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Residential Department: BackSpace: September 2012



Is the FHA heading for a bailout?

Since the first waves of the housing crisis began to hit, the Federal Housing Administration (FHA) has played an increasingly large part in efforts to stabilize the market. In fact, according to data from the U.S. Department of Housing and Urban Development,the FHA’s share of all home-purchase activity was 4.12 percent in fiscal year 2007. As of this past March, it was 16.05 percent, after hitting a high of 19.13 percent in 2010. The FHA currently holds 4.8 million insured single-family mortgages in itsportfolio.

Seriously Delinquent Loans by Type, Source: Office of the Comptroller of the Currency

“We had an enormous rush into the FHA program when the private market began to exhibit signs of distress,” says Keith T. Gumbinger, vice president at, a mortgage-data company. “Low-downpayment mortgages for borrowers with credit scores that weren’t quite up to par vanished from the marketplace — with the exception of the FHA program.”

The FHA’s generous terms for its mortgage-insurance program — credit scores down to 580, downpayments as low as 3.5 percent and loan amounts as high as $729,750 — make the FHA a popular option for many homebuyers with less-than-perfect credit. These borrowers, however, represent significant risk for the FHA in terms of loan defaults and eventual foreclosures.

With FHA delinquencies increasing in recent years, many industry experts are concerned about the agency’s financial stability and wonder: Is the FHA headed for a bailout?


This past June, the Office of the Comptroller of the Currency (OCC) issued its quarterly report on the mortgage market, with figures on delinquencies for government-guaranteed mortgages, loans from the government-sponsored enterprises (GSEs) and mortgages held by banks and thrifts. Of the three categories of mortgages, government-backed loans performed the worst.

For government-guaranteed mortgages — the majority of which are FHA-backed loans — the number of loans that were delinquent for 90 days or more increased by 26.6 percent from first-quarter 2011 to this past first quarter. In that same timeframe, 90 days or more delinquencies decreased by 14.7 percent for GSE loans and by 39 percent for bank-held mortgages.

Why is there this discrepancy in performance? According to Andrew Caplin, a professor of economics at New York University, the discrepancy should be expected. “[The FHA] is the only group that’s continued issuing extremely risky loans at a time when it’s known that the economy is extremely fragile and house prices aren’t rising,” he says.

Caplin has appeared before Congress several times to testify about the risks associated with FHA’s book of loans, and he recently co-authored a paper questioning the sustainability of the homeownership that the FHA is creating. In fact, the paper predicts that 90 days or more delinquencies for FHA-backed loans originated from 2007 to 2009 will increase to more than 30 percent within five years.

“There’s no sensible metric by which FHA mortgages are in anything but trouble,” Caplin says.

Gumbinger points out that the FHA was created to serve the low- and moderate-income population and its delinquency rates reflect that. “The FHA has traditionally had, because of the characteristics of its borrowers, higher loss ratios than prime mortgages,” Gumbinger says.

Although logically FHA mortgage-delinquency rates should be expected to be greater than those of prime mortgages, the upward trend still is somewhat disquieting. This past first quarter, the percentage of FHA loans in foreclosure, at 3.83 percent, was the second-highest level in the history of the Mortgage Bankers Association National Delinquency Survey.

Changing standards?

Years of increasing defaults have taken their toll on the FHA’s finances. By Congressional mandate, the agency is supposed to maintain a reserve fund with a 2 percent ratio of fund to loans insured. Because of the need to cover losses on insured mortgages, the reserve fund fell to 0.53 percent in fiscal year 2009. By the end of 2011, the ratio was down to 0.24 percent.

“The FHA is teetering on the edge of insolvency,” Gumbinger says.

In light of this, the FHA has taken steps to shore up its reserves and tighten the market for its loans in the past few years. The agency increased its upfront premium to 1.75 percent, and annual premiums have increased to more than 1 percent. In addition, borrowers with credit scores below 580 are required to have larger downpayments than the 3.5 percent minimum, and seller-assisted downpayments are no longer allowed. The agency also created an office of risk management.

Although these are steps in the right direction, it remains to be seen if these measures will be enough to offset what could be massive losses. “[The FHA will] have to improve their book of business if they are not to go to Congress and ask for money,” Gumbinger says.

“FHA takes the garbage, basically. They’re still a semi-subprime lender,” says Michael Meena, president of Augusta Financial Inc. Meena originated more than $40 million in FHA loans in 2011 and continues to do a significant portion of FHA-based business. “I believe that the credit requirements now may be a little bit low,” he says. “I don’t think it would kill the market if FHA said, ‘Our credit score requirements are 640 or 660 or even 680, instead of 580.’ I guarantee you those 580s don’t perform.”

FHA officials maintain that loans insured since 2009 are higher quality and eventually will lower delinquencies. The agency anticipates that its reserves will be restored by 2014, barring a second recession.

The B word

What the future holds, however, remains to be seen. With FHA reserves so slight, further economic malaise or increasing delinquencies could require the FHA to seek a taxpayer-funded bailout. “Housing is a long-lived asset,” Caplin says. “Its value depends today on what you think its value will be in the future. We have no idea what the future holds. There is no policy in place to make the future different from today. There’s every reason to be very worried.”

It’s especially troubling because the FHA plays such a significant role in the housing industry today. “FHA is a staple,” Meena says. “It’s probably 30 percent of our business.” Although he has seen a small drop-off in FHA business in the past few years, he attributes that more to conventional lending starting to step back into the market than FHA tightening its standards.

It’s unlikely that FHA’s market share will decline significantly in coming years, Gumbinger says. “I think they would like to return to their traditional role, but I don’t think in this set of market conditions — and market conditions for the foreseeable future — that they’re going to be able to pull back very quickly.”

Further measures from the FHA probably will be necessary when all is said and done. “It’s likely that the standards for FHA are going to need to be tightened as we move forward to push more people back into a hopefully resurgent market and to rebuild the finances so that the program runs for those for whom it was originally intended,” Gumbinger says.

As for the bailout question? It depends on who you ask.

“There’s no doubt that the FHA will be bailed out,” Caplin says. “The only question is: Is it in reality already being bailed out?”

Gumbinger gives it 50-50 odds. “If things heal going forward — job growth gets better, income growth gets stronger, household formation begins to pick up, [gross-domestic-product] growth is better — all those things would help support making monthly payments and support property valuations,” he says.

Whatever may happen, Gumbinger says, it’s an issue “that’s going to be with us for awhile.” 


Jennifer Garrett was an editor at Scotsman Guide. For questions on this article, call (800) 297-6061 or e-mail

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