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Will FHA Reform Create More “Exotic” Mortgages?

by Jeffrey Hogue
February 27th, 2008

Congress has still not approved legislation regarding FHA reform submitted by President Bush to Congress over two years ago. Given the length of time, and the dire need for reform in a turbulent real estate market, in a letter to Congress HUD Secretary Alphonso Jackson outlined certain provisions that he believes will better serve the FHA.

Specifically, Mr. Jackson advocated for, among other things, “flexible down payment options.” HUD clarified “flexible down payment options” to mean cutting in half the current FHA down payment requirement of 3% to 1.5%.

Now, this advocacy for more “lax” requirements for FHA loans will surely help a greater number of borrowers qualify for FHA loan opportunities. And, as HUD points out, the FHA’s core mission is “to expand homeownership opportunities to low – and moderate – income, first-time homebuyers who are underserved, or not served, by the existing conventional mortgage marketplace.” Although the reduction in the down payment requirement will “technically” serve this core mission, in the long run, does it really help low- to moderate-income first-time homebuyers? Or, does HUD’s advocated change promote and encourage financial irresponsibility, which led to the so-called sub-prime mortgage meltdown?

Reducing the FHA down payment requirement in the manner suggested by HUD will ultimately be tragic for the United States conventional mortgage marketplace. Destructive behaviors will be promoted if HUD’s suggestion is adopted by the legislature. Specifically, first-time homebuyers will, in a sense, be “enabled” to overpay for a home, or to pay for a home that they just cannot afford. Further, this legislation would provide borrowers with a higher incentive to default. With little to no “skin in the game,” so to speak, first time homebuyers simply have less to lose. With less to lose, it is easier to walk away. From a policy standpoint, any effort to reform the United States from a “debtor” nation will be undermined. During the last 20 years, in contrast to other economically competitive nations, the average American’s personal savings has gone from slim to basically nonexistent (site?). HUD’s suggested reform helps promote (rather than reverse) this disconcerting trend.

Simply put, reforming the FHA loan requirements to make it more akin to an “exotic” loan product is not the answer.

Attorney Jeffrey L. Hogue is a partner at the San Diego law firm of Hogue & Belong. Mr. Hogue is also a founder of the Mortgage Accountability Association.

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