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Growing Concern Over FHA Cash Reserves

by Karen Lawson
September 18th, 2009

The Wall Street Journal reports that the FHA’s reserves could fall below the amount mandated by Congress, and cites mortgage related losses as the cause of this problem. The looming potential of another taxpayer bailout is alarming, but FHA provides essential services for  first time buyers and low and middle income Americans unable to qualify for conventional mortgage loans or refinancing

In recent months FHA, which is an agency of the US Department of Housing and Urban Development, has upped its market share of single family mortgage loans due to the demise of sub-prime lenders and ”exotic mortgage loans that contributed to last year’s mortgage crisis. FHA’s market share was approximately 23 percent as of the second quarter of this year, compared to a paltry 2.7 percent in 2006; this demonstrates how FHA is filling the niche vacated by sub-prime and “easy credit” lenders.

FHA Dilemma: How to Boost Reserves?

FHA administrators state that they’re only required to report any shortfall, and don’t have to take further action. Edward Pinto, a former chief credit officer at Fannie Mae, may speak from experience: “…I’ve never seen an entity successfully outrun a situation like this.” Mr. Pinto also notes FHA’s added risk due its “making loans in a riskier environment.”  Riskier indeed. FHA reports mortgage defaults of 90 days or more at 7.8 percent during the second quarter of 2009;  year ago, the default rate for loans 90 or more days delinquent was 5.4 percent.

Meeting America’s Housing Needs Without Another Bailout

The financial industry has promoted homeownership as the “American Dream,” and many of us have a sense of entitlement when it comes to owning a home; we see it as a true mark of success. FHA mortgage loans provide fixed rate financing  with low down payments at reasonable rates; their main drawback is the mortgage insurance premiums that must be paid up front and annually. Borrowers typically add the up-front mortgage insurance premium (UFMIP) to their loan amounts, and then pay an annual premium of approxomately one half percent of their mortgage balance annually until their loan to value ratio reaches 78 percent or less. Increasing mortgage insurance premiums would likely discourage buyers from FHA mortgages and decrease its market share.

Although FHA administrators appear confident that they can avoid a shortfall of reserves, it also seems likely that they may have to make some changes to reduce risk. Higher down payments? Tighter credit standards? Requiring  larger down payments could help reduce the FHA’s exposure due to declining home values; and tightening credit requirements and mandating homebuyer education programs could help reduce mortgage defaults.

Taxpayers aren’t likely to support another bailout, and FHA provides an essential role in expanding accessibility to homeownership, and in the recovery of US housing markets. So what’s next?

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