FHA: The Balancing Act Between Risk and Accessible Home Loans

by Karen Lawson
December 18th, 2009

As its reserves verge on disappearing, FHA must weigh solutions for reducing risk with its purpose of providing affordable home loans to low and moderate income borrowers.

In 2006, FHA loans accounted for about 3% of the US mortgage market; today, the FHA market share is approximately 30%. In the interim, FHA reserves have fallen below the mandatory level of 2%. Critics argue that FHA has taken over the role of sub-prime lender in the wake of the wave of foreclosures caused by uninformed and perhaps unqualified borrowers taking out home loans with non-conforming terms that they didn’t understand and couldn’t afford. FHA denounces such criticism, pointing out that the average credit scores of borrowers of FHA loans have increased from the low 600′s to the 690′s in the last two years. Lawmakers and HUD officials are considering three primary remedies for raising HUD’s rapidly decreasing reserves:

  • Raise minimum down payment from 3.5% to 5%: Supporters point out that FHA guidelines allow borrowers to add the up-front mortgage insurance premium (UFMIP) and some closing costs to their loan amounts; with minimum down payments, this leaves the homeowner with very little equity in his or her property.
  • Increase mortgage insurance premiums: There is talk of increasing the monthly portion of the FHA mortgage insurance premium, but this would increase borrowers’ monthly payments. It seems logical to assume that raising payments places more of a financial burden on borrowers during tough economic times.
  • Adopt risk-based pricing on mortgage rates: Conventional mortgage lenders determine mortgage rates based on borrowers’ credit worthiness, down payment amount, and other factors. HUD secretary Shaun Donovan is reluctant to adopt this option. stating that “it could make it harder for borrowers to pay off their loans.”

Founded in 1934, the Federal Housing Administration (FHA) became part of the US Department of Housing and Urban Development (HUD) in 1965. By insuring mortgages for single and multi-family homes, FHA has provided an alternative to strict credit guidelines and hefty down payments required for conventional mortgages. Although FHA is self-funded, watchdogs worry that another taxpayer bailout could be needed if HUD’s reserves aren’t replenished.

Raising Down Payments and Mortgage Insurance: Impact on Housing Recovery?

Raising down payment requirements and mortgage insurance premiums may disqualify some borrowers otherwise capable of making their mortgage payments. FHA is also cracking down on its approved lenders that don’t follow FHA guidelines. It seems more effective to weed out negligent lenders than to drive away home buyers depending on FHA mortgage loans when US housing markets are only starting to show signs of recovery.

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