The Problem With FHA Loans
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It is feared that the highly anticipated and long awaited legislation covered in the bill ‘Restoring American Financial Stability’ which is being championed by Senator Chris Dodd may fall short of completing it key functions if the government’s central function in the home loan field is not properly rectified.
Hopes were high that while the focus of the deal would be on setting tougher guidelines for the mortgage market and that it would be primarily aimed at reforming the financial industry there would also be an attempt to move away from the state programs which are seen by many as being an integral part of the whole problem to begin with.
What has now come to light is that the bill is not going to make any allowance for the huge number of home loans covered by the FHA, or Federal Housing Administration. The number of home owners paying back mortgages under the FHA scheme has actually increased since the crisis began to bite. The percentage of mortgages administered under this scheme went up from around 27% in 2007 to 30% in 2009. The amount of disbursements shot up by over 80%, to well over $300 billon, in just a year.
Just when we are beginning to get over the shock waves caused by the subprime deals there is now the worry that these FHA mortgages may have a similar effect in the long term. These government backed loans usually give lower rates and require lower down payments than those offered by banks and other traditional lending institutions.
Many top banks ask for a down payment of 20% and then give a fixed rate of just over 5% on a 30 year mortgage. Turning to FHA mortgages, the down payment needed drops to just 3.5% and the rate to comfortably under 5%, a saving of around 0.40% when compared to other financial institutions is not uncommon.
Although the MIP, mortgage insurance premium, needed on all FHA mortgages means that the overall cost is usually higher than with a bank operated loan in some cases the FHA loan is actually cheaper overall. Even when it is not cheaper over the whole term many potential borrowers are unable to resist the lower down payment needed.
Part of problem can be traced back a Federal Housing Act from 1992 which forced Fannie Mae and Freddie Mac to make mortgages more affordable and accessible even if meant that they did not make much money on the loans.
This important change in strategy led to many riskier mortgages not just being approved but being given low repayment rates as well. While this incentive undoubtedly increased the levels of home ownership among the lower paid and in less wealthy areas it has also played a large part in the housing market crisis. If the new bill does not look at reducing at the attractiveness and accessibility of the FHA backed mortgages then this problem could turn out be the next crisis.