Borrowers Pay to Refill FHA's Pot

This morning, the Federal Housing Administration officially announced long-promised news: the agency is moving to shore up its rapidly eroding insurance fund. And here's the deal: you the borrower will be paying for it.

Starting this spring, borrowers who take out FHA-insured mortgages will pay an up-front fee of 2.25 percent of the total amount borrowed, in an addition to annual premiums. These fees replenish the FHA insurance fund, which pays lenders back in case of default. The insurance is essential because FHA loans allow borrowers to take on a mortgage as big as 97.5 percent of a home's value, far more than non-FHA lenders will permit, increasing the risk that borrowers will eventually default on their mortgages.

It may sound crazy to be pushing low down payments when they're a big reason why so many borrowers are underwater and defaulting on their mortgages. But FHA is committed to keeping the down payment at a 3.5 percent minimum for borrowers with credit scores of 580 or higher, Commissioner David Stevens said on a conference call with reporters today. (Borrowers with scores below that now have to put 10 percent down.)

Really, FHA has no choice.

The agency has effectively become the pump pushing new homebuyers into a sluggish housing market – it now accounts for half of all new home loans to first-time buyers -- and those buyers usually can't muster the down payments of 15 percent that they'd need without FHA. Raise the down payment, and the sales market would slow even further than it has. Borrowers may also continue to receive down payment assistance from sellers via nonprofits, a dubious practice HUD has tried to end but that Congress refuses to ban.

So while it's beefing up the insurance fund, FHA is continuing to pile on risks, charging borrowers increased insurance premiums to cover them. Stevens said that the Obama administration will be asking Congress to raise the legal limit on the annual premium, currently capped at .55 percent; FHA would then lower the up-front fee back down from 2.25 percent, to limit how much borrowers would have to pay up front. But in one form or another, borrowers will foot the bill.

Thanks to a surge of borrower defaults – the worst on loans made in just the last two years - FHA's reserve fund has dwindled to barely one-half of 1 percent of the value of loans it's insuring, far lower than the required minimum. The combination of insurance, a bureaucracy that can inspect only a fraction of loans and the low down payments has left FHA wide open to fraud and abuse by lenders, many of whom signed up with FHA when the subprime industry collapsed.

And while FHA is taking a hard look at its lenders and cutting off those who break its rules or the law, it's also encouraging some dicey practices in order to keep the housing market moving. Last week FHA set aside a rule that prohibits FHA borrowers from buying a house that the seller had owned for less than 90 days. The restriction was intended to stop flipping, the practice of speculators buying cheap and reselling at huge markups, often taking a chunk of the proceeds for themselves.

As an episode of The Sopranos recounted, flipping has over the years been epidemic in FHA lending programs. Such scams will remain illegal, and lenders who participate can be cut off. But count on some rogue actors to miss that memo.
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