FHA to Become Watchdog on Strategic Defaults?

by Karen Lawson
June 15th, 2010
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As part of a legislative bill being debated in the US House of Representatives, FHA is being asked to find solutions for controlling so called “strategic defaults.” Strategic default occurs when mortgage borrowers walk away from mortgage loans they are capable of paying. This typically occurs in areas where home values have steeply declined, leaving homeowners to pay mortgages of significantly more than their homes are worth.

FHA Mortgage Loans Not Available to Borrowers who Strategically Default

A proposal in the bill (HR5072) would make borrowers with a strategic default on their records ineligible for new FHA home loans. In a recent editorial, the LA Times notes that FHA has traditionally played a small role in housing finance, and asserts that prohibiting strategic default borrowers from qualifying for FHA mortgage loans is little more than a slap on the wrist. This may not be accurate as FHA is currently insuring about one third of new home loans; given current market conditions, there is no immediate reason to expect FHA to lose its market share immediately. The issue of strategic defaults may be best addressed by expanding programs for reducing mortgage amounts on homes that are 20% or more in excess of a home’s current value.

FHA Unlikely to Discourage Those Walking Away

Unfortunately for FHA, mortgage lenders, and conventional mortgage insurance companies that absorb losses on foreclosures, those who elect to walk away from their mortgages don’t appear to care that their credit scores and ability to qualify for home loans can be seriously impacted. FHA guidelines currently don’t allow borrowers who’ve had a foreclosure within three years prior to applying for an FHA loan to qualify, so how is a new proposal going to convince “walk away” homeowners that they’re going to suffer any consequences that don’t already exist?

Mortgage Loan Loss Mitigation Programs: A Ton of Prevention…

FHA is proactive in encouraging FHA approved lenders to prevent mortgage loan defaults in any number of ways, but there is a huge hole in mortgage lenders’ arsenal of foreclosure prevention options. Writing down mortgage loans is the missing piece of the puzzle, and one that is not easily addressed due to the complex nature of secondary mortgage markets and mortgage backed investments. investors in mortgage related securities are faced wit a decision to allow mortgage loan servicing companies to reduce mortgage rates and loan balances, or suffer the losses associated with foreclosure. Their reluctance to be proactive in reducing mortgage balances in line with current home values seems counter productive, and will only add to the numbers of foreclosed homes plaguing our communities and local economies.

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