October 2, 2022

Archives for September 2010

FHA Zero Down Payment Financing Returns

Home buyers can once again purchase a home using FHA financing with a zero down payment.

Previous zero down payment FHA loan programs were funded by seller contributions funneled through a nonprofit group which then donated the down payment to the purchaser.  These seller financed down payment programs were terminated in 2008 after the FHA experienced default rates three times higher than when buyers made a cash down payment.

The innovative zero down payment FHA home purchase program was recently introduced by The Lending Company of  Phoenix, Arizona.  In order to meet the FHA required 3.5% down payment the borrower receives a 2.5% gift from a non-profit organization and the remaining 1% can be gifted from a family member. 

The Lending Company notes that the program is not a seller-paid down-payment assistance program.  To further reduce the amount of cash required by the purchaser, the seller is encouraged to provide seller concessions to cover closing costs.  A borrower receiving both gift funds and seller concessions can potentially purchase a home without putting any cash into the transaction.

The Lending Company – The One Percent Down Solution Gift Program is designed to provide eligible homebuyers a gift of up to 2.5% of the sales price to be applied towards the FHA down payment and/or allowable closing costs for the purchase of a home.

Targeted towards quality affordable housing, approved homebuyers can purchase a home for as little as 1% down payment. The program also allows for the remaining 1% down payment to be gifted from any FHA allowable source.

Program Benefits:

  • The program provides up to a 2.5% gift to FHA qualified home buyers (subject to market conditions, greater gift amounts up to 5.5% may be allowed)
  • Seller can and is encouraged to contribute towards the closing costs to further assist the homebuyer
  • Minimum credit score of 620
  • Successful credit restoration allowed

It will be interesting to see how future default rates on this zero down payment program compare to earlier “seller funded” down payment assistance programs (DAP).  The Federal Housing Finance Agency is well aware that zero down payment mortgages default at a much higher rate, as detailed in a 2007 study by the Office of Federal Housing Enterprise Oversight.

This paper extends the analysis of mortgage default to include mortgages that require no down payment from the purchaser. The results indicate that borrowers who provide down payments from their own resources have significantly lower default propensities than do borrowers whose down payments come from relatives, government agencies, or non-profits. Borrowers with down payments from seller-funded non-profits, who make no down payment at all, have the highest default rates.

Source of down payment has not previously been considered in default modeling, but the relationship between default and the source of the borrower’s down payment may be related to trigger events. Borrowers who are capable of increasing their saving, or increasing their labor earnings, in response to unforeseen events may be less susceptible to trigger events. The need to save for a down payment may serve to separate those who can more readily increase saving and earnings from those who find it more difficult.

Loans with involvement from Down payment Assistance Program’s (DAPs), which effectively had no down payment, consistently showed the highest delinquency and claim percentages. Loans with a down payment from a source other than the borrower, such as a relative or government program, had lower claim and delinquency propensities, while loans with down payments from the borrower’s resources consistently showed the lowest rates of claim and delinquency.

This paper examines the case of literally “no money from the buyer” mortgages, and finds delinquencies and claim rates much higher than those for comparable loans with cash from the borrower.

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In January of this year, a bill was introduced in Congress that would have reinstated seller funded FHA down payments to purchasers through non profit groups.   The bill was never approved but  FHA Commissioner David Stevens stated his opposition, as reported by Bloomberg:

“We’ll always listen to proposals, but Secretary Donovan has been absolutely crystal clear that he’s against the idea, as am I,” said David Stevens, commissioner of the FHA, which is under the purview of Housing and Urban Development Secretary Shaun Donovan.

Stevens said that homeowners are more willing to default if they haven’t put any cash into their purchases.

“If a buyer puts down even a few thousand dollars, it’s a lot of money for them,” he said. “There’s a financial and an emotional commitment to the home that you don’t have otherwise.”

About 13 percent of down-payment-assisted mortgages originated in 2004 have defaulted compared with about 4 percent of other FHA mortgages, according to agency data.

None of the lenders, including San Francisco-based Wells Fargo & Co. and Countrywide Bank, acquired by Bank of America Corp. in Charlotte, North Carolina, incurred any losses, since mortgages they issued were insured by the FHA, the agency said.

Programs that provide down payments to purchasers may help home sales, but past experience suggests higher default rates and increased losses for the FHA.

Latest Government Scheme For Growth – The Invisible Tax Cut

Pulling forward future demand to stimulate economic growth didn’t work with the cash for clunkers program or housing tax credits.   Car and home sales collapsed after consumers who were going to buy cars or houses anyways bought today instead of tomorrow.  Past stimulus programs have increased government deficits without improving long term economic fundamentals.

Undeterred by previous failures the government is again attempting to pull forward demand, this time with accelerated write offs for new plant and equipment spending.

The new Obama tax break proposals are likely to be even more ineffective than previous stimulus attempts.  To “offset” the revenue loss of accelerated deductions, other taxes would be raised, effectively muting the net stimulus that the plan attempts to provide. 

NYT –  In a speech in Cleveland on Wednesday, Mr. Obama will also make a case for the package of roughly $180 billion in expanded business tax cuts and infrastructure spending disclosed by the White House in bits and pieces over the past few days. He would offset the cost by closing other tax breaks for multinational corporations, oil and gas companies and others.

The “tax cuts” for increased business investment merely accelerate the existing tax write off for business investments that are presently written off over a period of years.  If other taxes are raised to “offset” the accelerated tax deductions, the net effect of the plan would be to effectively increase taxes on businesses.

The lure of accelerated tax cuts (which increase cash flow) is not likely to affect decisions on investment spending since corporate America is already sitting on a record amount of cash.  Accelerating depreciation deductions will merely pull demand forward from companies that had already planned spending increases for plant and equipment. 

Rational consumers and businessmen do not base long term spending decisions on tax deductions.  Increased spending by businesses is based on an increase in forecast demand.   Consumer spending is ultimately based on confidence in the prospect for increases in future incomes.  

For good reasons, neither businesses nor individuals are confident about the future and there is deep skepticism that additional stimulus programs will do little more than increase the government deficit.  The latest stimulus plan is conceptually vacuous and likely to decrease public confidence in the government’s ability to formulate a plan for long term economic recovery.

Borrowers Chose Strategic Default On Reverse Mortgages

When reverse mortgages were last reviewed, it was predicted that many unqualified borrowers would wind up defaulting, despite the fact that a reverse mortgage has no payment due. 

As originally conceived, reverse mortgages were designed to fulfill a legitimate borrowing need.  Reverse mortgages were developed for elderly Americans who had a mortgage free home with substantial equity and wanted to cash out their home equity to supplement their retirement income without having to sell the house or face large mortgage payments.

In theory, the HECM made sense by allowing homeowners to remain in their homes and monetize their equity.  The lifetime HECM payment, along with other retirement income and savings would allow for a more comfortable lifestyle.  The only theoretical loser on the HECM program would be the FHA if property values dropped.

The HECM is available to all those 62 or older who have sufficient equity in their homes.  HECM program lends without regard to credit or income and is strictly  asset based lending.  Do these lending criteria remind anyone of  past  disastrous mortgage programs, such as  sub prime, ALT A or Pay Option ARMs??

A HECM does not require that the homeowner escrow for taxes  or homeowners insurance.  A known risk factor for default is a non escrowed loan.  The homeowner can face foreclosure  for not properly maintaining the property or for non payment of taxes or insurance.

Many homeowners taking out reverse mortgages were taking the maximum loan allowed upfront (instead of taking a monthly draw) and using the proceeds to payoff existing debt.  This choice left the elderly homeowner with little equity and no monthly cash payment to supplement retirement, a recipe for financial disaster.

The reason why borrowers are taking most of their available cash out upfront is because they are using the proceeds to pay off mortgages, consumer debt, medical bills, credit cards, etc.   Borrowers run up large amounts of debt when spending exceeds income, a situation likely to continue  after the borrower taps the last dime of equity from his home.  Since the HECM was the last option available, what happens in a couple of years when the borrower is again overwhelmed by debt?

Based on the credit profile and debt levels incurred prior to his approval of a HECM, what are the odds that the borrower’s finances turn around after his refinance?  My guess is that within a few short years, the borrower is in heavy debt again, unable to pay the property taxes or maintenance on the property and thus facing a potential foreclosure.  Since HUD will not be throwing senior citizens out of their homes, expect a mortgage modification program for reverse mortgages and further losses to the taxpayer on another mortgage program gone bad.

It now appears that, as predicted, many elderly reverse mortgage borrowers cannot afford to pay the property taxes due on their homes or are strategically chosing default since the decline in property values wiped out whatever equity they had left.  The end result is the predicted and ridiculous situation of borrowers defaulting on mortgages that do not have payments. 

This situation was confirmed in an audit report by the Office of the Inspector General.

HUD Was Not Tracking Almost 13,000 Defaulted HECM Loans With Maximum Claim Amounts of Potentially More Than $2.5 Billion

We performed an internal audit of the U. S. Department of Housing and Urban Development’s (HUD) Home Equity Conversion Mortgage (HECM) program because we found that an increasing number of borrowers had not paid taxes or homeowners insurance premiums as required, thus placing the loan in default. Also, we noted that HUD had granted foreclosure deferrals routinely on defaulted loans, but it had no formal procedures.

We found that HUD’s informal foreclosure deferral policy and its reversal had a negative effect on the universe of HECM loans and loan servicers (servicers).  As a result, four servicers contacted were holding almost 13,000 defaulted loans with a maximum claim amount of more than $2.5 billion, and two of the four servicers said they were awaiting HUD guidance on how to handle them. Further, the servicers had paid taxes and insurance premiums totaling more than $35 million for these 12,958 borrowers…

Since unreported defaulted loans were only obtained from 4 of a total of 16 HECM servicers nationwide, more defaulted loans may exist. Further, as HUD could not track these loans, it did not know the potential claim amount. In the event of foreclosure of the 7,673 loans for which HUD was aware and 12,958 loans of which it was not aware, HUD could lose an estimated $1.4 billion upon sale of the properties.

FHA Introduces New Minimum 580 Credit Score Requirement

The FHA is introducing new guidelines on loan to value ratios and the minimum credit score required for FHA borrowers.  As detailed in a Mortgagee Letter from the Department of Housing and Urban Development (HUD), the following credit requirements will apply for FHA borrowers, effective October 4, 2010.

  • To be eligible for maximum financing, borrowers will need a minimum credit score of 580 or higher.
  • Borrowers with a credit score between 500 and 579 will be limited to a loan to value of 90%.  A sub 580 FICO credit score borrower will henceforth need to make a 10% minimum down payment on a purchase transaction.
  • All  borrowers with a credit score below 500 will not be eligible for FHA-insured mortgage financing.

HUD’s newly introduced minimum credit score and loan to value requirements will apply  to all single family loan programs, except for Reverse Mortgages (Home Equity Conversion Mortgages) and Hope for Homeowners.

The new credit requirements are not expected to dramatically change the number of FHA mortgage approvals.  Most  lenders had already imposed a minimum credit score requirement of 640 or higher for FHA borrowers.  In limited cases, borrowers with scores between 620 and 639 could still obtain mortgage approval.

Many potential FHA borrowers with scores below 640 who cannot obtain mortgage approval may be left wondering why this is the case if the FHA has established a minimum score of only 580.  The explanation for this is that the FHA does not make mortgage loans but rather insures FHA loans made by lenders.  Despite the FHA insurance, banks do not have an iron clad protection from loss.

To protect themselves from loss exposure, FHA lenders impose various requirements that may include establishing higher minimum credit scores.   Some of the factors that influence banks in their assessment of risk on FHA loans are discussed below.

More and more banks are increasing the minimum credit score on FHA loans to attract a better overall execution (sales price) on their securities which improves profitability.  Nonetheless, the increase in the minimum credit score isn’t always about protecting the bank on a potential future loss.  In a lot of cases a bank feels more comfortable with a profit model that positions itself as a mortgage seller with a higher weighted average credit score on their pool for many other factors.

A credit score is an 18 month predictive measure of future performance but is not as reliable when a state or region is hit by some unpredictable negative economic factor.  An increase in the minimum credit score can be used as an override to protect against losses resulting from a sudden downturn in the economy.

Each bank executes a contract of sale with defined representations and warranties on their future liability.  The penalty (or loan buyback provision) is legally defined in the contract between seller and buyer of the loan.  However, not all contracts are the same with regard to liability issues.  When a loan default occurs, a post closing quality control review takes place.  If the loan originator was negligent with respect to due diligence, the bank is subject to full recourse provisions and required to repurchase  the loan which usually results in large losses to the bank.  An example of this occurred recently when Bank of America announced that Fannie Fae and Freddie Mac were demanding $10 billion of loan repurchases.

Given the complexities and potential losses to banks on the origination and sale of FHA loans, it is unlikely that banks will be decreasing their minimum credit score requirements any time soon.

More On This Topic

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What Are My Odds Of FHA Loan Approval With A FICO Score Below 620?

Basic Requirements To Be Eligible For FHA Financing