Number of Defaults Growing on FHA-Backed Mortgages
Saturday, January 24, 2009
The default rate for mortgages recently insured by the Federal Housing Administration has been climbing, an alarming trend for an agency that is playing a vastly expanded role in the mortgage market and backing roughly a quarter of all the loans made last year.
About 4.31 percent of the FHA-insured loans made in the two years ending Dec. 31 were at least 90 days late, according to the most recent update of an FHA database designed to help the agency detect problems with its lenders and programs. That's the highest in any two-year period since at least 2005.
On a monthly basis, FHA defaults have been rising since summer, according to the Department of Housing and Urban Development, which includes the FHA. Not all defaults result in foreclosure.
The lackluster performance comes at a time of increased scrutiny of the FHA by federal policymakers, some of whom question whether the agency can handle its soaring volume of loans and properly vet the lenders who are making them.
Although the FHA is a government agency, it has been self-sustaining since its creation in 1934, meaning no public money has been used to cover its losses. The mortgage insurance paid by the homeowners go into a fund that provides backing on mortgages made by FHA-approved lenders.
The FHA estimates that its share of new-mortgage dollars exploded from 2 percent in 2006 to 25 or 30 percent last year.
Demand for these mortgages has surged because they do not require the hefty down payments or stellar credit scores that lenders have come to expect from borrowers. In addition, the amount of money people can borrow with FHA-backed loans went up dramatically last year, and many borrowers have found them attractive for refinancing.
In a written statement responding to questions about the rise in defaults, HUD said it "has taken note of the situation and is monitoring it closely." The statement said HUD is working with lenders "to manage the increase in defaults, with the goal of providing more loan workout-assistance to as many borrowers as possible."
Several experts who track the agency attribute the rise in defaults to a batch of bad loans made in 2007, when the subprime market was faltering and borrowers with spotty credit were shoehorned into FHA loans instead.
Of the 1.78 million FHA loans made in the past two years, more than 1 million were originated in 2008, agency data shows.
Given that mortgages typically do not suffer a high default rate in their first year, that suggests that the loans issued in 2007 are "a significant problem," said Brian Chappelle, a banking consultant and former FHA official.
Lenders have since cracked down on which borrowers they qualify for FHA loans and have imposed restrictions that go beyond FHA requirements, including decent credit scores, said Dave Stevens, president of real estate firm Long & Foster, which has a lending affiliate.
"The lenders are protecting themselves now," Stevens said. HUD agrees, adding that restrictions in the market have resulted in better quality loans coming to the FHA. Because of that trend, Chappelle and Stevens say they are optimistic about FHA's future.
Others are less convinced.
"It confirms the fear that FHA, as the lender of last resort, is getting the debris of the mortgage system," said Howard Glaser, a consultant and former HUD official. "They're suffering adverse selection. . . . They're totally reliant on lenders to protect taxpayer interest in FHA."
The FHA insurance fund remains above the point where taxpayers would need to kick in money to cover defaults. But it is shrinking. As of Sept. 30, the fund had an estimated $12.9 billion, a 39 percent drop from $21.2 billion a year ago, according to a recent independent audit.
The $12.9 billion represents 3 percent of the mortgages insured by the FHA. That's above the 2 percent ratio required by law, but below the 6.4 percent at the same time last year. The audit concluded that the 2 percent threshold is "barely maintained" and the ratio could dip below that soon if worst-case scenarios are factored in.
James A. Heist, assistant inspector general for HUD, detailed additional challenges for the FHA at a recent House hearing: antiquated technology, its inability to hire more staff due to lack of funding, and the strain it faces in properly overseeing the growing number of FHA lenders. "FHA may not be able to handle its expanded workload or new programs that require the agency to take on riskier loans," he said.
The biggest problem facing the FHA and the lenders it works with is the fallout from plunging home values.
If home prices keep dropping, more borrowers will be vulnerable to foreclosure because they will owe more than their homes are worth. A financial blow, such as job loss, will make them more likely to default, because they won't be able to sell or refinance.
Of all the loans the FHA backed in the past two years, the ones deteriorating most rapidly are the ones used to refinance. Defaults on those loans shot up to 4.38 percent from 3 percent, overshadowing defaults among loans used to buy new homes. Defaults on loans used to purchase existing homes improved, dropping to 4.01 percent from 4.57 percent.