Do More FHA Loans Equal More Risk?

by Peter G. Miller
December 2nd, 2008
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With the enormous increase in FHA activity one has to ask: Should this be a cause of worry?

Home prices, after all, are falling nationwide. Financing homes with declining values means the lender — or lender’s insurance plan — has less security than one might wish. Indeed, figures from the latest S&P/Case-Shiller Home Price show that home values in 20 major metro areas have dropped 17.4 percent in the past year.

Combine plummeting home values along with the latest report from the Mortgage Bankers Association showing that government-insured loans, meaning mostly FHA mortgages, now represent about a third of the market and a little worry is not unreasonable.

If we were talking about the “affordability” loan products or “nontraditional” mortgages issued by lenders during the past few years there would be good cause to be apoplectic. With FHA mortgages the situation is different: The idea is not that there is no risk, rather such risk which exists with FHA mortgages is within the realm of reason.

Here’s why:

First, all FHA loan applications are boring, fully-documented and verified. No guesses regarding income, no foggy claims of employment. Either borrowers have what they claim or they get declined.

Second, all properties newly-financed with an FHA loan are appraised by an actual human who physically inspects the property.

Third, FHA loans require 3.5 percent down. This is not much, but it’s better than nothing down and means the government has some cushion — though not much the way values are dropping in some markets.

Fourth, to its credit, HUD has a strong record of trying to help borrowers avoid foreclosure. This is good both for borrowers and for the FHA program because it reduces claims.

The view here is that every FHA loan should be seen as reducing marketplace risk.

The reason is that as a country we are about to enter a terribly-difficult period. If we get by with a deep recession we will be incredibly lucky, if “lucky” can ever be the right term when many people lose both their jobs and homes because of bad times.

The value of FHA loans in the midst of such economic chaos is that they are, at least, reliable. FHA mortgages have no surprises, no fake inducements, no prepayment penalties, no sudden cost spikes. For those on the cusp of failure, it makes sense to keep paying that FHA mortgage because there’s no better deal out there.

Every toxic loan replaced with an FHA mortgage is a “win” for financial common sense and a benefit for us all because the potential for foreclosure is reduced. At a time when there’s not much in the way of happy economic news, such an advantage should not be underestimated.

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