There has been a lot of press recently about FHA loans and how the program has been under stress. At the end of February 7.46% of FHA insured loans were  in default or seriously delinquent. There has also been a sharp increase in FHA loans which go into default without the new owner making a single payment, a clear sign of fraud. These are ugly and eye popping numbers. Because of these statistics, I’ve heard commentators state that FHA is a broken program and that FHA is only picking up the worst loans, and setting itself up for failure. I’ve heard others say that FHA is like the sub prime loans of the past and we are making the same bad decisions now that got the mortgage market into a mess before. There is no question that FHA is under stress, but in my opinion it’s not because the standards are too low, the stress is a fact of life in the present economy.

FHA has always filled a need in the market. FHA is a federal program with a mission to increase home ownership for low and middle class families. FHA loans are fully underwritten and the emphasis is on whether the borrowers will be able to afford the home and make the payments in the future. The biggest obstacle to home ownership has always been saving up the down payment required to buy a home, and FHA offered the low down payment loans that made it possible for many first time home buyers to get in on the first rung of the home ownership ladder. FHA wasn’t a big part of the problems that got us into this mess. FHA had lost market share to low down payment conventional options every year up until last year, and was down to about 2% of the loans originated. But that was then, this is now. Conventional guidelines have tightened and price hits added to the point where many otherwise qualified buyers would pay so much more for a conventional loan that FHA is the only option. FHA loans now make up almost 40% of purchase loans. With more buyers who would have otherwise gone conventional forced into FHA, I am seeing more buyers with larger down payments and reserves than the typical cash strapped FHA buyer, and more buyers who have been home owners before, not just the typical first time home buyer. Rather than going down, the quality of FHA loans is actually going up.

With an explosion of new loans in a declining economy, it was a foregone conclusion that FHA would run into problems. But the truth is, this isn’t an FHA problem, it is a mortgage problem. Conventional loan delinquencies are at a record rate and Jumbo loans, which are above the conventional lending limit and made to buyers who are usually well to do, are now showing an increased rate of default. This is all linked to unemployment. As unemployment moves higher, more borrowers who were in good shape before will have trouble paying their loans, and that is exactly what has happened. The cities with the worst FHA default rates, Detroit, Elkhart Indiana and several cities in Florida, are all areas with high unemployment. As the economy recovers and unemployment goes down, this will take off the loan stress and bring the situation back to normal. The first payment defaults are more a result of the explosion in loan volume that FHA has seen. There have always been loan scammers and fraud involved in mortgages. Before it was concentrated in sub prime, now with so many more loans on the books, FHA is the target.

There have been a number of changes over the last year that take away some of the risk on the loans FHA insures:

• The minimum down payment has increased from 3.0% to 3.5%.
• Down Payment Assistance Programs, which were a way for the seller to fund the buyer’s down payment, are now gone.
• FHA cash out refinances have been decreased from 95% loan to value to a maximum cash out of 85%.
• The wholesale lenders have adopted minimum credit standards so that buyers will need at least a 600 credit score to qualify.

There is no doubt that more changes are on the way, and underwriting is likely to get tighter. But there are a lot of advantages to FHA and it is not a loan of last resort, but a loan that is the best option for many borrowers and many situations. These are some reasons you may want to consider FHA financing:

• Competitive rates and fees – FHA is comparably priced to conventional loans, and when you consider price hits, it is often priced better.
• It is the only option left for a low down payment purchase with a minimum investment of 3.5% of the purchase price.
• The entire down payment can come as a gift from a relative.
• With FHA approved condos and FHA spot loans, you can buy a condo at a good rate with a minimum down payment. With conventional guidelines you will need at least 10% down and there will be price hits if your down payment is less than 25%.
• To get the best pricing with a conventional loan you need a 740 credit score, and if your score is below 680 the price hits will make the conventional loan much more expensive.

FHA financing has gotten a bad rap lately, but without FHA as an option a whole lot less homes would be sold and less home buyers would be able to obtain financing.  FHA, along with all loan programs, will be under pressure and defaults are going to be a big problem until unemployment starts to fall. The home market is stressed now, but without FHA to pick up the slack left from tighter conventional guidelines, the housing market would be in even worse condition.

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