In previous articles, we have discussed lack of savings, cost of living expenses and how Debt Ratios are a poor indicator of Ability to Pay mortgage loans. Additionally, we have looked at the Wells Fargo YourFirstMortgage program and what to expect from it. Now it is time to look at FHA (Federal Housing Administration Loans) loans and how they perform.
The FHA’s mission is to assist underserved households to attain affordable mortgages. FHA typically serves the low income and minority markets.
What is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Specific traits of FHA loans include:
Minimum credit scores for FHA loans depend on the type of loan the borrower needs. To get a mortgage with a down payment as low as 3.5%, the borrower needs a credit score of 580 or higher. Those with credit scores between 500 and 579 must make down payments of at least 10%
FHA borrowers can use their own savings to make the down payment. But other allowed sources of cash include a gift from a family member or a grant from a state or local government down-payment assistance program.
The FHA allows home sellers, builders and lenders to pay some of the borrower’s closing costs, such as an appraisal, credit report or title expenses. Lenders typically charge a higher interest rate on the loan if they agree to pay closing costs.
Two mortgage insurance premiums are required on all FHA loans: The upfront premium is 1.75% of the loan amount — $1,750 for a $100,000 loan. This upfront premium is paid when the borrower gets the loan. It can be financed as part of the loan amount.
The 2nd mortgage insurance premium is called the annual premium, though it is paid monthly. Essentially, the insurance is an “add-on” to the interest rate of the loan and increases the rate and payment. For a 30 year loan, the premium is either .8% or .85%, depending upon the loan to value.
Allowable Debt Ratios for FHA loans are up to 55% making FHA with the highest ratios of any loan program allowed. Income used to qualify for the Debt Ratios could include sources that were not on the loan.
As a result of these traits, FHA loans are far riskier that GSE loans.
FHA Loan Performance
Since the new loan programs being offered by Wells are other banks are similar to the FHA loans, we can look to FHA loan performance as a key indicator of future performance of the YourFirst Mortgage loan and similar products from other banks.
The first chart represents Total Delinquencies by Month for the past Year. The rates only reflect active loans and do not include loans that have been “retired” or repurchased by lenders.
More that 11% of all FHA loans are currently delinquent or in default. GSE loans are currently running around 3 – 4%, so FHA loans overall are 3 times as likely to default as GSE loans and are inherently riskier than GSE products.
The next chart looks at Current Delinquencies by the Loan Origination Year. Again, it contains only Current Loan Numbers and does not include “retired loans” or repurchases.
As loans age, default rates generally increase as shown by this chart. But what is striking is the current number of defaults from 2005 through 2009 vintages. The level of current defaults show how the Great Recession and subsequent “recovery” have affected FHA loans with their much looser underwriting guidelines.
The 2010 -2013 years show a period of time where FHA loan underwriting had tightened in response to the Great Recession. Already, defaults are increasing as the loans age and this will continue as time goes on.
The 2014-2016 vintages are for new FHA loans under the Qualified Mortgage Rule. 2014 was the first year of QM, and those loans are already defaulting at an 8% rate. 2015 is at a 3.75% rate and those loans have not even been in existence for 1 year. Expect this number to climb to the 2014 level next year.
Essentially, this chart proves that the QM program has done nothing to improve FHA loan performance.
Credit Scores for FHA loans may be from under 500 up to 850. What is allowed is “conditional” upon other loan parameters, so if you are “strong” in other areas, then you could be approved with low scores. This chart compares Delinquencies to Credit Scores.
This chart reveals the weaknesses associated with using lower Credit Scores when approving FHA loans. Scores under 620 default at 25% to 35% rates, with those below 660 at a 15% rate. Yet, the FHA continues to fund low credit score loans and seek to actually do more of them in the future.
Down Payment Assistance Loans
FHA and the new YourFirstMortgage type loans allow for others to provide the money for Down Payments and in some cases, Closing Costs. This policy warrants its own look.
This chart shows the “obvious” of what to expect with Down Payment Assistance. They default over 25% of the time. And why? The people who use the Down Payment Assistance and similar programs cannot save enough money for Down Payments or Closing Costs. So how will they afford a home and new payment?
Why Do FHA Loans Default?
The real question to answer now is the reasons for loan defaults. FHA keeps records on default reasons and the next chart reflects their findings.
The real reason that loans default is Impaired Income and Liquidity. What this means is that a default occurs when the homeowner either incurs a loss of income and/or job, or else has too many Debt Obligations to be able to continue making payments.
This chart shows that Impaired Income and Liquidity issues are over 70% of the causes of defaults. As the economy worsens, we can expect that defaults will continue to rise from job loss or income reduction.
The charts represented here show that there are many risk factors to consider when doing FHA loans. And as the risk factors mount, risk itself increases proportionally.
The GSEs under YourFirstMortgage by Wells Fargo and other programs by BofA, Chase, Citibank and other lenders are now mimicking the FHA mortgage guidelines. Since we see how FHA loans default under these guidelines, it is possible to predict that the new GSE programs will also suffer under the new guidelines.
Once again, the government is pushing housing policies to stimulate the economy. Those policies will be adverse to the economy and homeowners.