Is FHA The New Sub-Prime?

Independent Auditor says FHA reserves have fallen below the 2% minimum reserve required by law.

A large increase in foreclosures has pushed the reserve fund at the Federal Housing Administration to a record-low level, according to an independent review of the federal agency’s books released Thursday.

The FHA’s reserves dropped to 0.53% of its total insured mortgages, less than the 2% required by law. The reserves measure how much capital the FHA has beyond the funds it has put aside for expected losses over the next 30 years.

Under most economic scenarios, the reserve fund would remain positive, the independent actuarial review said. The baseline scenario assumes that home prices will fall another 6.5%, leading to a significant increase in foreclosures. However, it is acknowledged that the full impact of future foreclosures is unknown and could create a situation where the reserve funds are negative.  This would then require a BAILOUT from the government, which really means from you and I, the American taxpayers.

The FHA has become a major factor in the housing industry, stepping in to guarantee about a fourth of all mortgages sold in the past year. As of the second quarter, about 50% of all first-time buyers had a mortgage insured by FHA.  Considering the flexible and minimal credit score requirements to obtain a FHA loan, this may well be creating a second round of “sub-prime” problems for the mortgage industry.

In response to the deteriorating position of the reserve fund, the FHA has stopped guaranteeing loans in which the seller provided the funds for the down payment. These are among the most risky mortgages.  It is amazing that this practice of allowing borrowers to put nothing down was ever allowed for a FHA loan, and stopping this now could well be too little, too late.

“There are real risks to the FHA and we are aggressively addressing those real risks with real reforms,” FHA Commissioner David Stevens said. The agency has increased its credit standards and has suspended lenders who violated FHA requirements. Again, the typical adult should be asking “why has it taken so long for them to see the obvious?”

Let us hope that the millions of FHA insured loans do not become another cross for the American taxpayer to bear.