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The FHA “Reforms” That Could Have Been

by Peter G. Miller
June 16th, 2010

With the passage of the 2010 FHA Reform Act in the House, it might be good to remember that such legislation is an alternative to what was proposed — and actually what passed — four years ago.

The 2010 proposal gives the FHA the right to increase the annual mortgage insurance premium from .55 percent to 1.5 percent. The legislation also gives the FHA more ability to go after lenders who originate FHA loans through the use of fraud and misrepresentation.

But, FHA “reform” could have been very different. In 2006 the House of Representatives passed The Expanding American Homeownership Act (H.R. 5121) on July 25 with a vote of 415 to 7. The measure failed in the Senate.

Good thing.

The 2006 Reform Proposal

Under the 2006 proposal, the FHA down payment would have been cut to zero and loan terms could go as long as 40 years. There would be risk-based mortgage insurance premiums — the better your credit, the lower your cost, the worse your credit the higher your cost.

In effect, the sensible financial standards demanded by the FHA before insuring a loan would have been lost.

Imagine where we would be today if such proposals had passed?

The number of FHA foreclosures would soar because large numbers of borrowers without down-payment money would have been able to finance houses. These additional buyers would have enlarged the number of purchasers in the marketplace, meaning that there would be more competition for property and thus higher property values. Combine higher property values with less equity and little savings and buyers would have little reason to keep their homes — they would simply be foreclosed or walk away, as are many toxic loan borrowers today.

Of course, it would be the FHA that was insuring such loans. The cost to the FHA is basically represented by the amount insured less the remaining sale value of the property. Since borrowers under the 2006 plan would have had smaller down payments the FHA would have had a larger loss per property and more properties with losses because of the no-down-payment option. The impact on the FHA reserves would have been impressive. Not good, but impressive.

Toxic Loans

The reason for the 2006 proposals was to make the FHA more like the toxic loans which were so popular at the time. In 2005 FHA loans represented just 4.08 percent of the market, a penetration which fell to 3.77 percent in 2006.

In reality, the 2006 reforms would have ended the FHA program. The big competition faced then by the FHA mortgage program were option ARMs and interest-only mortgages. If you want to have some fun, call up your nearby friendly lender and ask if you can get one of those loans today. Option ARMs are today about as common as love for BP, while new standards for interest-only loans make them implausible financial choices for virtually all borrowers.

As usual, when someone mentions the term “reform” it’s a good idea to read the fine print, to see what’s being changed — and to see who really benefits.

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