Congress has until August 2, 2011 to resolve the debate over increasing the federal debt ceiling. A failure to increase the debt ceiling would result in the shutdown of nonessential government services.
No one expects that social security checks or paychecks to the military and other essential personnel will stop being issued but a raft of agencies deemed nonessential will inevitably face shutdown, including the Federal Housing Administration (FHA).
According to David Min of the Center for American Progress, who has studied this issue, administrative functions at the Internal Revenue Service and Social Security Administration would likely be shutdown. As a result, lenders would be unable to process and approve FHA loans since they would be unable to verify borrowers’ social security numbers or obtain transcripts of required tax returns.
FHA lending could virtually grind to a halt if lenders are unable to obtain identity and income verifications necessary for the underwriting and/or approval of an FHA loan. Home buyers who have applied for FHA financing would not be able to close. In addition, the housing market would be greatly disrupted since potential home buyers would not be able to receive preapprovals required by most Realtors and home sellers. According to Mr. Min, the resulting drop in demand for housing due to FHA borrowers being locked out of the market could “cause housing markets to lock up”, leading to large house price declines.
Mr. Min notes that those most affected would be those trying to purchase, refinance or sell a house, but in the end, millions more would suffer as home equity disappears due to declining housing prices. Since 25% of all American homeowners are already in a negative equity situation, a further drop in home values would lead to higher defaults and foreclosures as homeowners throw in the towel on a hopeless situation. The downward price spiral in housing would be perpetuated since an increase in defaults would lead to more foreclosures and increased unsold housing, leading to additional negative equity, increased defaults and further drops in home prices.
An additional risk of not increasing the debt limit is an increase in interest rates as investors get nervous about a potential default by the U.S. on its debt obligations. The combination of higher rates and a shutdown of the FHA mortgage program would substantially harm a housing market already in crisis. The FHA, which some analysts speculate may need a future bailout, would also be harmed financially from increased foreclosures.
Housing is in horrific shape with millions of defaults and foreclosures perpetuating a downward price spiral of housing values. The last thing the country needs right now is to put additional pressure on housing markets by shutting down the FHA loan program.