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How The FHA Is Failing - Badly

Securing a mortgage loan from a private lender isn't really so private. In the cases of certain mortgages, the loans also are backed by the Federal Housing Agency as a protection against defaults. The time has come when FHA may need some protection of its own.

As more people reenter the housing market, they struggle to come up with a down payment. That more than likely makes them candidates to seek federally backed loans. In fact, about a quarter of the mortgage market loans currently are protected by the FHA. These mortgages have jumped from 530,000 in Fiscal 2007 to 1.7 million so far this year. The Government National Mortgage Association, which securitizes the loans, has raised its mortgage-related issuance from $85 billion to $287 billion.

Don't think these debtors only have low incomes. The FHA pool also includes homeowners who earn good money. While the maximum loan is $271,050 in places where real estate is relatively inexpensive, high-priced markets such as California and New York allow the borrower to get up to $729,750.

Congress mandates FHA to keep 2 percent of its loans in cash reserves. With more people getting such mortgages, the reserves are likewise growing. But there's a problem: If more people are defaulting on their loans, then FHA has to tap into the reserves to pay off foreclosures. So the reserves are shrinking. In fact, the agency already has fallen below the minimum reserves required.

The reasons for foreclosures vary. Some of the growing number of unemployed people could barely afford to buy homes after coming up with the required 3.5 percent down payment. Now they really can't afford to be in the homes. The delinquency rate that was 12.6 percent in the second quarter of 2007 has spiked to 14.4 percent in the same quarter of 2009.

Then there are some people whose home values are less than whey they owe. They referred to as "under water." They are simply closing their doors and walking away.

FHA has responded to the situation somewhat by raising the minimum down payment from 3.5 percent to 10 percent for borrowers with credit scores no higher than 499. But that's not enough. What if everyone who qualifies is required to pay more than 3.5 percent? What if it increases to up to 20 percent, which is the portion that conventional mortgages require to avoid paying private mortgage insurance? The result could cost the U.S. economy the recovery of the housing market.

Maybe the solution is increasing the type of mortgage insurance that is paid over the life of the FHA loan. The fear is that would price first-time buyers out of the market. This segment is viewed as the driver of the market.

Whatever the choice may be, it won't be easy living with the result. FHA is in a bad situation but waiting any longer for a remedy could make it far worse over the long term.

National Rate Averages

Mortgage Rates

Product Rate
5/1 yr ARM 3.147%
1 yr ARM 3.299%
15 yr fixed 3.221%
30 yr fixed 3.815%

Home Equity Rates

* Updated Jun 8, 2012