In view of higher than anticipated losses to the Federal Housing Administration (FHA), there are now many economists and analysts that are advocating that the FHA must take steps to increase down payment requirements in order to attract borrowers with more "skin in the game."
The FHA (Federal Housing Authority) has replaced sub prime loans for borrowers, either purchasing or refinancing existing loans, who have less than perfect credit. In addition, FHA is one of the few loan sources, since the housing meltdown, that allows low down payments (3.5%) and still qualifies you for almost the best mortgage rates. This extension of credit to "weaker" borrowers is causing an extreme strain on the FHA program which insures mortgages to lenders, in case of losses.
Borrowers with less to lose (less equity), and weaker credit historically have a higher rate of foreclosures when times get tough. Current FHA loan guidelines allow purchases with only 3.5% down payment, and credit scores as low as 620 (technically no bottom score is mandated, but most lenders require at least 620). With only 3.5% equity, which has very likely disappeared with the drop in housing values, and borrowers who already had iffy credit, the foreclosure rate has indeed been rising even faster than foreclosures for conventional loans in the last 2 years.
FHA is feeling the pinch financially. The reserves sound substantial at $3.6 billion, but in fact that number is down 72% from a year ago, and is a very small number relative to the $685 billion total loan amount that FHA has insured right now. In fact, if FHA were not a government agency, but was privately held, it would fall under more conventional standards of higher reserve requirements already.
There are even concerns that if the losses continue to mount, it is possible the FHA will have to go to Congress to seek financial assistance to buoy up the reserves.
Many analysts are suggesting that future losses might be averted if FHA starts requiring higher down payments. Home owners with large equity positions in their homes are much more likely to do whatever it takes to keep their homes. Conversely, those with zero to low equity positions realize that when times get tough, the best course of action might be to just walk away and try to rebuild in a few years.
This view has certainly been validated by the increasing rate of "strategic" foreclosures. Strategic foreclosures are those who are walking away from homes where the home owner is underwater, (owes more than the house is worth), so other than destroying a credit score, these home owners have no money to lose.
The suggestion to increase down payments and "skin in the game" is completely forward looking. Clearly there are hundreds of thousands (perhaps millions) of borrowers who are still at risk of foreclosure until this economy turns. FHA seems to continue to stand ready to assist home buyers with less than perfect credit get into homes.
After this housing crisis passes, there will be millions of people with damaged credit, from home losses and mounting credit debt who will hopefully be able to be home owners again at some point in the future. The fact that these millions of people fell on hard times, through job losses, cuts in pay, etc, should not preclude these people from ever being home owners again.
A foreclosure or deed in lieu of foreclosure can drop a solid credit score 300 - 500 points very quickly. Unfortunately, it takes longer to rebuild that score once it is damaged, so there will be a need for a source of loans for these potential borrowers.
The question now is whether or not housing values will stabilize in the near future, so any modifications to the FHA program will truly keep this government agency functioning. Even if the down payment requirement is increased to 5%, if home values continue to slide, foreclosures could potentially continue to rise. Is there another wave of foreclosures on the horizon as some have predicted?
What are your thoughts?
Other articles you might want to read include:
Top 10 states with highest foreclosure rates
Are you confused about where home values are headed?
Is there another housing bubble ready to burst on the horizon?
There is a new foreclosure every 13 seconds in America
Resources: WSJ: Housing Agency Reserves Fall Far Below Minimum
Comments
Increasing the down payment requirement will mean less people to qualify to buy the current inventory further dropping prices and making more people likely to foreclose. This would be a mistake.
I always smile at the term "less than perfect credit score". Why not just call it what it is. 620 is a BAD credit score. This person has proven that they are a BAD credit risk. Let's lend them some money and wonder if they'll pay it back.
Janet - The truth is that FHA loans have had relatively low foreclosure rates until recently, even with borrowers with credit scores even lower than 620. There are many reasons why people have "less than perfect credit" other than being dead beats, as your comment seems to imply. I have dealt with many borrowers who have had to go through bankruptcy due to out of control medical bills. The BK dumped the credit score, but in fact these people were good borrowers who were dealt some exceptional circumstances.
FHA has never made loans to total deadbeats. People who cannot prove at least 1 year of perfect paying records on either mortgages or rent are declined.
The issue now has become the loss of home values, coupled with the extreme loss of employment which is causing excessive foreclosures in both FHA and conventional loans.
Perfect credit is an indication of good paying habits, but a low credit score is not necessarily an indication of someone totally irresponsible.
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The price of homes will bounce back to what the market can afford. I believe that a home should not cost $2,000/mo of your income in the first place. A mortgage payment should not be more than 20% of your total combined income. This is why our economy is also struggling because people have somehow been sold on the idea that 50% of their income going to a mortgage payment is the norm. Because of this no one has money to vacation, or enjoy entertainment, eat out, etc. This lack of consumer spending is killing the economy as well. Homes need to adjust on their own, and people need to stop tinkering with the market by trying to accomodate everyone. Laisseze-faire was always the best political policy. The government and the doomsters need to step out of the way and the market will always correct itself. The housing market ballooned because of all these idiots trying to create loan programs that are not bearable by the market in the first place.
Johnny - Thanks for writing. There is some validity to what you say, but I believe the problem is far more reaching than your rule that mortgage pmts should stop at 20% of income. The problems that created the current problem can't be solved by govt stepping out of the way. Banks have to be reined back in. They have run amok with greed and lack of regulation.
Furthermore - loans need to be underwritten with some level of common sense - not automated underwriting machines.
A buyer with a $2,000 per month income should never be put into the same bucket of rules as buyers with $10,000 monthly income. The amount of disposable income for other living expenses is in no way equitable. Rules should be adjusted for level of income and level of other debt,including utility bills type of debt. Ex: It costs a lot more to heat a 3000 sq ft house than a 1000 sq foot house. Where has the common sense gone in loan approvals? I'm glad to see regulation of banks return.
One problem I see if the media is encouraging people to walk away from there home becuase the own more then it is worth. THis is very bad advice. If borrowers keep paying there note like they said they would in the near future the value will be higher than what they owe. If HUD increases the required down payment less peopl will buy and more house will flood the inventory and drive prices even lower.
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