The FHA was established in part to insure mortgages under certain criteria so that banks would start lending again. This enabled a larger pool of people to afford a down payment and make the monthly payments on their home, which played a significant role in the recovery of the U.S. housing market.
Today, the FHA helps families pursue the American dream of homeownership. Without the FHA, many of these families would not be able to purchase a home.
First-time homebuyers, with less than perfect credit, can secure an FHA loan to purchase a home with as little as a 3.5 percent cash down payment. Some borrowers even qualify to receive up to 6 percent toward closing costs.
These features are great benefits for first-time homebuyers who are stretched to make a traditional 20 percent down payment. There is an extra cost for a mortgage insurance premium (MIP) added to the cost of the loan due to the riskier nature of these loans. The MIP helps fund the cost of the insurance the FHA provides to its lenders.
There is also an FHA streamline refinance program for homeowners with existing FHA mortgages. This is a popular refinance program since it has very light requirements in terms of income documentation and employment verification, and does not require an appraisal of the property. This enables homeowners to quickly and easily refinance to today’s record low rates even if they are underwater on their mortgage. I discuss this in detail on my blog.
Not all lenders are approved by the FHA to participate in their program, so make sure to ask your lender upfront whether they can provide these loans. As always, I highly recommend you comparison shop for your loan with offers from multiple lenders to make sure you get the best deal. The Internet is a great place to start your search.
Now let’s look at the big picture regarding FHA loans from a market perspective. Since the financial crisis occurred several years ago, the secondary market for subprime loans has essentially disappeared.
Without an outlet for banks and lenders to sell riskier loans, they have retreated and are generally focused on originating mortgages they can sell to Fannie Mae and Freddie Mac by meeting their traditional “conforming loan” requirements. These requirements include a broad range of criteria, including larger down payments and higher credit scores.
With the absence of the subprime market, the FHA has played a stepped-up role to serve this gap in the marketplace.
The FHA will insure mortgages with lower credit scores in the 620 to 679 FICO range, which represents 39 percent of their loan volume according to the FHA’s most recent report to Congress. But the FHA also has been growing its presence in higher FICO ranges, such as recent college grads who have excellent credit but not a lot of cash for a down payment. These loans tend to have an elevated risk level due to their higher loan-to-value ratios, so traditional lenders are shying away from them in today’s market.
The FHA’s increased role in these underserved market segments has helped support the housing recovery.
While FHA loans are a great solution for many homeowners today, several economists are starting to get concerned about the role the FHA is playing and whether another bubble is looming.
As a result of this stepped-up activity by the FHA, the share of mortgages that the agency insures has increased fivefold since 2006 from approximately 3 percent of the market to 15 percent of the market, according to the agency’s most recent filing.
This has many watchdog groups concerned about whether a bubble similar to the subprime debacle is growing, but this time directly on the U.S. government’s balance sheet.
In fact, the FHA’s independent auditor, Integrated Financial Engineering Inc., recently forecast that the FHA may be facing a deficit in terms of the amount of cash reserves it needs for expected losses. This means the agency may have to get an injection of cash from the U.S. Treasury for the first time in its 78-year history. This would be an added burden for the U.S. taxpayer and would likely set off another political debate over the role of government.
Let’s hope that home values stay on their current trajectory and continue to rise, which tends to solve all problems in the housing market. That would certainly help the FHA self-fund its operations, and continue to play an important role in the U.S. housing market.
Make sure to let your friends and family members know about the opportunity in today’s market with FHA loans – especially if they are stretched to make a down payment, or have less than perfect credit. It’s one of the few solutions left in the marketplace for first-time homebuyers who need assistance to reach the American dream.
Tom Reddin, former president of Charlotte-based LendingTree, writes an occasional column for MoneyWise about mortgages and home ownership. A version of this column previously appeared on his blog, MortgageRates.US. He runs Red Dog Ventures, a venture capital and advisory firm for early-stage digital companies.