Compliance Article
12/14/2007
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It would be an understatement to say that the mortgage market has dramatically changed in the past year. With the current subprime market crisis, lenders and homeowners are once again looking to the Federal Housing Administration (FHA) to meet their lending needs. FHA products have once again become “in vogue.” This is actually quite a reversal from the past few years when the number of FHA originated mortgages had been on the downswing. By 2005, FHA loans accounted for only 6 percent of originations in the market, down from 19 percent in 2001. In contrast, over the same period, the subprime market share climbed from 5 percent to 14.5 percent. It is an interesting twist that the current chaos in the subprime market is now one of the key ingredients driving the popularity of FHA loans.
What exactly are the factors that have lead to this resurgence? There are really two overriding themes at work. Historically, the FHA has stepped in to promote homeownership and stabilize the housing market in times of crisis. This crisis is no exception. Outdated products and processes, arguably one of the key reasons FHA lost market share, have also begun to be addressed through both internal and legislative reform.
History of FHA
The FHA was created during the height of the Great Depression. At that time, homeownership was a difficult prospect, forcing 60 percent of the US into renting. One of the primary objectives in the creation of the FHA was to promote and increase homeownership. Over the years, FHA has continued to follow this founding objective. In the forties, the FHA provided funding for military housing and financing to returning veterans. In the fifties, sixties, and seventies, the FHA promoted the construction of privately-owned apartments for the elderly, handicapped, and lower income families. In the eighties, the FHA stepped in to help stabilize home prices in the oil-producing states when the private mortgage insurers pulled out.
That brings us to today, where an interesting parallel exists between the market during the Great Depression and the one of today. Back in the thirties, available mortgage financing was done using short-term balloon notes and was most often limited to 50 percent of the property value. In addition, lenders were unable or unwilling to refinance many of the balloons when they became due, thus, many borrowers lost their homes to foreclosure. Because of this situation, the FHA provided a revolutionary product that served both borrowers and lenders – an insured, 20 year fully-amortizing loan that could be based on up to 80 percent of the property value. Today, many borrowers have financed their homes using Adjustable Rate Mortgage (ARM) products that keep the initial payment artificially low with short-term teaser rates. Once the loan resets to a market rate, many borrowers can no longer afford the higher house payment and are facing foreclosure: Enter the FHASecure solution.
FHASecure
FHASecure is a temporary program designed to provide refinancing opportunities to homeowners and lenders, and at the same time help to increase liquidity in the mortgage market. Under this program, well qualified borrowers, that have become delinquent on their mortgage due to increased housing payments from resetting ARMs, are eligible to refinance into a prime-rate FHA loan product. Highlights of FHASecure include:
- The mortgage being refinanced must be a non-FHA ARM that has reset
- The payment history must show that the mortgagor was current for six months prior to the reset
- Under certain circumstances, if there is sufficient equity in the home, missed mortgage payments may be included
- Mortgagees must determine that the reset of the ARM caused the mortgagor’s inability to make the monthly payments and that the borrowers qualify for the new FHA mortgage
- FHA does not have combined loan to value ratios, so if the new maximum FHA loan is not sufficient to pay off the existing first lien, closing costs and arrearages, the lender may execute a second lien at closing to pay the difference
For more information on FHASecure, please see Mortgagee Letter 2007-11.
FHA Homeownership Incentives
The FHA is also promoting home ownership by making HUD-owned properties more affordable. Sales incentives are currently available in: Colorado, Michigan, Montana, Ohio, Pennsylvania, Utah, and Wyoming. While the incentives may vary from state to state, they may include:
- $100 down payments on HUD Homes that are financed using FHA
- Sales allowances that can be used to pay closing costs, make repairs, or pay down the mortgage amount
- Broker bonuses for owner-occupant sales
To learn about specific incentives for each state, please see HUD’s local HUD information web site.
Internal Reform
It is interesting to look at the trend in the number of Mortgagee Letters, the conduit by which FHA announces policy changes, issued over the past few years. Between 2001 and 2003, FHA released an average of 27 of these directives per year. The number jumped considerably in the next two years, with 48 Mortgagee Letters in 2004 and 50 in 2005. Although the number of directives doesn’t give any information as to the type of changes taking place, it is still a good indicator that change was on the agenda at the FHA. In fact, when you begin to examine some of the big internal changes being made at the FHA, they most likely occurred over this two year period.
New Products: Two key product initiatives were introduced by the FHA in 2004 and 2005 that helped bring FHA products more in line with the conventional market: Offering the popular Hybrid ARM product and increasing the flexibility in refinance transactions.
Although FHA has insured ARMs since 1984, they were limited to one-year ARMs. In early 2004, FHA introduced new hybrid ARM options for one, three, five, seven, and ten years. Since the introduction of these products, FHA has continued to tweak the guidelines, to better conform to those offered in the conventional arena. Caps on the Five-Year Hybrid ARM were adjusted in 2005, and in October of this year, the London Interbank Offered Rate (LIBOR) index was introduced.
Until recently, it was the norm for borrowers to refinance out of FHA insured loans into conforming ones. However, in October 2005, the FHA offered expanded alternatives for refinances, changing this trend. The loan to value (LTV) for cash-out refinances was increased from 85 to 95 percent. This is currently the highest LTV available for cash-out refinance transactions in the market.
Changes in the streamline no cash-out program were also introduced to add greater flexibility and provide more incentive to stay in an FHA product. Accrued late charges and escrow shortages could be included in the loan as existing debt. The amount allowed to borrowers at closing was increased from $100 to $500. Hybrid ARMs could be streamlined to a fixed rate mortgage, without the requirement for a new appraisal, and the threshold payment tolerance was increased to 20 percent from 5 percent when a mortgage was refinanced to a shorter term. As a result of these types of changes, 20 percent of FHA refinances are conventional loans being refinanced into FHA products, up from 6 percent last year, and cash-out refinances have increased 80 percent over the same time period.
For additional information on these policy changes, please see Mortgagee Letters 2004-10, 2005-14, 2007-13, and 2005-43.
Improved Processes: Over the years, because the processing, underwriting, and appraisal requirements for FHA loans have been slow to adapt to changing market conditions, FHA loans have earned the reputation of being difficult to close. Just hearing “203K,” FHA’s rehab loan, could strike fear into the hearts of processors. Stringent appraisal requirements frequently caused real estate agents to steer sellers away from contracting with FHA borrowers. However, several improvements in these processes have started to reverse these trends.
In 2004, FHA deployed the Technology Open to Approved Lenders (TOTAL) Mortgage Scorecard as a means of evaluating loans. Although FHA loans had previously used other scorecard methodologies within AUS systems, the TOTAL scorecard brought with it reduced documentation for loans that received Accept/Approve classifications. Closing cost requirements and consequently calculating maximum mortgage amounts were also streamlined in 2006. The dreaded chart of allowable closing costs has been replaced by a “customary and reasonable” test. A new streamlined 203K program has been introduced that slashes documentation requirements. For loans up to $35,000, no plans, or consultants are required. In addition, inspections for repair costs under $15,000 have been eliminated.
The biggest transformation, however, came at the end of 2005 when FHA completely revamped its appraisal procedures. Standard Fannie Mae forms were to be used and to be completed in much the same way as done for conventional loans. The much maligned Valuation Conditions/VC and the Notice to the Homebuyer Summary forms were retired. Many of the repair requirements were removed, and the appraiser’s duty was changed to one of reporting deficiencies. Lenders were given increased responsibility for determining when repairs were required. The ubiquitous requirement for pest inspections was also eliminated under most circumstances.
For additional information, please see Mortgagee Letters 2004-01, 2004-44, 2004-47, 2005-15, 2006-04, 2005-50, and 2005-34.
Legislative Reform – The FHA Modernization Act
While the internal reforms have made FHA loans more competitive and have helped to bridge the gap between products and processes available elsewhere, additional change is on the horizon. The FHA Modernization Act is currently making its way through congress. The goal of this Act is to more closely align FHA practices with the conventional market, and at the same time help the FHA reach more borrowers. Components of the Act include:
- Use of risk based Upfront Mortgage Insurance Premiums (This has already passed and will become effective in January 2008)
- Ability to insure 40-year loan terms
- Increase loan limits to match Fannie Mae and Freddie Mac
- Decrease the cash investment (down payment) requirement
- Streamline the procedures for condominium projects
- Enhance reverse mortgage product
FHA modernization is on its way. On September 18, the House of Representatives passed its version of the Act. All that remains is for the Senate to pass its version, and for the versions to be reconciled.
For additional information on the FHA Modernization Act, please refer to the FHA website.
FHA loans will probably be in and out of vogue many more times in the years to come. However, after 73 years the FHA is still going strong. In addition to insuring over 34 million home mortgage loans since its inception, it is one of the few government agencies that fully supports itself. Although its products and processes may at times lag those offered in the rest of the marketplace, the FHA has time and again been able to assist borrowers and lenders in times of need with innovative solutions.
