Is the government backing a new housing bubble?

Right now, under a plan introduced by President Barack Obama, an FHA-qualifying U.S. homebuyer can apply for a 30-year mortgage with a 30 year fixed interest rate of 3.75 percent and a 15-year fixed mortgage at 3 percent.

By The Fiscal Times May 18, 2012 12:11PM
By David FrancisThe Fiscal Times

Right now, the U.S. Federal Housing Authority is offering historically low interest rates on home loans as part of an effort to kick-start the housing market. Under a plan introduced by President Barack Obama, an FHA-qualifying U.S. homebuyer can apply for a 30-year mortgage with a fixed interest rate of 3.75 percent and a 15-year fixed mortgage at 3 percent. FHA loans require as little as 3.5 percent of the home’s value up front in the form of a down payment.

Compare this to a traditional mortgage offered by a private bank. Private banks require large down payments of buyers – traditionally 20 percent – to qualify for a low interest rate.

After the housing bubble burst forcing the United States into the Great Recession, traditional home loans have become harder to get. Banks have tightened lending standards, and wage stagnation and job loss have made it difficult for prospective buyers to save enough to qualify.  But without qualified buyers, the housing market can’t recover and play a part in the broader economic recovery.

The Obama administration’s answer to this Catch 22 is this government-backed FHA mortgage program, a plan aimed at adding buyers to a seller-heavy market. But according to experts, giving under-qualified buyers loans at such low interest rates creates the potential for many of the same problems that led to the housing bust in 2007: people with questionable finances who can’t qualify for traditional mortgages are entering an uncertain housing market, just as unqualified borrowers did in the years before the housing crash.

Without putting down large down payments, these borrowers are not building equity in their home. And any disruption in the economic recovery – the crisis in Europe spilling onto American shores, for instance – could lead to an economic slowdown that compromises their ability to pay for their homes.

“You’re creating a country of renters who are now renting from the bank,” said Roger Staiger, an adjunct faculty member at the Johns Hopkins Carey Business School. “Because of this lack of fiscal prudency, we’re never going to become a nation of non-debtors.”

According to Edward Pinto, a resident fellow at the conservative American Enterprise Institute, FHA loans are allowing a repeat of pre-bubble history. Buyers with questionable credit are being given access to the housing market, creating uncertainty and risk.
FHA “continues to make loans that are very high risk and they’re not pricing them right,” Pinto said. “There’s no incentive to put down a larger down payment. It makes it difficult for the private sector to complete as they price rationally, as private banks cannot compete with irrational pricing.”

Unintended Consequences
Merrill Lynch/Bank of America cite a recent report from the Treasury Department that raised some red flags, particularly regarding loans from the Federal Housing Authority (FHA). “About half of the modified FHA mortgages have defaulted within a year. In contrast, only 27% of Fannie and Freddie loans have become delinquent again. This is not surprising, since the FHA did not tighten lending standards as much as Fannie or Freddie, keeping a low downpayment requirement. For borrowers with FICO scores above 580, only 3.5% down is required, making it easy to fall into negative equity. It is, therefore, not surprising that 11% of the loans originated in 2009 and 24% of those originated in 2008 are seriously delinquent."

“When equity goes into a home, equity stays in a home,” Staiger said. “The familial financial security grows because every day you pay down principle. Exotic loans [like FHA loans] should be reserved for very special circumstances.”

Overcoming Barriers to Entry
During an interview with the Fiscal Times, acting FHA commissioner Carol Galante defended the FHA loan-making process. She said that the tight private lending market has led to a better quality of borrowers for FHA mortgages.

“Since the crisis, post-bursting of the bubble, we have seen our borrower profile improve, actually,” Galante said. “The average credit score [for FHA borrowers] is about 700. Pre-crisis it was more in the 640 range.” Galante said that borrowers with credit scores as low as 500 are eligible for FHA loans, given that they meet a number of other conditions. She said FHA accounts for risk in its mortgage portfolio by deep examinations of potential borrowers.

“The main thing is and always has been taking a full look at each of these borrowers,” Galante said. “It’s fully documenting their employment history. How long have they been employed, how stable is their employment, how much down payment they are putting down, their income-to-payment ratio.”

Galante also said that there are vast differences between FHA loans and the subprime loans that caused the housing bubble. “These are fully underwritten … to be a sustainable mortgage in a way that subprime never was,” she said. “One of the things that happened in the buildup to the crisis, FHA’s market share went from 15 percent to 2 to 3 percent of the market. Private subprime lenders siphoned off FHA borrowers.”

According to Galante, these mistakes have caused the private lending industry to pass over borrowers who have the ability to maintain payments over the life of a loan. “They have become so risk averse because they got hit so bad by the crisis. They’re perhaps overpricing the risk today to compensate for earlier losses,” Galante said. People who say we’re under pricing risk? Factually, that doesn’t add up.”

Economic Shock Could Lead to Disaster
Pinto said that some of the borrowers who qualify for FHA loans – those with credit scores near 500, for instance --  have slim margins for economic failure.  If the U.S. economy was to take a turn for the worse, many would be unable to keep up payments, leading to a situation similar to when mortgage rates adjusted higher prior to the real estate bubble’s implosion.

“If you’re meeting the qualifications for these kind of loans, chances are you’re on thin ice and might not able to take the shocks,” Pinto said.

More from The Fiscal Times:

David Francis is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' free newsletter.



14Comments
May 21, 2012 1:29PM
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"Galante also said that there are vast differences between FHA loans and the subprime loans that caused the housing bubble. “These are fully underwritten...."  Yeah, by the US Taxpayer !!!

 

I've always been told that one definition of insanity is to do the same thing over and over again while expecting different results.

May 22, 2012 1:07PM
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Why don't you title the article correctly instead of trying to be politically correct? Try this "Governments Plan to Cause the next Housing Bubble Creating Misery for all". This Country is already in the toilet BECAUSE of everything the Government has done to what used to be the FREE market economy. Another hidden tax on our children with more debt and deficit spending. Nothing in our Constitution says that it's up to the taxpayers and the government to ensure that everyone is entitled to live in a house, as opposed to an apartment. Entitlements only come from from the perverted philosophy which is in direct contrast to everything our Founding Fathers believed in about the free market economy. It's called the Radical Liberal Socialist Agenda - never more clearly stating it's purpose then when then President Bill Clinton stated, and I quote: "I can spend YOUR Money better than you can." It's been down hill ever since. Now it's an Obamination.  Re-elect no one. There are none so blind, as those, who will not see.
May 21, 2012 11:45AM
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1,000,000 of these new loans are already in default!!
May 22, 2012 2:04PM
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Nothing in our Constitution says that it's up to the taxpayers and the government to ensure that everyone is entitled to live in a house, as opposed to an apartment. --- true and there is nothing in the Constitution about corporate welfare either. Both rep and dems are at fault and play all the games!

May 23, 2012 12:20AM
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Get the government out of the market
May 23, 2012 1:08PM
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"Get the government out of the market".....Cool

that has to be the best statement I've heard all day.

Has the U.S. Government ever ran anything effeciently?

 

And we have a whole lot of PIN HEADS in this country that want the U.S. Government to run our health care.

 

That scares the heack out of me.

May 22, 2012 1:53PM
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FREE market economy--- have we ever had that?
May 23, 2012 1:24PM
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We could be headed to yet another housing bubble.

When did the last housing bubble start.

1999 the Gramm-Leach-Bliley Act....signed into law by none other that Bill Clinton.

That's the Law that  repealed much of the Glass-Steagall Act that FDR signed into law in 1933 which made it Illegeal for banks to deal in securities & other unsafe financial deals.

Yes, with the stroke of a pin Bill Clinton made it leagel for banks to wheel & deal again.....thus the start of the Big Housing & Banking BUBBLE.

 

May 23, 2012 11:17AM
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"Exotic loans [like FHA loans] should be reserved for very special circumstances.”

 

really... all FHA loans are either 15 or 30 year fixed rate fully amortizing loans, not very exotic to me.  Other than the low down payment they are as safe as anything out there.

 

The scrutiny of underwriting that happens on FHA is higher than private loans.  The paperwork is enormous.  If you ever tried to sell your house to a buyer getting an FHA loan, you would know how picky they are.

May 22, 2012 6:24PM
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This is not a new government program. FHA loans have been like this for decades, and the rates vary as the market varies. The only thing new is that they have more than doubled the premiums that buyers have to pay to FHA every year. After you pay the FHA insurance premium, the effective rate is 5%, which is still reasonable. You have to pay more than buyers who put at least 20% down, properly reflecting that lower down payments make the loans riskier for the banks.
May 23, 2012 4:22PM
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Yup, here we go again. I guess Mr. Nobama didn't consider the $11 trillion vacuum of real estate value in '07-'11as a "teachable moment". SO...BOHICA!!!
May 22, 2012 1:55PM
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Maybe Penny Mac can help out with those distressed properties.. check out who runs it.
May 22, 2012 2:00PM
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Why where fannie and freddie created ?  Yes, they got WAY out of hand (but so did the big banks), but I thought they were originally created  to help create a middle class in this country? Why was social security created? Wasn't it to help the older less wealthy population from becoming a poverty stat? Have these issues and problems gone away?
May 21, 2012 7:58PM
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I know years ago, we bought a house through the FHA and we DID NOT HAVE ANY PROBLEMS.
If it can give more people a chance to own their own home, then I am all for it. 
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