Investors & FHA Reform: What You Need To...

As fall approached last year, we started hearing whispers of the potential need for a bailout of the Federal Housing Administration (FHA).

By December, the word “potential” started appearing less frequently next to “bailout.”

Now as 2013 begins, it seems certain FHA will need taxpayer assistance this year.

Since the housing crisis, FHA has dramatically increased its footprint in the housing market, and currently serves about one-third of all underwater borrowers. The bulk of FHA’s problems are attributed to loans made to borrowers who required down payment assistance, and the default rate for these loans is through the roof, accounting for much of FHA’s current liability.

It’s worth noting that in an environment of “recovery” taxpayers are going to take another hit, and questioning frankly whether FHA’s current situation is indicative of a recovery. A few members of Congress have actually expressed concern about the problems at FHA, and offered up solutions.

The Letter

Recently, I came across a letter from FHA Acting Director Carol Galante responding to a letter from Tennessee Senator Bob Corker.

The correspondence is illuminating, as it sheds light on upcoming reforms at FHA that housing pros should know about. But there is some inside baseball going on here as well.

Galante needs Senate confirmation to assume the permanent role of heading FHA. And it is clear by the tone of Sen. Corker’s letter that confirmation would not come without serious reform.

Galante’s response indicates a desire to reform FHA and a desire to achieve Senate confirmation. She gave in to suggestions made by Sen. Corker and is moving forward with the reform process in 2013.

Here are some of the noteworthy highlights from her response to the senator:

Minimum Credit Scores for New FHA Loans

For borrowers with a credit score less than 620, the maximum debt-to-income (DTI) ratio must be no greater than 43%.

If DTI is greater than 43% the lender must manually underwrite and provide written justification accompanied by supporting documentation.

FHA estimates this policy will create a 20% reduction in claims from borrowers with a credit score less than 620.

Reducing FHA Market Share

This reform will initially concentrate on loans greater than $625,500. FHA will require a minimum 5% down payment and higher mortgage insurance premiums. The strategy is to drive more of these loans into the private market.

Access to FHA Loans after Foreclosure

FHA is extremely concerned about the perception that homeowners who went through foreclosure can automatically qualify for FHA-insured financing after three years. FHA will increase enforcement action on lenders creating this perception in 2013. FHA is sending notice that previously foreclosed borrowers must demonstrate improved credit and meet all underwriting guidelines.

FHA will also collect data in order to study whether foreclosed borrowers who suffered a one-time financial crisis (lost their job, for example) perform better the second time around.

They are also introducing a new housing counseling initiative aimed at a variety of borrowers, but will have a specific concentration on borrowers with a prior foreclosure.

Reverse Mortgages

Declining home prices and increasing life spans have been major factors in losses for FHA’s reverse mortgage program. Another risk has been the lack of a secondary market.

Combining these facts, FHA has decided that the increases in risks for FHA and borrowers is unacceptable, and thus will introduce new rulemaking to reduce the risks associated with the reverse mortgage program.

On the table will be new financial assessments for borrowers, the creation of set-asides for payment of taxes and insurance, and the elimination of the use of the Fixed Rate Standard program.

Anti-Flipping Waiver

In addition to these reforms, investors should already be aware that the FHA anti-flipping waiver has been extended through 2014. The waiver allows for FHA to insure mortgages for flips in less than 90 days under the following conditions:

All transactions must be arms-length, with no identity of interest between the buyer and seller or other parties participating in the sales transaction;
In cases in which the sales price of the property is 20 percent or more above the seller’s acquisition cost, the Waiver will apply only if the lender meets specific conditions, and documents the justification for the increase in value; and
The Waiver is limited to forward mortgages, and does not apply to the Home Equity Conversion Mortgage (HECM) for purchase program.

We’ll continue keeping our ears and eyes wide open on these issues, and helping our investor community stay on top of what matters most.