payment and closing costs. We had all been living high on the debt hog and it was beginning to show. Add to that the fear of falling home prices, a dearth of inventory, and a general uncertainty about our economy (especially jobs) – well you can clearly see why well-qualified buyers weren’t stepping up to the plate so quickly. Fear breeds fear and with all the foreclosure news twenty-four hours a day, you can imagine the fear out there in the general public.
So here we are today and FHA needs to raise some capital in order for you to keep your job and the FHA to continue to be relevant. People start throwing proposals out there, seeing what might stick. The ones I’ve mentioned in my blog post, well…they’re not going to cut it.
The idea of raising the down payment to 5% so that home buyers have “some skin in the game” is foolish at best. I do agree that 3.5% is low and it should be raised, but not now. We have a country still struggling and people still losing jobs. They’ve watched their 401ks and investments crash and burn. They’ve taken second jobs (if they can find them) in order to pay for food and gas price increases. They are trying to make a decent living and it isn’t always easy. Raising the down payment requirement? I’d be willing to bet the FHA coffers will get even lower. So will home prices as inventory levels climb once again. More inventory, lower prices – that leads to more people being underwater on their mortgage and that leads to more foreclosures. Uh-oh, this is spiraling out of control already.
Raising credit score requirements isn’t necessarily a bad idea, except for one thing. We are struggling (seems like a theme here). Everyone I know has had their credit score slip. I worked with some clients recently who had some of the best credit I have ever seen, but even they had slipped from past year’s benchmarks. I have opinions on credit scores that I won’t go into here, but I think we need to rethink our national credit scoring strategy. This is an industry that is out of control in my opinion, but since you don’t control it, I can’t really complain to you about it. Next time you see some lobbyists from the credit industry though, perhaps you’d like to pass on my thoughts to them over caviar and champagne. Thanks! If anything, we need to look at credit scores from a new angle. People with once perfect credit now find themselves unable to get a FHA loan (or any other loan), because they made some missteps over the past few years. Yes, there are people out there that have proven track records of being credit unworthy, but there are plenty that are worthy, but just don’t look it when you look at recent numbers.
Raising mortgage insurance premiums on FHA loans is about the only thing I see as a viable option. Of course, I’d like to hear what the opinions are about how much you would want to raise them. If it’s low enough, I’m sure most consumers could absorb those costs. If it’s too high and their monthly payments increase out of their range, well…we’re back to square one. I’d prefer to not raise them, but if we really need to do something, let’s work on this plan (and make it reasonable).
Lowering seller paid contributions….hmmm. I have mixed opinions on this one. First, I do see it as a danger to keeping house prices at bay. Unfortunately, this was allowed to get out of control and pushed home prices higher and higher. The solution there? Solid appraisals. The appraisal industry has already had a crack down on it, but we can talk about those ideas another day (localizing all appraisals is key to everything). The issue at hand is cash. If you go back and read the last few paragraphs, you’ll know that consumers are strapped for cash and worried about spending the cash they do have. Buyers have come to expect seller paid closing cost contributions, perhaps we should have never allowed them at all, but that chicken has already flown the coop. Trying to remove it altogether would be like asking the government to remove the “right to bear arms” – it just isn’t going to happen, no matter what anyone feels about it (for or against). I think we should keep the 6% cap in place. Train our appraisers to come up with true values (and if someone inflated the price in order to pay for seller contributions, it will be obvious in the appraisal). My opinion is that it’s the seller’s money and they should be allowed to do with it as they please – as long as there’s no artificial price inflation to cover that cost.
Once again, we come back to cash when it comes to whether you should allow upfront FHA’s mortgage insurance premiums to be rolled into the loan. I think in the long term it might not be a bad idea. Right now? Not the best idea. Perhaps making a percentage of it due in cash and the rest of it being rolled into the financing? Just trying to think of something better than the all or nothing approach.
One thing I don’t think has been mentioned is an education program on FHA loans. Do you know how many people think FHA loans are only for “poor people” or people with bad credit? I used to think that myself before I took finance classes when obtaining my real estate license. So many people just don’t know what an FHA loan is. They don’t know the questions to ask a lender and they don’t know it’s a viable option for them. I do my best to educate my clients, but I’m just one Realtor®. This sort of education program might actually bring more loans to your door, which in turn can increase the holdings of the FHA. With that money, some smart investing, and perhaps a bit of corporate downsizing of your own (your salaries and expenses for 2009 alone account for over $1.4 billion – we’re making cuts where we can, perhaps you should too)?
I know that the FHA loan programs are looking to draw in more funds, but at what cost? Less loans means that we’re just spreading the burden among a smaller amount of people. Let’s find ways to generate more loans to increase your overall numbers. Let’s not do it blindly and just let anyone with a picture I.D. and a job (no matter what the salary) take out an FHA loan, as we know that isn’t the solution. We need to get buyers borrowing, it’s as simple as that. The more the merrier (and hey, it wouldn’t hurt my industry either!).
So there you have it, one Realtor’s® opinions on FHA loans and where we’re at today and where we’re heading in the future. I’d love to hear from you – feel free to contact me and discuss or ask for advice. I don’t even charge for it.
Sincerely,
Matt Stigliano, Realtor®
San Antonio, Texas
photo courtesy of Caitlinator
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Comments
Matt,
I can tell from the amount of time you spent on this, you must have a lot of passion on this subject.
Take a look at this article from the other day on “Is the FHA at Risk”: http://www.cbsnews.com/stories/2009/11/29/eveningnews/main5826890.shtml?tag=contentBody;featuredPost-PE
I think what you see here is that the FHA is deliberately trying to decrease their exposure, which has quadrupled in the last 3 years. I really think they are making some tough decision to ensure their long-term viability and independence (some of this may also be a reaction from media/political pressure.)
It’s unfortunate, but just like how the fed has interest rates at zero and will eventually jack them up to ensure against inflation; I think the FHA has to also safeguard their exposure at a rough expense to the public at large (I am though, by no means an expert on this subject and would love to hear your/other people’s thoughts to my post).
Doug
Doug – My passion lies in the love of looking at things and trying to see them from different angles.
I agree with you that the FHA is deliberately trying to decrease their exposure, as it has grown a little too quickly. I think I mentioned over on ActiveRain, but one of the things that disturbs me is that in a world of forecasts, trends, and predictions FHA seemed to suddenly say “uh oh, we’re in trouble.” They pushed back a meeting that was meant to occur in November (if I remember correctly) because the document with all the number had to be redone. You know as well as I do, that they were crossing their fingers and hoping they could solve a few things – essentially buying some time.
I do agree that FHA has to fight to stay viable. Without the money in reserves to back up the loans it takes on it’s doomed for failure (and a hurtful costly one – who would pick up the tab is FHA were to crumble?).
The conversation on ActiveRain about this has been interesting and educational in some ways. I wasn’t aware of some of the history of changes made in the FHA (as I wasn’t in the business back then), so you might want to check that out (since I know you like getting your head around these sorts of things).
I think it’s possible to find ways to raise the capital needed without slashing the pool of qualified buyers for FHA. If they cut the available pool, then the burden of filling the reserves would be higher on an individual basis.
I like the idea of raising the upfront mortgage insurance premium (and still allowing it to be rolled into the loan) and perhaps a slight increase in monthly mortgage insurance premiums. Would $10, $20, $30 be too much for most people? Probably not. Question is, would it be enough for FHA?
I do think that once we’ve done some more balancing in the housing market (preferably organic and not artificial), we can look at more drastic changes like the ones suggested that would require buyers to bring more cash to the table.
I just don’t think that now is the time if we want an effective long-term recovery plan.
PS The article was great – especially since it quoted the now defunct Lend America.
Oops. Looks like the revamping didn’t work out too well.
Quote taken from CBS News article “Is the FHA at Risk?“
.-= rerockstar´s last blog ..An Open Letter To HUD About FHA Loans =-.
FHA has been running much longer than Fannie, Freddie and VA and will continue on… Unfortunately, when the subprime market blew up, lenders started dumping b-c paper loans into FHA and with the housing crunch, too many people are finding it too easy to leave their homes, some of which have FHA loans on them too.
In my opinion, increasing the down payment isn’t the answer nor is increasing the MIP or making the buyer pay it in cash. FHA will start to look just like conventional. Increasing the upfront MIP that gets financed might be an answer as taking the 1.75% MIP to 2.25% will only add a few bucks to a mortgage payment.
The key to this is FHA has to tighten the reins a bit, enforce their underwriting guidelines and help people buy homes that should be buying homes. There is nothing wrong with a 620 minimum credit scores, realistic qualifying guidelines and a stable employment history.
As home prices stabilize and unemployment numbers improve, the housing and mortgage market and foreclosures will all improve and FHA’s temporary financial issues will improve.
Excellent article! I would like to add one thing in regards to the credit requirements. As a Certified Credit Counselor, I do agree there should be minimum credit requirements, but not necessarily based on score alone. Too many people have had their scores damaged through no fault of their own due to universal default. I would suggest that more emphasis be placed on a verified payment history (including items that do not appear on the credit history) versus score alone.
Great letter and post – I had very similar thoughts when I heard about the move to change FHA requirements. I have worked with many buyers this year who have basic jobs and can afford their rent but not huge savings above and beyond. What has enticed them is the ability to buy a home and get some money to fix it up and not increase their monthly expenditure. They all need the closing cost assistance and many get gifts for the downpayment. But they are not huge credit/default risks. Simply renters who want to become owners. The program should not be drastically changed – unless they want to up the MI premiums.
Matt, very well stated. Much better to all the Sellers to contribute 6% to the closing costs and have the Buyers reserves in place. Quite honestly in lieu of 3.5% down let that pay the upfront mortgage insurance fee and honestly finance the home at 100% of the appraised value. Not more.
I’m confused,
Only yesterday one of the agents that I source property through, told me that she is going off after FHA loan deals, as she put it, ‘thats where the future is’. Forgive me if I’m wrong, but when a business is so highly geared as FHA clearly is, and there’s no straight forward way of building is cash base in the short term, it can usually spell doom, I don’t see the logic in the philosophy that FHA is the way forward. Unless the spin out there is to encourage more agents to try and get through more FHA deals….. back to the photo I.D, job, ‘your in’.
Ken – I don’t think (hope) FHA isn’t going away anytime soon. It’s a great alternative to conventional loans and I’ve even said to a lender before, why would you go conventional? Of course, there are good reasons, but I’d say for your average home buyer FHA is a great way to buy a home.
I do agree that the upfront mortgage insurance premium would be one of the best places for FHA to help fill it’s reserves back up, but of course, I do think buyers should retain the ability to roll it into their loan. At this point in time, any more cost added to what’s needed at the closing table is only going to slow buyers down again, something the administration has tried to avoid.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
Dave – One of the things I think we’ve lost sight of in the financial world is the human element. We can look at credit scores and mathematical equations all day long, but does that truly show us the buyer on the other end? We try to rationalize humanity into an algorithm and I think we all know human beings are a bit more complex than that. I commented on the ActiveRain side of this post in a very similar fashion.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
Sue – This kind of goes back to my comments to Dave above. Just because someone fits a certain set of criteria, doesn’t mean they’re going to default on their loan. I’m sure there are plenty of people out there that don’t have the savings for a down payment, but their pride and worth ethic would not allow them to ever default on their mortgage. Some people are dedicated to do things, no matter what the cost or burden to them. We can’t quantitfy these people with math, but we can see in their hearts where they’re going and what they want to do with their lives.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
Bobbi – I’m not sure about all the seller paid assistance programs. I came in as they were on their way out, so I didn’t get much experience with them, other than talking theory about them.
VA loans are 100% financing. Do we think they are horrible loans? I have been looking at some statistics and will be covering that in a later post, but I’m beginning to wonder how many agents out there say what they say for political purposes. Don’t get me wrong, I don’t mean Republican vs. Democrat (although there’s plenty of that go around too), but political in the sense that the hot button issue is that we all watch as the housing market got out of control and like it or not, Realtors® had something to do with it. Closing you eyes and wincing when someone signed a loan everyone knew the client could never repay isn’t good business and I think a lot of agents got caught up in the whirlwind of things. I wasn’t here for it, so I don’t know how I would have reacted, but I have an idea how I would react now (since I’ve been able to learn from the experiences of others and formulate my own opinions over time).
Carl – I think most agents would agree that we don’t need to go back to “photo I.D., job, you’re in.” At least I sure hope they don’t. We got too creative with our lending practices and it came back to haunt us.
I think FHA is still a viable model, but it has to remain in a place where it’s a viable option vs. conventional loans or it would be doomed. If FHA woke up tomorrow and instituted the same guidelines as conventional loans, I truly think there would be no reason for a borrower to mess with FHA. For that reason alone, I think FHA will make itself relevant no matter what it takes.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
Matt,
This is a superb letter. I agree totally that this is not the time to make these changes. If they can hold off for a year or two, that would be much better. By going to 95% LTV and only a 3 percent assist, that would have cut out many of the houses that sold to first time homebuyers in Philadelphia in the last 12 months. Many of these borrrowers have excellent job histories and credit scores, they just needed the low downpayment and the sellers assist to get that first home. Taking that away would be a big crunch. It is a tough period out there but the time to make these changes are not now.
P.S. Will tweet this article as well !
Matt,
You raise some good points here. And I think that the unintended consequence of most of these options is that by cooling the FHA market, which will cool the housing market in general, the FHA would slow their own revenues… and that would decrease their reserves.
I think the only viable solution is the increase the premium slightly. As the market recovers (or WHEN the market recovers) there will be fewer foreclosures. This will allow the FHA to get back to their mandated minimums.
Further slowing the market will only push more people into strategic defaults… which will further erode the reserves of the FHA.
After the market recovers, I think that moving to 5% down and lowering the cap of seller contributions to the 5% area would be good ideas.
The problem we are facing now is that people that bought 2-3 years ago with 20% were STILL upside-down. Going from 3.5% to 5% down would not have given them “skin in the game”…
Lane – Your first paragraph is a winner. Simple logic dictates that if we lessen the pool of buyers we have two options: a) watch the reserves dwindle more or b) raise the cost of entry on that smaller pool. If we take on “b”, logic would then follow that the pool would again decrease. Rinse and repeat.
The premium is the simplest, most swallowable solution for buyers. The cost won’t kill them and the FHA can still raise more money to fill the reserves. Is it a perfect solution? Of course not. At this point, I don’t think anything is the perfect solution to a housing recovery.
Your last paragraph should be quoted everywhere there’s a discussion about FHA and the phrase “skin in the game.” I don’t think we can blame put all the blame on consumers being upside-down onto FHA loans. Conventional, sub-prime, FHA, VA – you name it. They all got caught up in a swift boom that left us hanging.
The interesting thing I find is that I know I will have this exact same conversation at least once in my real estate career. We’re a boom and bust industry and I doubt we will ever discontinue that cycle.
Chris – Sorry I missed responding to you the first go around. It occurred to me that I knew you had commented, but I hadn’t responded.
In markets like Philadelphia, where housing isn’t always the cheapest, I can see how making changes now could affect your area even more by pushing out those marginal buyers, who aren’t bad risks and will be great home owners, but are just on that borderline between renting and owning.
Thanks for the tweet.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
You know, I think your comment about education is important. I think if FHA discussed the ways they have to help homeowners having trouble, we may be able to avoid a lot of foreclosures. At least it seems that way in this area. Many people have no idea of their options, and feel they have nowhere to turn – and that’s really sad, especially when they do have an FHA loan.
Joslyn – I think one of the problems with the education on FHA loans is that the government seems to not know how to “market itself” (for lack of a better way to put it). Just take a look at the HUD website for a great example. I go there frequently to do research or read up on some recent changes, etc. It’s not pleasant, appealing, or even well put together. Why would a consumer spend time there learning about HUD and FHA loans. Even as a real estate agent, I constantly am finding tidbits of news that I might have not heard the day before and I am actively looking for it. Imagine how much a consumer misses – they don’t spend nearly as much time as a real estate agent does reading the news about real estate (if they do, they should probably get a license!).
Of course, until then, the real estate agents will need to shoulder that burden, even if it is only one consumer at a time that we can educate, one is better than zero.
.-= rerockstar´s last blog ..Realtor® Speak 101: Home Equity =-.
Excellent article!! I am a big fan of FHA. Those are a majority of my purchase loans, and I feel that FHA offers the best of all worlds. It forces people to put some skin in the game, but also allows people to save some money for home improvements and other expenses. Part of the problems in the past few years have been customers draining their savings to get into a home and invarably they end up with no reserves for emergencies.
I agree with all of your comments except for the fact that I feel as if the monthly mortgage insurance percentage should be raised slightly to cover these losses.
I do feel that we need to educate the public more on FHA loans and its benefits and to also inform the public that these type of loans are not just for “poor or credit challenged” people.
Great job!!
Sincerely,
Paul Thompson
Home Mortgage Consultant
Wells Fargo Home Mortgage
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