Late FHA loans spike 62% - but it's not as bad as it sounds

NEW YORK (CNNMoney.com) -- The recent spike in the number of delinquent Federal Housing Administration-insured loans has some people worried that taxpayers will eventually have to bail the agency out.

Seriously delinquent FHA loans, those 90 days or more late, jumped 62.1% in the past year to 558,944, or 9.4% of FHA loans, as of the end of January, according to agency statistics released on Friday.

The FHA, however, insists its finances are sound. Its loan portfolio actually performed better than most mortgage products, according to David Stevens, the agency's commissioner.

"The FHA default rates are increasing at a slower rate than even prime mortgages," he said.

But the reason for this increase may be more of a statistical glitch than an actual trend. Loans that go into the seriously delinquent bucket stay there far longer, boosting the numbers and making comparisons problematic, said Jay Brinkmann, chief economist for the Mortgage Bankers Association (MBA).

Many lenders and servicers are overwhelmed by sheer volume of loans and are reluctant to take back homes they don't think they can sell. As result, they keep the loans hanging out in the 90-day late bin rather than moving them into foreclosure.

Lenders are also trying to modify more mortgages, which can take months to accomplish. Meantime, many of the borrowers sit in the seriously delinquent bucket.

In contrast, loans that are 30- or 60-days late actually declined in the past year, according to the FHA.

Until the mortgage bubble burst, FHA loans made up a small portion of the housing market. Now, the agency originates almost a third of all home loans. That means most of the agency's notes were issued in the past three years -- when prices were plummeting.

"There are a lot of young loans in the FHA book," said Mike Fratantoni, vice president of Single-Family Research and Policy Development at the MBA. "Mortgages typically hit their peak delinquency rates two or three years after origination."

Those early years are toughest because many borrowers have struggled to afford their homes and their incomes have not risen enough to offset any setbacks.

Additionally, the price drops pushed many FHA borrowers underwater. These homeowners only had to put 3.5% down to start, so they could quickly end up owing more than their homes were worth in places where values plummeted 20%, 30%, 40%.

Once these mortgages clear the system, the FHA portfolio should emerge in sound condition. Recent FHA borrowers have been of high quality; their average credit score has risen 33 points in the 12 months through December to 694 and is up from the low 600s a few years ago.

Some FHA mortgages are simply bad loans. After subprime lending froze in 2007, overly aggressive mortgage originators, who could no longer hook up borrowers with subprime loans, turned to FHA loans for their risky clients.

Commission loan officers and rogue mortgage brokers pushed the envelope of who qualified for FHA loans, according to Allen Hardester, a Columbia Md.-based mortgage consultant. They pushed the edge on debt-to-income ratios, credit scores and loan-to-value ratios.

"They took advantage of lax underwriting by FHA to interpret the guidelines broadly," he said.

The resultant delinquencies have not persuaded FHA to impose risk-based pricing, in which borrowers pay more if they have lower credit scores. But the FHA does now require that borrowers with FICO scores of less than 580 put down at least 10% of the sale price, rather than the 3.5% minimum requirement for more qualified borrowers.

And the agency has also eliminated seller-assisted down payment programs, which HUD has said accounts for a disproportionately large share of FHA delinquencies.

In these transactions, sellers kick back the down payment to homebuyers, usually through a third party. The result is that buyers have no "skin-in-the-game," which makes the loans more attractive to risky borrowers.

Commissioner Stevens said the FHA is on a sound financial basis. Its primary reserve fund is at $32 billion, its highest level ever. There's a secondary reserve that has fallen below its mandated level, but the FHA has taken steps to boost it. It recently asked Congress to increase the monthly fees it charges borrowers to insure their loans.

"Given the environment, the FHA has made very responsible changes to its underwriting," said Fratantoni.