FHA officials have acknowledged that the agency is facing serious financial pressures, but the problems may be even more serious than reports to date have indicated. An analysis of loans approved in 2009 and 2010 found that the foreclosure risks are well above average, threatening losses that could exceed $20 billion. That projected loss would be in addition to the $13.5 billion deficit identified in an agency audit citing exposure related to the collapse of the housing market.
The recent study, by Edward Pinto, a recent fellow at the American Enterprise Institute, focuses on loans originated after the housing implosion, which makes the conclusions “particularly disturbing,” industry observers say. Pinto analyzed 2.4 million FHA-insured loans, looking at their location and borrower characteristics. He found that the agency does not accurately assess the repayment prospects of borrowers, approving high-risk loans and failing to set premium prices that accurately reflect those risks.
Although FHA underwriting standards generally set a maximum housing debt-to-income ratio of around 30 percent, exceptions allowed by the rules pushed that ratio much higher. More than 40 percent of the loans approved in 2010 went to borrowers with debt ratios exceeding 50 percent or with credit scores lower than 660 – borrowers who, Pinto said, were “just a car repair away from failure.”
“The FHA’s underwriting policies encourage low- and moderate-income families with low credit scores to make a risky financing decision,” he said, “one combining a low score with a 30-year loan term and a low down payment. This sets up for failure the very families and communities it is the F.H.A.’s mission to help.”
Equally problematic, he noted, the agency doesn’t adjust the guarantee fees charged to reflect the risks, charging the same amount regardless of their credit scores or size of the down payments they make. He also found a high concentration of loans in low-income zip codes, where foreclosure rates will likely reach 15 percent – above the average of 9.6 percent the FHA’s recent audit is projecting for the two years Pinto analyzes.
The problem is not the agency’s commitment to providing mortgages to low- and moderate-income borrowers, Pinto emphasizes; it is the failure to underwrite those loans prudently and control the risks. He suggested specifically that loan terms should be shorter (20 years rather than 30) and maximum debt loads lower.
“The [agency] should set loan terms that help homeowners establish meaningful equity in their homes with the goal of ending their dependence on F.H.A. lending,” he said.
FHA officials disputed Pinto’s conclusions, particularly the suggestion that long-term loans increase the risks to borrowers and the agency. “The assertion that FHA is setting up potential homeowners for failure by insuring a 30-year, fixed, rate , fully documented loans for underserved borrower is not supported by the information presented, George Gonzalez, an FHA spokesman, told the New York Times. He added that “selective use of FHA data ignores that the [agency] has successfully provided access to mortgage financing for millions of creditworthy borrowers for almost 80 years.”
As home prices rise and analysts report the housing industry is recovering, young adults are shaking off the fears the housing collapse created and starting to look more favorably at home ownership.
More than 90 percent of the young renters (between 18 and 34) responding to a survey by Trulia said they expect to purchase a home “some day,” and 31 percent say they plan to buy within the next two years – up from 22 percent in January of 2011 and 28 percent in May of this year.
“Millennials have been shaken, not scarred by the housing bust,” said Jed Kolko, Trulia’s chief economist. “Nearly all of them want to own a home someday, if they’re not homeowners already. But many of them think today’s low prices and low mortgage rates will last. They may be in for sticker shock if the cost of homeownership has returned to normal levels by the time they’re ready to buy.”
The survey news wasn’t entirely positive, however. Only 72 percent said homeownership is part of their personal American dream – down from 76 percent in 2009 and 7 percent in 2010. Older renters (55 and above) are even less enthusiastic – only 39 percent said they intend to become homebuyers, compared with 75 percent in the 35-44 age range.
Although young adults appear to be regaining their appetite for home ownership (see above item), builders are not curbing their appetite for constructing multi-family housing.
Increasing demand for apartments has pushed rents and property values higher, while low interest rates have created a favorable construction climate. As a result, multifamily construction activity has been increasing steadily for the past two years. Starts increased by 54 percent in 2011 and have been averaging more than 35 percent ahead of the 2011 pace this year.
But even as industry executives have welcomed the multifamily recovery, they have begun to worry that a new bubble could be forming, threatening to produce a glut of vacant, and over-valued rental buildings as home ownership rates begin to rise.
Historically low interest rates have reduced the ratios between annual revenue and market value, pushing property values higher. But industry executives worry about what will happen when interest rates begin to rise.
“Don’t get complacent,” Patrick Simons, an analyst at Strategic Property Economics, warned in a recent client newsletter, noting, “these levels are not the historical norm.”
Some analysts think the norm may be changing, as policy makers and consumers rethink traditional assumptions about home ownership in the wake of the subprime debacle that contributed to the housing market’s collapse. “It is entirely possible that some people aren’t supposed to rent a home – that some people are supposed to rent,” Stephen Gordon, chairman and chief executive officer of Opus Bank, told American Banker.
Federal regulators are planning to tighten the rules governing reverse mortgages. Consumer advocates have been urging action for some time, warning that misleading marketing and inadequate counseling are putting seniors at risk. Rising delinquency and foreclosure rates on these loans have confirmed those fears. The Department of Housing and Urban Development (HUD) reported recently that default rates on Home Equity Conversion Mortgages (HECMs) insured by the Federal Housing Administration, are four times higher than on conventional FHA loans.
HUD officials are seeking emergency authority from Congress to set a lower limit on up-front reverse mortgage loans (an increasingly popular option for borrowers) and to add safeguards, which could include an ability-to-pay assessment or an escrow requirement, to ensure that borrowers can make property tax and insurance payments and maintain their properties. Failure to meet those obligations is the major cause of defaults on these loans.
If Congress doesn’t grant that request, HUD officials have said they will use the agency’s existing authority to end fixed-rate loans under the standard HECM program, making them available under a lesser-used HECM Saver program, which has lower loan limits and lower origination costs.
“We’re not suggesting that a fixed rate HECM loan is a bad loan,” Charles Coulter, a deputy assistant secretary at HUD. Told Reverse Mortgage Daily in a recent interview. “What we are suggesting is that the way the loan is being used today is not consistent with the intent of the overall program….Reverse mortgages can help seniors age in place in cases where they don't have access to other liquid capital,” he added. “We're just trying to get this program to operate more consistently with that statement than it is today."
Consumer advocacy groups have expressed their support for HUD’s proposed changes in the HECM program but are urging the agency to adopt “a more comprehensive package of protections” to protect borrowers. That request came in a letter to HUD from Consumers Union and California Advocates for Nursing Home Reform (CANHR).
Seniors who opt for a lump sum reverse mortgage payment “are at higher risk of prematurely using up all their equity and losing their homes” Norma Garcia, senior attorney and manager of the financial services program at Consumers Union, told reporters, adding, “Consumers Union has long supported requiring lenders and brokers to perform a suitability assessment that evaluates whether the loans put borrowers at risk of losing their homes, if the borrower understands the complex nature of the contract, and if there are more cost effective alternatives available .”
HUD’s proposed changes in the HECM program represent, a positive step that will help ensure borrowers don’t wind up with a reverse mortgage that may not be suitable for them,” Prescott Cole, senior attorney with CANHR, said in a press statement. “But more must be done to protect seniors and their families. Too many seniors are falling through a fiscal trap door while trying to unlock their home equity with a reverse mortgage.”
Regulators have been trying for years to develop the right combination of disclosures to ensure that mortgage borrowers have the information they need to compare loan terms and make informed choices. But it seems the problem for some consumers may be that they don’t shop for loans, not that they lack information that would help them do so.
Nearly half the low-income borrowers responding to Fannie Mae’s November National Housing Survey said they did not obtain more than one quote before obtaining their current mortgage; nearly three quarters of upper income borrowers, by contrast, said they did some comparison shopping before choosing a loan.
“Although a home purchase is the largest financial obligation most people will ever make, many borrowers do not fully understand their mortgage products and costs," said Fannie Mae chief economist Doug Duncan. "As a result, some homeowners in this position may find themselves with unsustainable payments down the road."
The study also found that, despite extensive mandatory disclosures about the loan terms, some borrowers still do not understand key details including the amount by which payments on an adjustable rate mortgage could increase over the life of the loan. That information gap was evident across income lines, with more than 40 percent of survey respondents unable even to guess what the increase might be.
Other studies have found that borrowers who shop effectively can save $1000 or more on closing costs and are likely to obtain more attractive interest rates as well.
Other findings of the Fannie Mae survey included:
- Lower income consumers are more likely than higher income borrowers to be influenced by mortgage brokers and real estate agents in selecting a lender.
- Higher income borrowers are more likely to say competitive officers would influence their choice of a loan.
- Although both higher- and lower-income borrowers said they shop for loans, lower-income borrowers were less likely to obtain quotes from more than one lender.
- Higher income borrowers were also more comfortable using mobile devices in searching for homes and mortgages.
- More than two-thirds of all respondents said the lender’s reputation was a major factor in their loan choice.
“Consumers who more fully understand the mortgage choices available are more likely to be better able to make effective trade-offs between cost, risk, and service offerings,” Steve Deggendorf, director of business strategy in Fannie Mae’s office of Economic & Strategic Research, said in the report analyzing the survey results. “This could help make for more satisfied consumers and help prevent future delinquencies, defaults, and foreclosures,” he added.