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Why FHA Loans Are Becoming More Important

by Peter G. Miller
February 9th, 2010

S&P announced today that it was downgrading both Citigroup and Bank of America from “stable” to “negative.”

“The outlook revision reflects our increased uncertainty about the U.S. government’s willingness to provide additional extraordinary support to highly systemically important financial institutions in a way that benefits debt holders,” said Standard & Poor’s credit analyst John Bartko in reference to the Bank of America. “We previously stated our belief that the extraordinary support was temporary. We believe markets are beginning to stabilize and the U.S. government is seeking ways to reduce the potential for moral hazard and systemic risk associated with large financial institutions.”

Well, okay, what does this have to do with someone who wants an FHA mortgage?

First, there’s the matter of size. Citigroup and Bank of America are enormous.

Second, Citigroup and Bank of America are major players in the mortgage game. In December, for example, the Making Home Affordable program reported that Bank of America had more than 1 million mortgages which were at least 60 days late, while Citimortgage has almost 242,000 late loans.

Third, if you’re the government you want big companies selling FHA loans because they can do business in big volumes. Big volumes can give you economies of scale, especially when the loans are properly underwritten.

Turning To The FHA

If you look at what the big lenders have been doing during the past few years you can see where they’re headed: more FHA mortgages.

The increasing role of the FHA mortgages is inevitable.

Think about it: What lender still wants to make option ARMs? How about interest only loans? Piggy back financing? How about loans without full documentation?

Essentially all the “nontraditional” mortgage concepts introduced and flouted during the past few years are dead. They were absurd notions to begin with and no lender with any sense wants to raise them again.

New Goals

Instead the new goal is less mortgage risk if not zero mortgage risk and you can’t have less risk as a lender than with FHA financing. All you have to do is underwrite loans according to the guidelines and you’re home safe.

This new trend explains several items in the news.

Have you noticed that you increasingly hear about lenders being dumped by the FHA? The reason for the government’s new vigilance is that not only do lenders want less risk so does the FHA. Lenders who don’t play by the rules set up by the FHA are out.

Have you also noticed news reports about the suddenly tougher standards now required for FHA loans? Some of those standards are coming from the FHA (think of higher up-front premiums) but most are actually coming from private lenders who want to make sure they’re comfortably within FHA guidelines.

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