The FHA's balancing act

by Dina ElBoghdady

The Federal Housing Administration lost relevance in the first half of the decade when home prices soared and borrowers turned to easy-to-get subprime loans with lower upfront costs. But as the mortgage market unraveled, borrowers flocked back to the FHA. The agency does not make loans. It insures qualified lenders against losses if borrowers default. Since its creation in 1934, it has collected fees from its borrowers to pay lenders for loans gone bad. In the past year and a half, FHA-insured loans made up roughly 30 percent of all new single-family home purchase mortgages — up from 3 percent in 2006 — and about 20 percent of new refinancing deals.

But as the agency's loan volume expanded, its default rate shot up. The cash reserves the FHA has set aside to pay for unexpected losses have eroded to dangerously low levels. If FHA funds are depleted, taxpayers would have to come to the rescue for the first time in the agency's history. The agency is now trying to protect itself against risk without undermining its key role in propping up the housing market. To that end, the FHA has tightened some standards while loosening others. Here are some of the changes underway.

The changes on FHA loans and how they will affect borrowers and sellers
Recent Changes
Upfront insurance premium

What is it? A fee the Federal Housing Administration collects from borrowers that can be paid in cash at the closing table or rolled into the loan.

What's changed? The FHA raised the premium earlier this year from 1.75 percent of the loan's value to 2.25 percent.

Why? The money will replenish the funds FHA uses to compensate lenders for default-related losses.

How does this affect me? If you take out a $300,000 loan, you will now pay $6,750 in premium instead of $5,250. If you roll the premium into the financing, you will also pay interest on it during the life of the loan.

Cash-out refinancing

What is it? Refinancing a mortgage for a higher amount than is owed on the loan and taking the difference in cash — in effect, pulling equity out of the house.

What's changed? Borrowers can tap up to 85 percent of the home's current value. Previously, they were allowed to take up to 95 percent of value.

Why? Borrowers can tap up to 85 percent of the home's current value. Previously, they were allowed to take up to 95 percent of value.

How does this affect me? Cash-out deals have become tougher to find. Even with conventional loans, many lenders offer this type of financing only to people with top-notch credit and significant equity.

Flipping

What is it? The practice of buying a home and quickly reselling it for a profit.

What's changed? On Feb. 1, the FHA suspended a policy for one year that banned FHA borrowers from buying a home if the seller had owned it for less than 90 days.

Why? The goal is to encourage investors to buy poorly maintained foreclosures, fix them up and sell them to FHA buyers as soon as they hit the market. This in turn should help clear the glut of homes for sale.

How does this affect me? This opens up a wider range of properties to FHA borrowers. But inspections must be done to determine whether the home is in working order. If the price of the home is 20 percent higher than what the investor paid, a second appraisal is required to determine whether the increase is justified.

Condominium spot approval

What is it? To purchase a condo in a building that is not FHA-approved, FHA borrowers had to receive "spot approval" for the unit. The process required the condo's management to fill out a questionnaire addressing the agency's must-meet conditions.

What's changed? The agency eliminated spot approval earlier this year. Now, any condo buyer with an FHA loan must stick to an FHA-approved building. A lender, developer/builder, homeowners association or management company can submit a package to the FHA seeking approval. The change was part of a broader initiative to tighten FHA condo policy. Some elements of that initiative have been temporarily loosened through Dec. 31 to try to stabilize the condo market.

Why? Condos are widely considered the market's shakiest segment because they are popular with speculators and financially vulnerable entry-level buyers. A lot of foreclosure-related losses have come from condos, which is why industry policies have forced lenders to look more closely at the makeup of entire complexes before extending loans.

How does it affect me? As part of the temporarily loosened guidelines, the FHA will insure the loans on up to 50 percent of the units in a condo building, though it will back 100 percent if a project meets certain criteria. At least 50 percent of the units in a project must be owner-occupied or sold to owners who plan to occupy the units. As for new construction, 30 percent of the units must be pre-sold before an FHA loan can be financed there.


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