Should FHA home loans be more expensive?

The federal mortgage insurer's reserve fund has slipped below its mandated minimum. Now the FHA and some lawmakers want to raise up-front costs for borrowers.

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By Les Christie, staff writer

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NEW YORK ( -- Should it be more expensive to get a mortgage insured by the Federal Housing Administration?

That is the question the House Financial Services Committee examined on Wednesday afternoon.

Currently, FHA loans comprise more than 30% of the entire home-loan market. But as some of those insured loans have defaulted, the FHA loan-guarantee fund has slipped below the Congressionally mandated 2% level. As a result, some lawmakers are suggesting that FHA loans need to be more expensive to obtain.

In fact, a House bill, the FHA Taxpayer Protection Act of 2009, would increase the minimum down payment required to obtain an FHA loan to 5% from 3.5%. That, sponsor Rep. Scott Garrett, R, N.J., believes, would make borrowers more committed to maintaining their mortgages.

Almost 90% of FHA purchase loans issued between January and August 2009 had loan-to-value (LTV) ratios of 96 or higher, according to written testimony from Robert Story, chairman of the Mortgage Bankers Association. That amounts to a very small commitment on the parts of buyers.

Housing and Urban Development secretary Shaun Donovan's testimony said he is committed to raising the expense of borrowing, though the agency is still exploring the best options and doesn't necessarily support raising the down payment requirement.

"We have made the decision to exercise our authority to increase the up-front cash that a borrower has to bring to the table in an FHA-backed loan -- to make sure that FHA borrowers have more 'skin in the game' and a stronger equity position in their loans," he said.

Still, he added, "FHA is not 'the next subprime' as some have suggested."

He disputed Garrett's statistics that tried to make the case for increasing down payments. Garrett said that FHA mortgages with loan-to-value ratios of 100 were twice as likely to fail as those with LTVs of 95.

Donovan responded that many of those failed 100 LTV loans involved seller-supported down payment programs, which contributed disproportionately to delinquencies. Last year Congress prohibited those programs.

Donovan outlined three options for raising borrowers' skin in the game: Increase the down payment requirement, currently at a minimum of 3.5%; raise the up front premium insurance premium from 1.75% to as much as 3%, which the FHA already has the authority to do; and decrease the allowable seller concessions for closing costs, which are now 6%, to 3%.

Critics of increasing the up front borrowing costs claim it's both unnecessary and could imperil the weak housing market recovery.

"While the program is experiencing shortfalls in its excess reserves due to our economic crisis, FHA remains financially strong and a critical part of our nation's economic recovery," said Vicki Cox Colder, president of the National Association of Realtors, in her written testimony before the committee.

Besides, she added, "It is important to recognize that this is not FHA's only reserve fund. FHA also has a Financing Account separate from the Capital Reserve. FHA's actual total reserves are higher than they have ever been with combined assets of $30.4 billion. This is an increase of 13% over the previous year."

Outlined problems

Donovan acknowledged problems at FHA, including antiquated systems and equipment and inadequate personnel numbers.

"Little of this may have been obvious when FHA's market share was 3% as recently as 2006," he said in his statement. "But when our mortgage markets collapsed last fall, and homebuyers increasingly turned to the FHA for help, the potential consequences of these lapses in risk management became very clear."

The agency has acted to lower risk over the past several months. It hired a chief risk officer to improve risk assessment; increased enforcement efforts that resulted in suspending some lenders and withdrawing FHA-approval for many others; and strengthened underwriting, including instituting procedures that should improve appraisal accuracy.

One measure Donovan seems loath to take is to establish risk-based pricing. He politely debated Representative Randy Neugebauer, R, TX, on the issue. Neugebauer questioned why FHA doesn't charge borrowers with low FICO scores higher rates, since they are at higher risk of default.

"Charging more [for those with lower FICO scores] is not necessarily the answer," said the HUD secretary. "It could even work against it by making it harder for the borrowers to pay off their loans."

Besides that, Donovan expressed a real reluctance for the idea of FHA becoming an even bigger player in the mortgage market than it is now. Raising prices for borrowers with low FICO scores and lowering them for those with high scores could put the FHA in direct competition with private lenders for the lower risk borrowers.

FHA -loan risk has also declined, some industry analysts believe, thanks to the drastic improvement in the quality of borrowers it services. According to Keith Gumbinger of HSH Associates, a publisher of mortgage industry information, their average credit score has jumped to 693 from the low 600s two years ago.

Janis Bowdler, a director for the National Council of La Raza, a Hispanic civil rights organization, said, "According to the FHA, had loans not been made using seller down payment assistance programs, known for being a haven for fraud and abuse, its capital reserve ratio would still be at the recommended 2%."

She emphasized how important affordable FHA loans are to the minority community, which accounts for a much larger share of these mortgages than the greater mortgage market.

More prudent approach

Ann Schnare, a partner with Empiris, an economic consulting firm and a veteran mortgage industry figure, said she thinks the agency could take a few small steps, like increasing the down payment requirement, to ensure the account's viability.

"While FHA borrowers are required to put 3.5% down, they are also allowed to finance the up-front premium and a portion of their closing costs," she said. "The net result is that many FHA borrowers are in a zero or even negative equity position the moment they move into their homes. This dramatically increases the risk of foreclosure, particularly in a bad economic environment and a weak or declining housing market."

She also recommends an slight increase in monthly insurance premiums to build up the reserve fund.

Donovan said stepped up enforcement itself could help restore the Capital Reserve Account. Most of the projected losses over the next five years, 71%, will come from loans already on the books. Many of those loans were of poor quality due to negligence on the part of lenders.

He wants to go after those lenders to make them responsible for the losses the FHA suffered. To top of page

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