FHA “Submarine” Loans: How Far Underwater is too Far?

by Karen Lawson
March 9th, 2010

A study conducted by economists from New York University asserts that FHA may be understating its risk associated with home loan delinquencies. This risk, if not managed appropriately, could lead to the FHA needing a taxpayer bailout. Concerns have been mounting since FHA reserves fell below the legally mandated level a few months ago. If FHA is forced to request additional funds from Congress, it will be the first time in its 75 year history.

Depressed Housing Markets, Unemployment Adding to FHA Risk

Although FHA contends that it would not need a bailout if housing markets were to sink to catastrophic lows. Anyone owing more on their mortgage loans than their homes are worth might wonder if we aren’t already near the bottom of the housing market barrel; with unemployment rates hovering near 10% and many workers accepting part time positions or jobs that they’re over qualified for, the ongoing risk of mortgage defaults continues to be at the forefront of critics’ concerns.

While FHA estimates that about 6% of its home loans may be at 115% or more of home value, the recently released economic study suggests that this rate may be as high as 14% of FHA home loans. The economists cite areas where high rates of unemployment prevail; homeowners who have little home equity are generally believed to be less likely to work at keeping homes they cannot afford. Concerns about underwater mortgage loans are even more pressing with FHA streamline refinancing, a program that allows borrowers to refinance existing FHA mortgage loans using new FHA refinance mortgage loans. The study estimates that about one third of streamline refinance mortgages during 2009 were underwater, but FHA calculates the number of underwater streamline refinance mortgage loans at about 1.5%. Whatever the actual number of underwater loans, the potential risk associated with them likely cannot be accurately measured due to variable factors including homeowner motivation, modification and loss mitigation programs, and changing housing markets.

Mortgage Lenders Slow Response Increases FHA Exposure

A major issue for homeowners who are underwater on their mortgage loans is their inability to sell their homes unless mortgage lenders are willing to accept the proceeds of a short sale. Homeowners are complaining about mortgage companies’ slow response to their requests for help. Caught between lawmakers’ concerns, meeting the needs of struggling homeowners, and mortgage loan servicing companies overwhelmed with requests for help. FHA must find a way to minimize its current and future risk exposure without significantly reducing access to home loans for borrowers depending on FHA mortgage loans.

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