FHA: A Siren Who Just Might Break Your Heart

It’s an FHA love fest! We have national trade organizations smiling and shaking hands with members of the House and Senate over proposed legislation to modernize FHA.  The House approved the bill, suspiciously titled “The Expanding American Homeownership Act of 2007” (I guess “FHA Reform” might have hurt FHA employee’s feelings). This bill will provide some nice upgrades such as increasing conforming loan limits, reducing downpayment requirements, simplifying approval requirements for condos and co-ops, and allowing people with little credit history to use, for example, utility bill records to establish a credit history.  Now we’re waiting on the Senate where opinions differ.

I don’t mean to spoil the FHA happy party, but FHA loans ranked as “seriously delinquent” are higher than subprime ARM loans right now in Washington state as well as overall in the U.S.

See page 13 of this PDF, released last week at the Wash Assoc of Mtg Brokers state convention in Bellevue:

So what do rising FHA delinquencies mean for real estate agents?

Lenders must fully underwrite FHA loans.  If a loan goes into delinquency, the lenders must take a look at what happened:  Lenders and FHA-approved underwriters are held accountable for their bad underwriting decisions. 

What the industry use to do: sell that homebuyer a subprime ARM underwritten on the initial teaser payment rate, which made their debt-to-income ratio look great.

Worse, the industry might have shoved that person into a stated income loan where the borrower “magically” comes up with an income figure that comports with a decent debt-to-income ratio.

This transferred the risk away from the lender and onto the borrower “if” the borrower is unlucky enough to get prosecuted for mortgage fraud.  Stated income subprime high LTV loans are now gone. We’re now living through the painfully obvious proof that borrowers make lousy underwriters.

That risk now falls back on the lender. If the loan defaults, bank auditors and examiners call into question the decisions made by the underwriters.  Recall that with a stated income loan, the borrower inflated the income so the debt-to-income ratio looks great to auditors. With fully-underwritten FHA loans, the bank can go back and examine the decision. Speaking as a former underwriter, banks and their underwriters are not thrilled about re-living their underwriting decisions. If FHA delinquencies continue to rise, banks are going to tighten FHA underwriting policies, as they well should. 

[photopress:FHAsiren.jpg,thumb,alignright]Realtors following this thread ought to continue to be reminded that the “anyone can get a loan” party is OVER and FHA ought not be thought of as an easy and fast way to inject corpses with an FHA drug to bring them to life as first time homebuyers.  Said another way: just because anyone, even zombies, could have received a subprime loan in 2006 doesn’t necessarily translate into FHA-approvable borrowers in 2007 and 2008.

Realtors, add some time to the “loan approval” section in the purchase and sales agreement and please make sure that the FHA borrower is working with 1) a federally chartered bank with current FHA approval (state chartered banks may or may not have this in place); or, 2) a mortgage broker that ALREADY HAS FHA loan approval.  This would mean a medium to large sized mortgage brokerage firm, preferably with an FHA-approved underwriter on staff locally.

If your client is working with a mortgage broker, Realtors: query the LO to see how much experience the LO has with originating FHA loans.  Why let an LO practice on your file? Also, some mortgage brokers might have rules in place that direct the loan originator your client is working with to transfer your borrower’s FHA loan file to a main office. Check on this ahead of time.