Jackson Jambalaya

Think the housing industry can't implode any further? Guess again. Now FHA defaults are skyrocketing. The Washington Post published a very good story today on this problem. Buckle your seat belts:

"This decade's housing boom rendered the agency irrelevant. Americans raced to aggressive lenders, seduced by easy credit and loans with no upfront costs. But the subprime mortgage market has crashed and borrowers are flocking back to the FHA, which has become the only option for those who lack hefty down payments or stellar credit. The agency's historic role in backing mortgages is more crucial now than at any time since its founding.
With the surge in new loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans. In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency's overall growth in new loans, according to a Washington Post analysis of federal data.....
Once again, thousands of borrowers are getting loans they do not stand a chance of repaying. Only now, unlike in the subprime meltdown, Congress would have to bail out the lenders if the FHA cannot make good on guarantees from its existing reserves. And those once-robust reserves are showing signs of stress, raising the possibility that taxpayers may have to pick up the tab for the first time since the agency was established in 1934.....
The agency's share of the mortgage market is up from 2 percent three years ago to nearly a third of the mortgages now made, its highest level in at least two decades, according to Inside Mortgage Finance, an industry trade publication. The FHA does not lend money directly. It provides mortgage insurance for borrowers working with FHA-approved lenders and uses the premiums to cover its losses. If the premiums are not enough, taxpayers could be on the hook.
At the same time, Congress has substantially increased the amount a homeowner can borrow on an FHA loan in pricey areas, thrusting the agency into markets it was previously shut out of, such as California, where plunging home prices have made people more vulnerable to foreclosure. (Kingfish note: It was increased to $721,000 in such "high-cost" areas. In Mississippi was nearly doubled to $271,000.) Moreover, lawmakers last year put the FHA in charge of a program created to address the roots of the financial crisis by helping delinquent borrowers refinance into new mortgages.
On top of all these strains, the agency now faces this swell of loans that default almost immediately. ...." FHA Defaults climbing

This should come as no surprise and is scary for several reasons. FHA requires a 3% down payment (unless you are getting funds from down payment assistance programs such as the bond money program operated by Mississippi Home Corporation.). The FHA rates for the last few years have been low, usually below 7%. The income and assets are verified, these are not "liar" loans. Despite these guidelines that should make FHA mortgages much safer than subprime, Alt-A, and Fannie Mae no-down payment loans that have exploded the housing industry, the defaults are STILL rising to very dangerous levels.

This problem does not exist because of the economy going south as there is no reason a borrower on such a mortgage should default on the first payment. Within a day or so of the mortgage's funding, the lender contacts the employer on the phone usually to verify employment just for this reason (its a standard industry practice.). The lender reviews pay stubs, tax returns, W-2's, and bank statements. There are only a handful of reasons FHA is imploding. Fraud is being committed by the lender or borrower. Sloppy underwriting practices. FHA's cashout refinances (Until recently, a borrower could get a cash-out refinance through FHA for 95% loan to value, a recipe for disaster as the default rates on such mortgages are very high.). FHA has no minimum credit score requirement (Most of the lenders have imposed their own, however.). FHA accepts "alternative" credit if a borrower has no credit history in the form of utility payments, rent payments, etc. The appraisal guidelines are not as strict as they are for Fannie and Freddie. The mortgage insurance rates are lower.

However, the pressure to use FHA programs has been great the last few years as many mortgage companies who only originated subprime mortgagees and were facing extinction obtained FHA licenses so they could pursue subprime borrowers as FHA had easier underwriting requirements compared to Fannie Mae and Freddie Mac. Some subprime lenders entered the FHA market just to stay afloat even though they lacked any FHA expertise.

One such lender was GMFS in Baton Rouge. The owners once operated United Companies and UC Lending, former subprime lenders that collapsed in a similar implosion of the subprime mortgage market in the 1990s. Undeterred, they opened another subprime mortgage lender a few years later, GMFS LLC. As subprime lending withered, GMFS received approval from HUD to become an FHA lender, thus allowing it to escape the collapse of the subprime mortgage industry. Unfortunately, GMFS's track record on the performance of its FHA loans dovetails with the assertions made in the Washington Post story about new FHA lenders contributing to the FHA implosion.

A quick review of HUD's website reveals GMFS has a "compare ratio" (How lenders compare nationally to other lenders on defaults.) of over 200%. In plain English that means GMFS has a default rate double the rate for the average lender. In comparison, Trustmark, a long-established local FHA lender (Both companies fund loans for mortgage brokers) has a rate that is a quarter of the national average. GMFS's numbers are even worse as 96 of 832 FHA mortgages went into default (90 days or more late) in the last two years (Over 11% according to HUD's Early Warning System). Trustmark was much lower: only 10 of 736 FHA mortgages went into default for the same time period, a default rate of 1.36% (See earlier post: How do local lenders compare on FHA.), demonstrating while FHA became a safe haven for subprime lenders and borrowers, it became a whirlpool of further financial destruction for taxpayers.

Subprime crashed. Mortgage lending not supported by the government is non-existent. Fannie Mae and Freddie Mac have turned into financial money pits with no end in sight. Now we are looking at another time bomb about to go off at HUD while we are wasting our money bailing out Citi, AIG, and every one else with a hand out for some dough. The whole mess is blowing up in the faces of the politicians who don't have a clue what they are facing nor what to do. Even now, some congressmen seek to pass a law making the now-banned FHA down payment assistance programs legal once more (see note below) even though the default rates are triple those for borrowers required to make a down payment. Strap yourselves in boys and girls, the roller coaster is about to give you some more thrills and excitement as the madness continues.

Earlier posts: Fannie and Freddie's Ticking Time Bomb

Note: For years down payment assistance programs were offered. Ameridream, Nehemiah, and others offered the following deal: If an FHA borrower had no money for a down payment, these programs would have the seller raise his sales price by 3.5% or so. The overage would go to these companies which then would cover the necessary down payment while holding back a fee. These were controversial for two reasons: It is argued they are artificially inflating the price of the home and the whole scheme is a shell game. The default rate is triple as stated earlier. Congress banned these programs recently yet some are seeking to reinstate them. Here is a link to an online campaign to stop their reinstatement: Stop FHA Subprime Campaign