July 22, 2024

FHA Loan Losses May Trigger Taxpayer Bailout and Higher FHA Insurance Premiums For Borrowers

Due to increased loan losses on FHA insured mortgages, borrowers may soon be facing an increase in FHA insurance premiums.

In testimony before Congress, Shaun Donovan, Secretary of the U.S. Department of Housing and Urban Development (HUD), stated that due to an almost total depletion of the FHA Mortgage Insurance Fund, it may become necessary to impose higher insurance premiums on FHA insured mortgages.

The FHA is required by Congress to maintain an insurance fund capital ratio of at least 2% in order to cover losses on insured mortgages.  An audit of the FHA’s reserves by the GAO show that the fund’s reserves fell again last year by $2.6 billion.  The FHA’s reserves have been below the minimum 2% requirement since 2009 despite steps taken by the FHA to improve loan portfolio quality.

According to Secretary Donovan, “For the near term, any worsening of economic conditions in 2012 that creates a diminished value on the current, outstanding portfolio in excess of approximately $7 billion would put the MMI Fund in a position where additional support would be required. Should it be necessary, the first place where additional support for the current portfolio would come from is net receipts on new endorsements. FHA could also implement policy changes, such as insurance premium increases, to provide further support to the Fund.”

The FHA has also taken actions to ensure that a taxpayer bailout of the FHA will not become necessary.  Secretary Donovan noted that the FHA has raised mortgage insurance premiums three times since 2010 and implemented more stringent credit score requirements for borrowers which require a 10% down payment by borrowers with a credit score below 580.   In addition, the FHA will soon finalize changes regarding seller concessions.  According to Donovan, allowable seller concessions will be reduced and will not be allowed to exceed actual closing costs.  In the past, seller concessions, were usually covered by inflated appraisal values rather than true economic concessions by the seller.  The result of abuses with seller concessions ultimately wound up increasing the FHA’s losses on defaulted mortgages.

Further contributing to losses on FHA insured mortgages were lending abuses and outright fraud by FHA approved lenders who approved unqualified borrowers that later defaulted.   Secretary Donovan stated that “as a result of FHA’s heightened oversight of lenders, over the past three fiscal years HUD has withdrawn the approval of over 1,600 lenders to participate in FHA programs.”

The FHA has been swamped with losses for loans made during the height of the housing bubble.  Loss claims for the years 2007 to 2009 surged as housing values collapsed.  Losses for 2010 and 2011 have declined but are still at very high levels compared to earlier years.

The FHA’s biggest worry is a continued slide in housing prices which could potentially wipe out the FHA insurance fund completely and result in the FHA requesting a bailout from the U.S. Treasury.  According to the FHA, if the decline in housing prices for 2012 is the same as in 2011, the decline in the value of the FHA loan portfolio would require the FHA to request $13 billion from the U.S. Treasury.

Some private analysts are predicting that the FHA will ultimately need a much larger bailout by the taxpayers.  In October 2011, an astonishing 17% of all FHA loans were in some stage of delinquency.

According to Edward Pinto of the American Enterprise Institute, the FHA will need another $21 billion bailout to reach its 2% congressionally required capital reserve if the losses on delinquent loans match previous loss ratios experienced by the FHA.

Based on the huge number of defaulting FHA mortgages, it seems likely that the FHA will be forced to belatedly implement higher down payments, higher insurance premiums and more stringent underwriting requirements.  If housing values continue to crash, even these measures may not prevent the FHA from a collapse similar to what we saw with Fannie Mae and Freddie Mac.