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Increasing FHA Home Loans: A New Housing Crisis?

by Karen Lawson
October 14th, 2009

US lawmakers have noted the rapidly increasing number of FHA loans, and wonder if it could represent heightened risk to FHA’s dwindling reserves, and ultimately, taxpayers. With the demise of sub-prime lending, FHA has become the primary source of home loans for people with bad credit, and borrowers who have minimal cash for meeting down payment and closing costs. In 2007, FHA home loans accounted for about 6% of US home loans, but so far in 2009, FHA home loans account for more than 21% of US single family mortgage loans.

Perceived FHA Home Loan Risk Concerns Lawmakers

In response to FHA’s expanding role in guaranteeing home loans for cash-strapped and credit-challenged borrowers, lawmakers are concerned about the rising delinquency and foreclosure rate for FHA home loans. The delinquency and foreclosure rate for FHA mortgages has increased from 5.5% in early 2006, to about 8% at the end of June 2009. Reasons for concern over growing FHA exposure include:

  • FHA loans for people with bad credit: FHA offers more lenient credit requirements compared to underwriting requirements typical of conventional mortgage lenders. Although FHA guidelines have recently been tightened, increasing delinquency and foreclosure rates pose a threat to FHA’s reserves for reimbursing mortgage lenders for losses associated with foreclosure.
  • Low down payment requirement: FHA allows a minimum 3.5% down payment; this could soon increase to 5%. Conventional mortgage lenders typically don’t accept less than 1% down, and may require no less than the traditional 20% down payment for people with anything less than a perfect application. Lower down payments allow people of moderate income to achieve home ownership, but critics suggest that homeowners with little investment in their homes may be more inclined to walk away when problems arise. FHA’s growing home loan delinquency rates appear to substantiate this concern.
  • Been there, done that:Lessons from the sub-prime crisis suggest that owning a home is a financial responsiblity that many are not prepared to handle. Homeowners who can still make payments have asked why those in trouble should be bailed out by government sponsored programs. As an agency of the federal government, FHA risks potential public backlash if its lenient lending policies lead to higher foreclosure rates and a cash bailout should its reserves disappear.

As FHA adjusts its lending requirements to achieve optimum risk management, it must also consider its niche of providing accessible home financing to people of moderate income, and yes, even people with credit problems. Recent economic conditions render everyone vulnerable to bad credit; many of us are but one layoff or medical emergency away from deciding whether to buy groceries or pay medical bills, credit cards, or even our mortgage.

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