I usually try to limit political comments in this blog since it is primarily intended to be a training and guideline update source designed to help loan officers originate and close FHA loans. However a June 21, 2008 editorial in the Wall Street Journal entitled “The FHA Time Bomb” has such a smörgåsbord of misinformation and misdirection that I feel compelled to comment.

I am equally certain that some of my political bias may slip through in my comments. So I must step out in front of that and make sure everyone knows that, in spite of having spent most of my career as a specialist and expert on government backed loan programs, my political views are distinctly libertarian. When I see a problem, my very first instinct is to think that too much government caused it. However, when I look at the evidence gathered to support a particular policy viewpoint, I try to keep my political predispositions at bay until I see what the numbers really tell me.

The Wall Street Journal (WSJ) editorial begins by stating that FHA just announced that it “suffered a $4.6 billion dollar loss last year.” First, in spite of the way it was widely reported, this was not exactly what FHA Commissioner Brian Montgomery said. Here is the exact quote from his testimony before Congress:

Currently, FHA is solvent. In fact, we have a reserve of about $21 billion.

However, as a result of our annual re-estimate, we had to book an additional of $4.6 billion in unanticipated long-term losses, mostly due to the increased number of certain types of seller-funded loans in the FHA portfolio.

I’m not completely sure yet, but maybe this statement should be looked at a little more closely. First, Commissioner Montgomery uses the present tense to describe FHA’s reserve fund of $21 billion. Then he says a “re-estimate” is responsible for FHA having to “book” an additional $4.6 billion in unanticipated long term losses.

Does this mean that FHA has $21 billion after deducting $4.6 billion? Maybe some astute commenter can clue me in on exactly what this means, but it does not appear to say that FHA lost $4.6 billion last year. In fact, it seems to closely resemble the recent losses “booked” by many lenders which are simply predictions on how much a particular loan portfolio might end up losing.

In addition, he blames the losses on “seller-funded” loans which I assume means seller funded non-profit down payment assistance programs. This will be addressed later in the post.

So now we get to the real reason for the announcement. Government regulators often have their own political agendas and I smell one here. I hear rumblings and rumors, but have not seen proof, that this fight to get rid of non-profit down payment assistance might possibly be related to the political influence of private mortgage insurance companies who are losing business to FHA right now.

For more details on what I think about the studies FHA uses to blame this problem on non-profit down payment assistance, please see my June 11, 2008 post entitled “FHA Guidelines: FHA Down Payment Assistance On The Chopping Block?” and also take a look at this excellent May 2006 article in Realty Times by David Reed entitled “Non-profits and No Down Payment: A Second Opinion” which was published soon after the studies were made public.

Further, no one seems to pay attention to the fact that, in the same testimony, Commissioner Montgomery also said:

Since September 2007, FHA has helped pump more than $76.1 billion of mortgage activity into the housing market; more than $30.3 billion of that investment came through FHASecure.

I would like to direct you to Peter Miller’s June 23, 2008 post on FHA Mortgage Guide entitled “Bush To Congress: FHA Reform Bill Faces Veto“, as well as “HUD Numbers Don’t Add UP“, “The Truth and Nearly The Whole Truth“, and many others on the same subject which you can find in the list in the right sidebar beside those articles. Why should we trust the other numbers in the same speech without more detail?

To add to the confusion, here is Commissioner Montgomery’s testimony before Congress on November 2, 2007 just after the end of fiscal year 2007:

Homeownership and, more importantly, homeownership retention have long been a priority for FHA. We believe borrowers with FHA-insured mortgages have unparalleled access to loss mitigation alternatives that help them weather personal financial crises and reinstate delinquent loans. In Fiscal Year 2007, FHA provided loss mitigation support to 91,000 borrowers, 86,500 of whom were able to keep their homes.

While not every one of these borrowers will be successful in the long term, historically 89 percent of all borrowers who benefit from loss mitigation still have active loans two years after the assistance. This success is responsible in part for a reduction in both the number and percentage of FHA foreclosures from a high of 1.74 percent in FY 2004 to 1.45 percent in FY 2007.

By the way, the fiscal year for FHA runs from October 1st of the previous year through September 30th of the year in which it is numbered. Neither May nor June 2008 corresponds with any fiscal quarter that would seem to be a natural point to report the $4.6 billion loss. The timing of this announcement appears to be more politically motivated than anything else.

Next the WSJ editorial gripes that the housing bill being debated on the Senate floor at the time would “expand the FHA portfolio to about 1.5 million mostly high-risk subprime mortgages” and wonders why Congress wants FHA to get into that market when all the private lenders are bailing out of it. This completely ignores the fact that FHA is not in any way slated to just take over subprime mortgages. There is a whole qualification and underwriting process that will occur for every individual loan brought into the FHA system.

The WSJ editorial further points out that the Senate bill raises FHA limits and states – with no proof or reasoning – that this “puts the taxpayers on the hook for tens of billions of additional losses.” Again, this ignores the credit standards for approval of the loans.

However, to be fair I also have a problem with raising the FHA limits. Except I actually have a reality based line of reasoning for my concerns. Many of the areas with higher prices – for which the FHA limits are being raised – are absolutely loaded at present with stated income, no income documentation, and negative amortization Option ARM loans whose borrowers will never qualify for an FHA loan because they never really made enough money to qualify for the home they bought. So the few FHA loans that will be possible in those markets are going to be made in areas where values will still continue to fall in spite of the best efforts of FHA to stabilize the market. Whereas, I completely disagree on the causal relationship between down payment assistance and defaults, I thoroughly believe in the causal relationship between falling values and defaults.

Next the WSJ editorial attacks down payment assistance programs as a “scam”. I have addressed this issue already, but I would I would like to point out that the editorial states incorrectly that “Until recently, lenders even got a tax write-off for their ‘charitable contribution.’ Everyone won – except the taxpayer.” I have no idea where the author of the editorial pulled this from unless they misunderstood the IRS notice to sellers stating they could not deduct the down payment assistance program fee from their taxes. This was always the rule. The IRS was just reminding sellers of this and requiring the non-profit agencies to notify the parties involved. Lenders never took such a tax deduction, although I’m sure saying so adds a little extra emotional punch to the editorial in today’s anti-lender environment.

The WSJ editorial next states that the reason for such a large loss by FHA is “financial mismanagement”. The editorial states that the upfront mortgage insurance premium was lowered from 2.25% to 1.5% in 2000 and the losses would have been zero had the higher insurance rate been reinstated.

The WSJ is often fond of pointing out the very true fact that lower tax rates produce more total tax receipts. Given that FHA’s portion of the mortgage business was in decline even with the 1.5% premium, similar logic would seem to indicate that fewer good (i.e. non-defaulting) mortgages would have fallen into the FHA bucket at the 2.25% rate while the percentage of defaulting mortgages would have been higher. In addition, the editorial completely ignores that risk based mortgage insurance premiums take effect for FHA mortgages in July 2008

Interestingly, as part of the ammunition for the editorial, the Wall Street Journal publishes a relatively useless chart showing the recently announced figures from the Mortgage Bankers Association regarding mortgage delinquencies. This chart which is supposed to be such an indictment of the FHA mortgage insurance program actually shows FHA delinquency rates to be amazingly steady over the years.

Those of you familiar with how the FHA “Neighborhood Watch” system works may be thinking right now of another factor which might be at work here as well. Once a loan is delinquent in FHA’s system, it continues to show as a default for the next two years even after the borrower has brought the payments up to date! So if the FHA delinquency figures are being obtained from that system, they may be grossly overstated.

Take a look at Peter Miller’s FHA Mortgage Guide post “Government Loans Show Low Foreclosure Rates” to get a better idea of what is going on with these numbers. Also take note of Commissioner Montgomery’s statements referenced above on actual FHA foreclosure numbers.

Everyone needs to sit back, take a breath and remember that the FHA program was always intended for riskier borrowers and will almost always have higher delinquency rates than prime mortgages.

All the above having been said, I still do believe that great caution should be observed in trying to use FHA as the solution to the foreclosure problems. There are deep problems going on in the economy that take more than a few feel good bills in Congress to resolve. All the hysteria over mortgages may be throwing up a smokescreen that diverts attention to the real problems caused by fundamental problems in our financial system and a bankrupt government.

Given HUD’s early June 2008 announcement that it had to withdraw $4.6 billion in May from capital reserve fund to cover unexpectedly high losses which HUD (with bad reasoning in my opinion) blames on down payment assistance programs, I am 100% in favor of driving as many good FHA loans into the system as possible in order to offset the negative effects of those defaults.

FHA approved lenders should be making similar efforts instead of directing all their marketing toward troubled credit borrowers. There are many cases where FHA insured mortgages beat conventional scenarios now for loans above 80% of the home’s value – even for good credit borrowers.

For those interested, here is the text of HUD’s letter to “at risk” borrowers:

Dear Homeowner,

Do you need help with your mortgage?

Your area is experiencing a disturbing home foreclosure rate that has accelerated in recent months. News reports cite the damaging effects of “sub prime loans” as a major factor in the unsettled market. By focusing on education and safe mortgage alternatives, though, the Federal Housing Administration (FHA) of the United States Department of Housing and Urban Development (HUD) is working diligently to address this unacceptable foreclosure trend.

Over the past few months, FHA has worked with mortgage loan servicers to identify solutions for the crisis facing current homeowners. Your current mortgage does not have to be FHA insured for you to benefit from our help. If you are facing financial difficulties due to a recent or imminent mortgage reset, or other housing-related difficulty, I urge you to contact us at 1 (800) CALL-FHA. There you will have the opportunity to learn about foreclosure prevention, legal rights, and credit counseling, among other topics.

Many homeowners may also be able to take advantage of our recently announced FHASecure program. This new program allows eligible homeowners to refinance into a secure, fixed-rate FHA loan even if they are in default.

Additionally, a new partnership between mortgage companies and non-profit housing counselors called HOPE NOW is available to you. Their mission is simple: reach out to homeowners who may be having difficulty paying their mortgages. For more information or to see if your mortgage company is a member of this caring coalition please go to www.hopenow.com.

Again, please contact us at 1 (800) CALL-FHA (800-225-5342). As part of the federal government, the Federal Housing Administration wants to help you protect and preserve the American dream – your home.

Sincerely,

Brian D. Montgomery
Assistant Secretary for Housing
Federal Housing Commissioner

Now if we could just get HUD to look at some of the real causes of these losses, like FHA TOTAL Scorecard allowing debt ratios that are far too high for people in real life to sustain – a problem I plan to address in another post – then maybe FHA could really avoid having to tap into the insurance fund in the future.

You can find all the details here.

HUD has realized that making homes ineligible for FHA financing just because the loans had been transferred to subsidiaries or the lending institutions who foreclosed didn’t fit the guidelines was causing more harm than good in an already devastated housing market. The foreclosure problem is causing enough damage without needlessly blocking legitimate lenders from selling homes with FHA financing.

Keep in mind that this does not mean open season for “house flippers” again. In HUD’s press release, they state:

With certain exceptions, FHA currently prohibits insuring a mortgage on a home owned by the seller for less than 90 days. This prohibition is intended to prevent property “flipping,” a predatory practice that strips a home of its equity before being quickly resold at an inflated price to an unsuspecting buyer. FHA’s new policy will permit the immediate sale of foreclosed properties to legitimate borrowers wishing to use FHA-insured financing.

The waiver is limited to “sales of properties acquired by mortgagees, whether sold directly by mortgagees, or by their subsidiaries or by vendors to whom they have transferred titles to properties for the purpose of effectuating sales of those properties.” In other words, this waiver does not apply to foreclosed homes that have been purchased by investors in hopes of making a profit.

This could be a real boon to smart first time homebuyers in today’s market.

I’m about to place in your hands one of the most powerful tools there is to make sure you get your loans approved by FHA underwriters – the ability to excel at packaging a loan submission.

First things first. These tips are worthless without the proper foundation. Here’s that foundation in one sentence: Make sure you have a borrower who really deserves a loan!

I know loan officers think everyone who wants a home deserves a loan as long as there is any way to squeeze them into the FHA guidelines. Use common sense though. Make sure you really do believe someone will be able to make the payments before you go out of your way to get a mortgage approved for them.

Don’t use the typical excuses so common during the mortgage boom years that you “aren’t their parent” or “it’s up to them to know whether they can make the payments” or “they’ll just go on to someone else.” These excuses are a prime reason that today you are having to fight tooth and nail to get loans approved that were once easy to close.

I’m not telling you all your customers must have pristine credit. I am saying you should not be helping deadbeats who haven’t changed their habits, but want a home because “they are tired of throwing their money away on rent.” Market yourself better and find the people who really did have an unexpected problem ruin their credit and who have learned their lesson. Remember FHA will cut you off from the program if you allow too many deadbeats through your filter anyway.

With that in mind, here are 3 power tips for writing an effective FHA credit explanation letter.

Tip Number 1: Don’t write the credit letter. Let the borrower put it in their own words.

Probably not what you were expecting, but this is very important. A perfect letter put together completely by the loan officer can easily be detected by the underwriter and it will hold less weight when they see it. Allow the borrower’s own words and own personality to make their way into the letter.

Tip Number 2: Don’t leave the borrower completely on their own to write the letter.

Most loan officers still simply give the borrower a list of derogatory accounts and ask them to explain them. Don’t do that. Give your borrower the proper guidance. Tell them what you expect from them.

Sadly, the average high school graduate today is functionally illiterate when it comes to the task of putting together such a letter. You are doing good people a disservice when you leave it all up to them. They could probably do a fine job of explaining it themselves if they were speaking directly to the underwriter and the underwriter could ask follow up questions. That doesn’t happen anymore, so you must help them get it right from the beginning.

After the borrower explains the details of the situation which caused their credit problems and you have informed them that it is a crime to lie in this instance, have them write out exactly why the problems happened. Make sure they address and account for every single negative item on the credit report no matter how old or how insignificant it appears. Get them to explain in their own words why they feel this problem won’t happen again and exactly what they have changed in their life to prevent it from doing so. Then have them explain why they feel the underwriter should reasonably expect them to be able to make the payments.

Don’t skip any of those points. Once the borrower understands what is needed, let them put it in their own words.

Many loan officers tell their borrowers to keep their explanation letter short. Don’t fall into this trap. Make sure the borrower explains everything in tedious detail to the point that anyone who picks up that loan file 10 years from now can easily understand why this borrower ended up being approved.

Here’s a bonus tip: To satisfy the underwriters who don’t like to read, always include your own cover letter in the submission file briefly summarizing the borrower’s credit explanation and adding your own interpretation of which compensating factors the underwriter should consider.

When you structure the explanation part of your file this way, you are helping the underwriters make the decision without having to figure out on their own how they are going to justify it. This makes them more comfortable giving you an approval with fewer conditions.

Tip Number 3: Document the borrower’s credit explanation and solution.

This is the extra punch even experienced loan officers often leave out, but it is the step which can take you above the level of the average loan officer into the category of miracle worker in the eyes of your borrower and their real estate agents.

Get some documentation to prove the borrower’s credit explanation is true and that their explanation of how they have changed things is true. I know this involves extra work for you and for the borrower. It is worth it. If the borrower had a medical problem get something from the doctor, or include bills in the file. If the borrower was laid off, include a copy of their termination letter or evidence of receipt of unemployment benefits. If the borrower said their problems occurred because they had no medical insurance, prove they have it now. You get the idea.

Of course the borrowers often have difficulty finding this type documentation. That’s why the average loan officer never gets it. Push them. It doesn’t take much documentation to add considerable punch to your case that the loan should be approved.

Every day I talk to loan officers crying over turned down files that should have been approved. The common element in almost all of these cases is that the loan officer left it up to the underwriter to figure out why the loan should be approved. To avoid extra work which might be wasted, loan officers submit the loan hoping it will slip through without having to provide this documentation. Underwriters don’t have time for this. When you put them in this position their answer will be to turn the loan down or approve it with approximately four thousand conditions of approval.

Times are difficult in the mortgage industry today. The mortgage originators who survive will be those who find a way to help the people other originators aren’t helping. Becoming an expert on FHA loans can be the best way for a loan officer to do that. Use these tips to get more loans approved and get more referrals from your happy customers.

1. Make sure the loan you are submitting makes common sense.

Incredibly, this is one of the most common mistakes made by originators who entered the mortgage business within the last 5 to 7 years. Subprime programs generally only required that the loan fit into their matrix and never cared about the reasons the person had credit problems. Make sure that you can verbalize a good case that it makes sense to believe that this borrower can reasonably be expected to make the payments on the loan. Often this requires asking a lot of uncomfortable questions of the borrower to make sure that you truly understand their situation. Even when your submission is approved by the automated underwriting system and theoretically the underwriter needs only to validate the information and not make a credit decision, the underwriter may well find something wrong if the loan does not make common sense. Lenders are held accountable by HUD for loans that default. They can always find a reason to override the automated underwriting findings if they want to.

Stating a good case for loan approval is even more important when the FHA Total Scorecard underwriting system has referred your loan to an underwriter to make the decision. Do not ever assume that just because the debt to income ratios meet guidelines and the borrower hasn’t been late on any payments in the last 12 months that you don’t need to submit a well constructed cover letter with your loan – in addition to the borrower’s own credit explanation. Make sure that both your cover letter and the borrower’s explanation fully account for what happened to cause the borrower to have credit problems and why the underwriter should now believe that the borrower has solved the problem.

Loan officers who “grew up” in the days of subprime lending based on credit scores and matrices often foolishly leave it up to the underwriter to probe through a huge stack of papers in the submission to come up with their own justification for approving the loan. Rest assured that the underwriter is too busy to do that and will only gripe about you to their colleagues after they give you an approval with a stack of conditions which are often impossible to comply with. This is one of the most common rookie causes for real estate closing delays. Let the underwriters know what you want them to base their decision on and you stand a greater chance of getting an easy approval with conditions you can comply with.

2. Check the CAIVRS number before processing the loan.

CAIVRS stands for Credit Alert Interactive Voice Response System. Don’t ask me why HUD sometimes transposes that to CAVIRS instead of CAIVRS in their own documentation. I guess it sometimes serves their purposes to keep the public confused?

The CAIVRS system verifies that the borrower has not been disqualified from using government insured financing because of past defaulted FHA/VA mortgages, student loans, or any of several other reasons. An amazing number of people are not aware that they have officially been excluded from FHA financing. This commonly happens due to “charged off” student loans that the borrower may have long forgotten about and which also do not show up on their credit report any longer. Just slightly less common are cases where the borrower’s ex-spouse was foreclosed upon and the borrower says they were not even aware of the situation. Strangely, even this fails to show up on the borrower’s credit report fairly often.

Whatever your company’s procedures, make sure you check the CAIVRS as early as possible.

3. Collect all the correct documents.

Make sure you have documentation to support the information you entered into the automated underwriting system, or that was mentioned in your cover letter and the borrower’s explanation letter. Surprisingly again, many loan originators fail to think ahead strategically when compiling their loan submission package. Loans which started out with an approval from FHA Total Scorecard often revert while in process to a “referred to underwriter” status.

First, this would occur much less often if originators took the extra few minutes necessary to verify the information being submitted by examining original paystubs, W2s, divorce decrees, bankruptcy filings and other support documentation before turning the loan over to their processor.

Second, if the loan is later unexpectedly downgraded to refer status, much more documentation is needed.

Here are a few quick but painful examples of that.

When there is no valid automated approval the borrower’s rental history must be verified. I have seen many loans fall through at this stage because the loan officer failed to even ask the borrower if their rent had been paid on time! Remember, the rental history is not a factor if the loan is approved by automated underwriting because that history is not shown on a borrower’s credit report.

Another common version of this problem occurs when the loan officer fails to examine documentation showing that extra income (for example, child support payments) has been received consistently in the past and that payment is going to continue. Again, the loan ends up falling apart well into the processing stage, leading to much greater frustration and anger from borrowers and real estate agents thus disappointed.

An equally common mistake is not verifying that a retirement account submitted on the application as an asset can legally be liquidated if necessary. For example, many teachers have substantial funds in their retirement accounts, but these funds often can not be liquidated unless the teacher is fired or dies. These funds are not considered to be liquid assets but many rookie loan officers get automated approvals based on these funds which subsequently go down in flames.

4. Compute the income accurately.

Sounds obvious, I know, but tales of mortgage closings which fall through because the borrower’s ratio of debt to income is too high are legion among real estate agents as they swear to never use that particular mortgage broker or lender again. Real estate agents and borrowers are reasonably amazed that such a basic element of the loan approval process could have slipped by the mortgage originator’s attention until so late in the process.

Here’s what happened. The loan officer asked the borrower “How much do you make?”. The borrower told them an amount from their last paycheck, or worse an amount from their best paycheck. The loan officer submitted the loan through automated underwriting and received an approval so they told the agents and borrower to go ahead with their purchase offer only to find out after finalization of the purchase contract that 30% of the borrower’s income comes from overtime pay they have only been receiving for the last year. Oops, this doesn’t fit into FHA guidelines. Alternatively, the loan officer does look at the borrowers paycheck ahead of time, but fails to note that part of the gross pay comes from overtime or bonus pay or commission pay. So the originator submits the gross income, but it isn’t entered into the system correctly and factors such as commission income actually play an important part in the automated systems risk analysis of the loan. Either way the result is not good for the parties involved.

One effective strategy to prevent this is to be very conservative in determining the borrower’s qualifying income and not count bonuses and overtime pay when submitting the loan for automated approval unless absolutely necessary. If the borrower has been qualified with less than the maximum income that can be squeezed into the loan officer’s calculations, unpleasant surprises are less likely to occur.

5. Be sure you have ALL the borrowers assets listed and listed correctly.

Loan officers frequently fail to gather complete information on all the borrower’s assets once they have an automated approval. Once again, automated approvals are downgraded to “referred to underwriter” status fairly frequently for many strange and different reasons. A good strategy for the mortgage originator is to gather documentation for every dime in every account the borrower has squirreled away anywhere, but submit the loan through the automated underwriting system with the fewest assets necessary to get an approval. When the loan is downgraded later on, the extra assets can often save the loan officer’s reputation.

Another common mistake regarding assets has already been mentioned. The assets must be verifiably liquid. For this reason, FHA guidelines require that the loan file include proof that the assets would be available to the borrower without being fired or dying. In addition, due to potential withdrawal penalties, FHA loan guidelines will allow only 60% of the vested amount of the account to be counted towards the borrower’s liquid reserves. Frequently, the entire balance has been submitted into the automated underwriting system.

These 5 tips won’t guarantee your deal will go through underwriting without a hitch. After all, FHA guidelines seem to change daily now, but a little attention to these details will go a long way toward improving your reputation among borrowers and real estate agents.

I’d love to hear more tips, traps and problems to watch out for from the originators, underwriters and managers in the trenches.

Then came the effective demise of the subprime mortgage market and a credit crunch in the conventional financing arena. In the mortgage industry, we started to repeatedly hear the mantra “FHA is the new subprime”. We’ve been waiting for the “modernization” of the FHA program. I’ve even been pushing that agenda myself.

Each month more of the former subprime specialists have moved into FHA mortgage origination. Unfortunately, many have also brought along their excessive reliance on loan matrices and credit grading instead of common sense analysis of the borrower’s patterns of credit usage. One of the most common questions I receive from mortgage brokers through the contact form of this website is some version of “How many late payments are allowed in the last 12 months on FHA”. I often get the electronic equivalent of a blank stare when I tell them it depends on why the payments were late. Originators who entered the market since 2000 or so aren’t accustomed to caring why a borrower’s credit is in it’s present condition.

As a result, FHA loan production has jumped precipitously in 2008. Unfortunately, many of the originators of those FHA loans have not taken the time to learn the programs. They are submitting incomplete loan packages with no credit explanations, no cover letters, often no FHA required disclosures. One of the complaints I hear constantly now from underwriters is that they are nearly having to process the loan files themselves rather than concentrate on their underwriting. Underwriting turn around times are stretching to several weeks with many lenders!

Predictably, since FHA underwriters and lenders are held responsible for defaults on the loans they approve, this deluge of applications resulted in a tightening of the underwriters’ attitudes about what they would accept. It just wasn’t worth the chance of missing something under pressure when large numbers of loans are being submitted to them by a group of people accustomed to trying to slip something by the underwriters rather than be responsible for the loan’s performance themselves.

Now the tightening has gone further. Several lenders have started implementing credit score requirements for FHA loans. This requirement started at 500, moved to 550 and now several lenders are requiring 580 credit scores. One of the latest to require a 580 score (as of March 28, 2008) is Flagstar Bank, traditionally known among FHA originators as one of the most common sense based FHA lenders in spite of their conservative outlook on the conventional side of things.

This trend is a snowball rolling downhill, because as more lenders institute this guideline lower credit score loans are going to become concentrated among the few lenders who haven’t instituted the requirement. As their ratio of low credit score loans to total originations increases, these lenders are going to be forced to institute similar guidelines in order to continue to sell their loans in the secondary mortgage market.

So, if you’re part of a young couple that listened to the wise advice of financial guru Dave Ramsey and you have no credit cards and no debt, there’s a good chance you are about to be locked out of the housing market. At least temporarily. If you’re older and you were laid off and lost your health insurance just prior to a major health problem, you may be locked out of the housing market even though you have since fixed the problem. Lenders don’t mean any personal insult in doing this. It is purely self defense.

If you’re a loan originator just now entering the world of FHA mortgage origination, these are dangerous times. Please don’t just try to wing it or rely on your processor. Get some education. Preferably get together with an experienced mentor to learn what to do. Let’s not allow this problem to get completely out of hand before we do something about it.

First, as a preface for my next update I would like to point you to Peter Miller’s blog FHA Mortgage Guide where he points out reports that HUD itself has been violating RESPA for some time! You can find the post entitled “Fake Morality” by clicking on the links in this paragraph.

Second, I would like to point out that HUD has released new RESPA guidelines for public comment. We have been waiting for quite some time to see these guidelines and you can download them here. Make sure you are on a high speed connection or have a little time to spare, it is 96 pages long. Keep in mind that this is just a release for public comment and is not necessarily the final version.

I will have more comments on these guidelines in the next few days and would love to hear yours.

FHA loans do not have prepayment penalties with one small exception. When you pay off an FHA loan through either selling or refinancing the property, you must pay interest through the end of the month in which you are paying off the mortgage. So if you are selling or refinancing to pay off an FHA mortgage, make sure your payoff reaches your lender as close to the end of the month as possible. Otherwise, you will be paying interest for the rest of the month after you have already paid off the mortgage.

Feel free to contact me through the contact form at the top of the page if you have any questions.

More mortgage broker education on FHA Guidelines is available in “ABCs of FHA Lending“.

Issue Number 1: FHASecure

Personally, I have pretty much given up on FHASecure. If I find someone who miraculously actually qualifies for the program, their second mortgage holder often insanely refuses to resubordinate their lien.

It is my opinion, though, that the substantial publicity for this loan program has caused more people to look into using the FHA program after they thought they had no way to refinance their mortgage due to falling home values. There has been a real value to that. The standard FHA program already provides a solution for many. They had no other choice but FHA, but they never would have tried FHA without the publicity.

Amusingly, as often occurs in government bureaucracies headed by political appointees, HUD has seemed to be chasing their tail lately trying to put the best spin on the FHASecure program. Now, according to an article by Peter G. Miller in Realty Times, they have come up with the claim that the term FHASecure really applies to any conventional to FHA refinance! Huh? I know what I heard in the conference calls and read in the mortgagee letter, and this is definitely not what it started out as.

You can find Peter’s article at: http://realtytimes.com/rtpages/20080116_hudconfusion.htm. I encourage you to go and read it.

You can also find HUD’s Frequently Asked Questions for lenders about FHASecure at http://www.fha.gov/about/fhasindqa.cfm. You can get detailed answers to a lot of the questions you may have about the FHASecure program guidelines there.

Issue Number Two: Risk Based Mortgage Insurance

There has been a lot of discussion among the sources I read about how the FHA Modernization bill we are all pushing would shoot itself in the foot by adopting risk based mortgage insurance. I partially agree.

I have been in a state of confusion about this because HUD’s original entry in the Federal Register and even their Frequently Asked Questions page both indicate that regardless of FHA Mortgage Reform risk based mortgage insurance was to take effect on January 1, 2008. Yet it seems to have been delayed although I personally haven’t seen any official notification of the delay. I only know that I have just been told by lenders that it is business as usual. This comes from the HUD FAQ:

“In addition, why has FHA waited until now to price for risk, as do other insurers?

Since it appeared unlikely that Congress would appropriate funds for FHA to continue its operations, FHA had a choice: either raise premiums across the board for all borrowers, thereby exacerbating adverse selection, or adopt the risk-based premium structure, with existing caps, that takes effect January 1, 2008.”

Those against the risk based mortgage insurance point out a GAO study done in July 2007 which indicates that when risk based mortgage insurance rules are applied that:

“GAO’s analysis of data on 2005 FHA home purchase borrowers shows that 43 percent would have paid the same or less under the risk-based pricing proposal than they actually paid, 37 percent would have paid more, and 20 percent (those with the highest expected claim rates) would not have qualified for FHA insurance.” (emphasis added)

Obviously, it would completely ruin the effect of FHA mortgage reform if 20 percent of those who would qualify for an FHA loan won’t even be eligible any more. However, there are at least a couple of other factors at work here.

First, is the fact that we don’t know exactly how the final bill will look. The Senate version delays the implementation of the risk based mortgage insurance for a year in order to allow for more time to work on the details. I think this is prudent. So if the Senate version wins out on that issue then it won’t quite be an immediate disaster. The currently published version of the risk based mortgage insurance excludes those borrowers with no credit score from maximum financing. I would hope that the potential delay in implementation could provide time to fight that provision.

Second, according to HUD’s FAQ again:

“…because FHA’s premiums are now based on risk, it can lower the accept/refer cut point to allow a greater percentage of mortgages to receive the accept risk classification with all the associated benefits, e.g., documentation relief.” (emphasis added)

We don’t know, and GAO didn’t know when they did their study last year, what the potential effect of this change might be. I don’t know if it would make up a 20% loss or not. And, honestly … nothing personal if you are one … but I don’t trust the work of government bureaucrat accountants anyway. Government numbers rarely work out as predicted.

What I do know is that FHA foreclosure rates aren’t that bad. Check my earlier posts in the archives for more information on that. So the program doesn’t really need all that much tweaking or modernization. I hope that politics on this issue doesn’t take a good idea and turn it into a disaster. I would love to hear your comments. Just click on the link below that has the word “comments” in it.

I’m not talking about the underwriters but the underwriting rules themselves. The underwriters were just following them. The commenter felt that while the boom was underway conventional underwriters were pressured to to do their jobs too quickly and thus made mistakes.

They definitely did receive pressure, however FHA underwriters had all the same pressures, and had all the same time constraints yet FHA default rates have actually gotten lower. The reason is that HUD holds the lenders accountable and will cut them off from the FHA program if their default levels are too high. So if a lot of business comes in the door, underwriting times just get longer. They don’t relax the rules because they know they’re selling the loan to someone else and won’t have to worry about it. HUD will cut the lender off no matter who holds the loan when it defaults.