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.

47 thoughts on “FHA: A Siren Who Just Might Break Your Heart

  1. Outstanding post, Jillayne! For FHA loans, I would suggest Realtors asking their LO if (1) they do FHA loans, and if so, do they work for a lender who is Direct Endorsed with HUD or if they are sponsored.

    I have had LOs refer FHA loans to me recently when they realize last minute (during a transaction) they may have an FHA buyer. This is why buyers should get preapproved before they enter into a purchase and sale agreement.

  2. Great post.

    When I first read Tanta’s piece, I was sorely tempted to link to Ardell’s “Stated Rocks! (or something like that)” post, but that post had become vintage, and a link would likely have been ignored.

    Glad you are bringing it, as well as the added take-home message, to light here, Jillayne.

  3. Excellent post Jillayne, it sounds like the purpose of the FHA loan is to qualify borrowers who in practicality are prime but of some reason or another do not fulfill the formal requirements of a prime borrower. Is that a fair assessment or is it more of a true subprime loan where a much higher risk is accepted and assumed even after the more in-depth analysis that seems to be involved in issuing these loans?

  4. tj, I wouldn’t say that FHA borrowers are possibly defined as “prime”. I recently did a refi where the borrowers mid score was in the 500s. They did not have any late payments for the previous 12 months and they qualified with their DTI.

  5. Hi biliruben,

    I absolutely adore Tanta’s work. One of my readers here on RCG suggested that I read Calculated Risk because he said I reminded him of the way Tanta writes. FHA is not the end-all cure for subprime. For example, if subprime had never been invented, there’s no way the sheer number of homebuyers would have been able to qualify as FHA borrowers, nor should we now open the floodgates again and turn our own government into the new subprime lender.

    For those that wish to follow along, Tanta is not a fan of stated income loans and explains in depth as to why stated income loans ought to go away for good, click on the “stated income loans” link in the original blog post.

    FHA underwriting standards should stay where they are: conservative but balanced to favor the first-time homebuyer that presents as an overall good risk.

    When I use to underwrite FHA loans, it was a BIG DEAL in our department when an FHA loan went delinquent and foreclosed. We all sat around and listened to the underwriter justify the decision to grant someone the American dream, and then we tried to learn from the file. If an FHA-underwriter has too many delinquencies or foreclosures, there’s a risk of being put on a list of underwriters whose work must be supervised/signed off by a senior underwriter.

    FHA loan files, especially the ones Rhonda and I blog about such as borrowers that don’t fit the average, computer-generated “yes” profile, will need to be hand-underwritten and Realtors ought to be prepared for those files to take longer. Some will be approved and some will be declined.

    What use to happen: Real estate agents would bad-mouth lenders, brokers, and loan originators who “couldn’t get the deal done.” When, in reality, the borrower was not quite ready to leave the renter ‘hood.

    Rhonda says it all the time: Real estate agents get those homebuyers pre-APPROVED (not just prequalified) before that offer is made.

  6. Hi tj,

    Rhonda’s assessment is accurate, with a twist.

    Sure, a “prime” borrower with good credit score and some money to put down could, if he/she wanted to, select an FHA loan over a conventional loan.

    Loan limits on FHA are set low in order to attract first-time homebuyers to the program and help people who are a good credit risk become homeowners. (example: why ought our government subsidize the wealthy’s ability to obtain a mortgage? Someone who is wealthy and buying a million dollar home but has awful credit, and I have met people like this, ought not need to rely on the government to subsidize their ability to obtain a home. Gee, now that I type this, I realize Fannie and Freddie are GSEs.)

    Next tier down, we have people who are a good credit risk, because they have a good “overall picture” of their ability to repay. FHA looks at the whole person and not just a score.

    So in Rhonda’s example from comment #4, we have a refinancing homeowner with a nasty 500 credit score, but they’ve kept their nose clean for the past 12 months. FHA would want this person to be able to show things like a stable work history, documented monthly income, a decent debt-to-income ratio, and cash reserves on hand. If things start looking marginal, then maybe a letter of explanation is called for, regarding those late payments last year. What happened in that person’s life to make them miss paying their creditors? What did he/she do to get back on track? What are the chances that person will not pay the mortgage?

    A human underwriter, whose FHA approval number will be stamped onto that file, will write a narrative explanation as to why the loan was approved (or declined).

    W-2 employees who used stated income loans are not going to be able to go FHA unless they can qualify under FHA guidelines for their debt-to-income ratio, and of course, the rest of their overall credit picture looks good.

    Self employed borrowers who used stated income loans are not going to be able to go FHA unless they can document income which will show that they have the ability to repay the loan, and the rest of their overall credit picture looks good.

    This is why I wrote this post; so Realtors don’t get high off of the vapors of FHA love wafting out of their computers when they read about this new bill that passed the House (but not yet the Senate.)

    On the PLUS side, there are many good reasons why we ought to be celebrating the return of FHA lending, but I’m going to let Rhonda cover that side of the FHA story.

    In the recent past, Nasty 500 credit score borrower would have received a nasty subprime interest rate or possibly directed into an option ARM, where “you can choose your monthly payment!” if the rate/payment looked too high once subprime rates/payments were quoted.

    But because N500 had a good overall credit risk picture, FHA gave him a thumb’s up.

    Realtors like to use heuristics or, “rules of thumb” when trying to assimilate lots of data about, for example, lending rules and procedures.

    One challenge with FHA, is that there are 74,937,195,364,822 rules to memorize. And that’s just the rules, not including updates to the updates to the updates.

    That’s why a human underwriter, preferably on site, is recommended, IMHO.

  7. Jillayne, do you know what the percentage of mortgage companies have human on site underwriters (should we call them HOSU)? I’ve only worked for one mortgage company so that’s the only norm I know.

  8. Thanks Jillayne and Rhonda! I think you both confirmed what I meant. I.e that FHA is more of an alternative way to be able to qualify a reasonably low credit risk. That alternative being a more thorough look at the financial circumstances instead of automatically disqualify on the credit score. It’s not really a subprime loan in the sense of accepting a known high risk in exchange for a significantly higher borrowing cost?

  9. Hi tj,

    You got it. Because the borrower’s ability to repay is being fully documented, FHA interest rates aren’t going to be sky-high subprime.

    Years ago, everyone use to receive the same interest rate on their loan, no matter what their credit score.

    Enter risk-based pricing…..the mortgage industry tore the idea off from the credit card industry and subprime lending exploded.

  10. Hi Rhonda,

    I have no idea. FHA-approved mortgage banks, and federally chartered banks will often if not always have a team of FHA approved underwriters at the main office, and perhaps onsite underwriters scattered within some of their retail mortgage branches.

    Medium to large sized mortgage brokerage firms will sometimes have FHA approval with an onsite underwriter at the main branch, at least that’s what I’m seeing around town here in my travels.

  11. Thanks again Jillayne, I’m curious to know if a very recent immigrant with good income and cash reserves would be able to go FHA? Assuming that he does not yet have 2 years employment records and a very short but clean credit history?

  12. Sometimes I wish we could just turn back time. I remember the minute I read on the internet that Credit Scoring was going to be used. I screamed. I cursed. Everyone in the office looked at me like I was nuts. They had no idea what it was…nor did they give a RA.

  13. Years ago, fewer people qualified for a mortgage. Pre-FHA you needed a significant amount of down payment (I believe more than 20%)…it’s BMT!

    Ardell, FHA does not use credit scoring…at all.

    tj, I don’t think the scenario you reference at #11 would qualify for an FHA loan. If they had enough down payment, and credit that could be used from their previous country it’s a possibility they could go conventional. It would also depend on what their status is (are they a citizen, perm. res. alien, what type of visa…etc).

  14. Great Post! thanks for the PDF to the DFI that was very useful. I will share your post with those that I work with as that was very well written.

  15. Jillayne,

    Great Post! Covering a topic that does not get much ink. You may want to see a post on Appraisal Scoop From Oct 2nd also it is titled “Nehemiah Corporation of America Responds To HUD’S Rule Banning Private Downpayment Assistance Programs” Makes for a Great Read and also touches on another item.

  16. Great post. I guess I have to rewrite my first time buyer book since I just heard from my LO that Nehemiah would be DOA in February. I have a whole section on how great they are!
    Have to develope a different approach to the apartment dwelling first time home buyer.
    What’s more, have to make all new postcards!
    Darn darn darn. Has this sub prime mess taken away a really valuable tool for buyers who fall so far behind escalating house prices while trying to save up a down payment, that they’ll never buy anything? I loved that program!

  17. Hi Apella,

    Thanks for the idea. Readers interested in the Nehemiah slash and burn can read Apella’s recommended blog post here:


    Likely, biliruben and I read about it on Sept 28th here:


    Downpayment assistance programs….
    I hope they had the time of their lives.
    Good riddance.

  18. Hi Rhonda,

    Three months from now, I’d love to read a follow up comment or separate blog post about the ratio of conventional v. subprime v. FHA loans that you’re doing when compared with before the meltdown. Maybe a Dec 06 to Dec 07 comparison.

  19. Ardell,

    I remember when everyone (owner occ) received the same interest rate on a conventional loan. It didn’t matter if one person had stellar credit and the next person had awful credit.

    If both qualified to repay the loan, both received the same interest rate.

    So, some would say that it isn’t fair for the great-credit people. They ought to be rewarded with a BETTER rate than those late-payers.

    But, in reality, we saw everyone’s rates go up, to make up in profits for the delinquencies, defaults, foreclosures, and all the related costs of expanding credit to people who don’t pay their bills.

  20. Jillayne, I’ll mark my calendar! With Brian being in California, I’m assuming the FHA loan limits are too currently low for him to be able to do much gov.

    BTW I was never a huge fan of DPAs either.

  21. “With FHA singing her siren song, are you, sailor, planning on being wooed into becoming FHA approved?”

    We had an eagle as recently as last year (World Wide was a Title 1 lender in the early 90s). The cost of the audited financials, combined with the insistence that EVERY originator be W2 compensated , became onerous to our business model.

    Will we? Maybe. If HUD limits increase, SoCal is designated as a high-cost area, and cash-to-close is reduced to 1.5%, we’ll have to get our eagle back to remain competitive in the $650,000 and under market.

    Absent that reform, it just isn’t necessary for my practice. We’re in a “wait and see” pattern.

  22. I forgot to comment on the DPAs. They really worked in the late 90s. One of my purchase niches was to take a seemingly 90% sub prime borrower and run him through LP at 85% for a FHA loan.

    LP loved the lower LTV and approved nearly everyone- it was like magic. Armed with that approval, the DPA program, combined with a 6% seller contribution, got my borrowers great deals and me a lot of loans.

    Was it gaming the system? I’m sure it was. Did HUD pay out claims? I’m sure they had a few. Most of the buyers, however, refinanced out of those loans in 2001-2 and into conforming loans.

    That was a case of the DPA programs working but we were in a steady rising market back then.

  23. “Realtors: query the LO to see how much experience the LO has with originating FHA loans. Why let an LO practice on your file?”

    Oh, Yes! My first purchase was a FHA loan. I had funded streamlines prior to that. It was both my first purchase and my first HUD purchase. I still remember the Realtor’s scathing comments (she was operating as a dual agent and had to reduce her commission a LOT) after the closing.

    The buyer came in with the absolute minimum. He bought at 95% of list price. He had an ARM that dropped and never returned to its original level.

    That Realtor eventually sold over 20 units in the condo complex because the buyer and I referred her a bunch of buyers; what she lost on the initial deal she made up for in volume.

    Jillayne’s correct, Realtors- make sure the originator knows what he/she is doing.

    Waxing nostalgic on a Thursday morning!

  24. Jillyayne,

    Not really so. Only for “A” paper. “A” paper had a broader range, but clearly not the same rate regardless of credit credentials. B and C and below paper had higher rates and higher up front fees. Highest credit had the same rate as other “A” paper, but often lower up front fees.

  25. The reason FHA is important here is if the lowest properties don’t move, those people don’t move up. It won’t help first time buying in all price ranges. But if the low end doesn’t move, the natural flow of move up is hindered. Theoretically the second and third legs of the move up have downpayments from the equity in what they are selling, and are not zero down buyers.

    So making sure everyone is up to speed on moving the under $350,000 crowd, will help all market segments in turn.

  26. Hi Ardell,

    Regarding this last comment #30, absolutely.

    Still, it is important for Realtors/real estate agents to grasp that FHA is not subprime. I know YOU know that, but FHA has been pushed aside for so long in the greater Seattle area that many real estate agents who entered the market in the last 7 to 15 years may not have ever had ANY homebuyer go through an FHA loan approval process.

    Also, I’m not so confident that FHA will be the great gift from above for the over $350K crowd. I think there are a very wide range of factors influencing how the over $350K buyers/sellers will fare during the next 18 months.

    But we shall see! I’m very curious to see how local mortgage originations are split over the next 18 months, meaning, how many FHA loans v. conforming v. subprime (what’s left of it) are being originated?

  27. Hi Brian,

    Thanks for your comments. I have a question for you. I have heard that there are some lenders out there wooing mortgage broker/LOs into submitting FHA loans to them (the lender) and coaching the LO to put the lender’s address on the 1003 (loan application). Lender rep coaches LO by saying “we will just pay you on a W-2 for this loan.”

    To me, this sounds pretty bad but maybe it’s a way for brokers/LOs to (completely ignore HUD rules?) and bring FHA loans into their mix.

    What do you think? Is this going on in California, too?

    Hat tip to Howard at the htschoemmortgage blog.

  28. I haven’t heard that but nothing surprises me, Jillayne.

    If lenders are doing that, they should and will lose their eagle. I can be morally relative with a lot of silly lending rules; that relativity results in discussions with an underwriter, about my opinions. Those discussions have resulted in many approvals for well deserving borrowers.

    Blatant disregard for a federally-backed program is reprehensible. I don’t blame the brokers/originators, either. If the HUD licensee is stupid enough to risk the eagle to “gain a few more loans”, they should lose it.

    You and I talk about the industry cleaning itself up. Lenders need to start saying “NO”. If they accommodate loan hacks, then they need to stop complaining about them fouling up the industry.

  29. I know I’ve spoken with several FHA approved lenders who indicated to me that I could do FHA via their offices. They have told me that I can I take the loan application but must list their office on the 1003. Then they would pay me as a W2 employee on the loan.

    National Mortgage News recently reported that Department of Housing and Urban Development officials are finding that non-FHA-approved mortgage brokers are charging “exorbitant

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  32. I’ve never done a FHA loan, and I don’t know anyone who has one either. I wonder what percentage of all mortgage loans the FHA loans are. I kinda imagine it’s not a big portion. It sounds like this is similar like subprime, or even easier to qualify for. I hope the bill would focus more on how to qualify customers who can repay their loans, not just to make the loan easy to be qualified for.

  33. Jillayne

    This just goes to show its worth keeping back issues of your favorite magazines!

    Just finished reading your article and the excellent comments.

    1. Someone asked if you could revisit this in a few months. Great idea!.. Looks like Congress has put the bill on the back burner. Any news? Are FHA originations truly up?

    2. I attended my first all day training on FHA this week (don’t flame me please, for not having done an FHA before!). Everyone has to have a first time somehow, but I do not think I will be practicing on a purchase, probably a refi w/ a 60 day lock! 🙂

    3. At the training the presenter was somewhat less than emphatic about the W-2 requirement. I’m baffled: the FHA written guidelines could not be more specific…an FHA LO MUST be an employee. His after training explanation was that the penalties for violation were minimal, while the rewards could be considerable. Having gone thru several gyrations to be with a broker that would go W-2 (while allowing me to retain the independence I require, to do the right thing), I found the ambiguity frustrating.

  34. I’m mad as hell and I’m not gonna take it anymore!

    (http://www.nationalmortgagenews.com) Yesterday the National Mortgage News report contained an article titled, “Lenders Oppose Broker Surety Bonds. To read the entire article you must subscribe and search the archives under the article title listed above.

    The bottom line, five leading lender groups that are supporting quick passage of the FHA reform bill want the House & Senate banking committee leaders to drop a provision that would allow mortgage brokers to purchase a $50,000.00 surety bond in lieu of meeting the current FHA net-worth and audited financials requirements. They argue that there is no federal oversight of brokers and I quote, “it is critical that they continue to submit the annual audited financial statements to the FHA in order to participate in the program, more importantly, protect the integrity of the FHA.” Are you kidding me? Who are these born again, holier than thou lending groups who’s existence is predicated on the maintenance of FHA integrity? Same lender groups that just lead us down the path of credit destruction? Someone pass me a bag, it’s gonna get messy around here. This is about market share and keeping brokers from shopping the lenders/banks for their clients. Frankly I don’t give a hoot about the audit, it can be done for around $3,000.00. This integrity based mortgage broker finds the net worth requirements to be the problem. In today’s environment how does a new MBB owner establish and maintain a $63,000.00 business net worth, 20% of that mandated to be liquid. The NAMB has countered that surety bond provisions in the House-passed bill have, “belts and suspenders to protect the FHA program. NAMB executive vice president Roy DeLoach said, he stressed that the FHA commissioner can control the number of brokers using surety bonds. In addition, EVERY broker HAS TO be coupled with an FHA-Approved direct endorsement lender, who reviews every loan before the closing! AMEN to that!

    Signing the letter were; The Mortgage Bankers Association, The Lenders One/National Alliance of Independent Mortgage Bankers, The Independent Community Bankers of America, The American Bankers Association, The American Financial Services Association, and the American Institute of Certified Public Accountants.

  35. Hi Howard,

    Thanks for stopping by RCG. FHA is a government sponsored program. What purpose does it serve, if any, to have businesses worth at least $63,000 originating mortgage loans?

    Said another way, would having these capital reserves protect the taxpayer? The borrower? The integrity of the FHA program?

  36. I am of the opinion that capital reserves are no better at protecting the borrower, taxpayer and FHA program integrity than adequately established coverage via surety bonds. The honorable MBB will live with whatever the FHA decides. What is upsetting to me is the self serving and veiled nature of the approach by the listed lender groups. I am tired of hearing the, “skin in the game,” argument as well. Lenders, Banks & Wall Street all had skin in the game. They then proceeded to systematically rip it off of each other via SIV, CDO’s and other securities vehicles of mass destruction. I love how Pimco’s Bill Gross refers to it as, “Shadow Banking.”

  37. Wow! I was surprised to hear that FHA had higher defualts then subprime? FHA should have put in place higher standards 2 years ago to prevent forseen issues of today. I agree it’s about the ability to repay the loan not just qualify for it.

  38. I don’t have actual stats but I’m betting FHA market share two years ago was in the dumper. They absolutely had higher standards than that of some of the crazier sub primers out there.

  39. Good to learn something about FHA loans from this article. I am not a trained FHA loan originator so I have never dare to take any FHA loan customers. Need more education on this.

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  41. I am not familar with FHA. It was good to read more about it. I would need more education also to take any FHA loan cusomers.

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