December 21, 2024

Elderly Americans Last Refinance – Reverse Mortgages

July 6, 2009 by 1 Comment

Reverse Mortgages – More Easy Lending

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.

Almost all reverse mortgages are purchased by HUD and insured by the Federal Housing Administration (FHA).  FHA insured reverse mortgages are known as “home equity conversion mortgages” (HECM) and they provide the following advantages to elderly homeowners:

  • Provides supplemental cash income to elderly homeowners.
  • Does not require a monthly payment.
  • Allows the homeowner to remain in his residence until death or sale of the property.
  • Should the borrower decide to sell and move, the  amount of the loan repayment cannot exceed the value of the house.
  • HECM allows the borrower either a monthly lifetime payment (based on value of the home and age at time of mortgage closing) , a lump sum payment, a line of credit or a combination of the above choices.

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.

HECM Program – Theory VS Reality

The disadvantages for a borrower of a reverse mortgage are as follows:

HECM rules require a borrower to make a full draw at closing to obtain a fixed rate mortgage.  Most borrowers take the adjustable rate option and a line of credit.  The adjustable rate HECM presently has a low borrower rate of around 3.1% based on a lending margin of 2.75% and a LIBOR index of only .32%.  At some point rates will rise again and rates on the HECM could rise dramatically – the lifetime cap on the loan is over 13%.  Borrowers could see their credit lines reduced and their equity vanish quickly with higher interest rates.

Borrowing money without having to make a loan payment equates to compounding interest working against the borrower since the loan balance increases each month along with interest charges.  Borrowers who later decide to pay off the HECM and sell their homes may find that most of their equity has been lost due to accrued interest.

The HECM is a very complex product.  Despite the fact that HUD requires a potential borrower to receive financial counseling, it is unlikely that most borrowers fully understand the type of mortgage they are taking out.

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??

The fees on a HECM are very high and include an upfront and monthly mortgage insurance payment to the FHA, loan origination fees and other closing fees.  Total fees over the life of the loan can reach 12%.

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.

The most striking feature regarding the use of reverse mortgages by elderly Americans is the large amount of equity that is being extracted upfront, leaving them with only a small future monthly cash payment as can be seen in Exhibit 3 below.

HECM CASH PAY BY YEAR

HECM CASH PAY BY YEAR

Courtesy: HUD.GOV

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?

HECM – Loan Of Last Resort

The number of reverse mortgages has increased tremendously as other borrowing sources have disappeared.  Many of the reverse mortgage borrowers are retirees with limited income who would not qualify for a traditional mortgage loan under current underwriting guidelines.  In the past, many of these borrowers would have taken out a stated or no income verification mortgage.   The  large increase of HECMs starting in 2005 correlates to the time period during which no income verification loans were being discontinued.

Reverse Mortgage Volume

Reverse Mortgage Volume

Here’s an actual example of a HUD approved HECM.  Borrower has a home worth $525,000 and owes $290,000 in mortgages and other debt which will be paid off with a $350,000 HECM.  Homeowner is left with about $60,000 at closing.  Borrower has an abysmal credit score of 510 and  is 90 days past due on his current mortgage.  Income is unknown since HUD doesn’t care about the borrowers income.

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, 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.

More on this topic

Smarter planning would probably eliminate the need to borrow when retiring.   Bob Adams writes an informative and thoughtful blog on the challenges of successful retirement – a site worth bookmarking.

Filed Under: FHA, FHA Defaults, Housing, loan modification, Mortgages, refinance, Reverse Mortgages Tagged With: , , ,

TARP 2 – Will Bad Loans Wipe Out Newly Raised Bank Capital?

June 22, 2009 by 1 Comment

Are The Banks Paying Back TARP Money Too Soon?

Since the beginning of the year, major banks have raised over $200 billion in capital, far in excess of the $75 billion of new capital that the government stress tests had called for.  The market prices of major bank stocks have recovered dramatically since March, indicating that Wall Street investors see a recovery in the banking industry.

In addition, the banking industry is enjoying one of the largest net interest margins in history due to a very low cost of funds.  Wells Fargo, for example, in the fourth quarter saw its average cost of funds decline to 1.5% while its net interest margin exceeded 4%.  With banks able to access cheap funding thanks to the super low rate money policy of the Federal Reserve, banks almost have a license to print money.

The big question is will the banks be able to earn enough to offset the huge amount of future write downs that will be needed on their troubled loans?  Earlier this year, Bloomberg reported that the International Monetary Fund (IMF) estimated U.S. banking losses through 2010 at $1.06 trillion.  To date the banking industry has taken write downs of only half that amount, indicating further write downs of an additional $500 billion will be necessary.

In addition, delinquency rates on $1 trillion of commercial real estate loans held by banks have been increasing at a higher rate than anticipated.  Credit card losses for the banks have also been rapidly mounting from previous estimates.

Mortgage Default Surge Could Wipe Out Banking Capital

Total Estimated Losses

Total Estimated Losses

Courtesy:  T2 Partners LLC

The banking industry’s mortgage portfolio is the real wild card and may result in the need for huge additional write downs to cover the cost of mounting defaults.  The banking industry is facing a potential nightmare surge in mortgage loan defaults, even if real estate prices stabilize at current levels due to the large negative equity positions of many homeowners.  (The above chart shows the total estimated banking losses of which only a fraction has been realized to date.)

There is no historical model to predict the correlation of mortgage defaults to equity position, but one would expect that being deeply underwater on the mortgage will result in a strong economic motive to stop paying or simply walk away.  How many homeowners, for example, will continue to make a mortgage payment on a $200,000 mortgage when the home is valued at $100,000?  The greater the negative equity, the greater the odds of a mortgage default, especially if the homeowner is under financial stress.

Unfortunately, the problem of negative equity is not theoretical.  In the latest overview of housing and the credit crisis, T2 Partners LLC, has assembled an in depth excellently documented case on why the pain in housing is not about to end quickly.  One eye opener in the report is the estimate, by type of mortgage borrower, of negative equity.  T2 shows the following stats: 73% of OptionARMs, 50% of subprime , 45% of Alt A and 25% of prime mortgage loans are underwater.  Combine this with a weak economy, job losses and negative income growth and the potential for additional huge write downs on residential mortgages seems inevitable.

The impact of a poor economy and huge negative equity is already being reflected in default rates never experienced in modern economic history.  Almost 10% of all mortgages are in some stage of delinquency or default.  The delinquency rate on prime mortgages, never expected to exceed historical delinquency rates of approximately 1%, are now over 4.5%.  Note that prime mortgage loans are the loans that were never expected to have more than a minimal default rate based on the borrower’s credit and income characteristics.

The banking industry is likely to need every dollar of newly raised capital and then some to cover future loan losses.   If future banking industry profits are overwhelmed by additional loan losses, it will be years before banks can be solidly classified as well capitalized.   A capital constrained banking industry will survive in some form, but it may not be able to provide the new lending necessary to foster future economic growth

Filed Under: Banking Industry, Housing, Mortgages, Problem banks Tagged With: , ,

The Cost Of Easy Money – $14 Trillion and Counting

June 16, 2009 by Leave a Comment

Supervisory Insights – Where The Money Went

The FDIC released their Supervisory Insights report today which contains a detailed breakdown of the almost $14 trillion dollars committed by the Government to support the financial system over the past two years.   This huge commitment of taxpayer money can be viewed as the  cost of cleaning up after the Greenspan era of easy money.   The cost of the financial devastation that ensued from the easy money/easy lending era  far outweighs any illusory benefits that may have been gained.

The FDIC report easily recognized  the precipitating factors of the financial crisis of 2008.

The factors precipitating the financial turmoil of 2008 have been the subject of extensive public discussion and debate. The fallout from weak underwriting standards prevailing during a multi-year economic expansion first became evident in subprime mortgages, with Alt-A mortgages soon to follow. Lax underwriting practices fueled a rapid increase in housing prices, which subsequently adjusted sharply downward across many parts of the country.

Excessive reliance on financial leverage compounded problems for individual firms and the financial system as a whole.

One indicator of the gravity of recent developments is this: in 2008,  U.S. financial regulatory agencies extended $6.8 trillion in temporary loans, liability guarantees and asset guarantees in support of financial services.  By the end of the first quarter of 2009, the maximum capacity of new government financial support programs in place, or announced, exceeded $13 trillion.

And some of the old banking basics—prudent loan underwriting, strong capital and liquidity, and the fair treatment of customers—re-emerged as likely cornerstones of a more stable financial system in the future.

The obvious question is why were prudent loan underwriting standards abandoned in the first place?  Lenders, borrowers and regulators alike were all blinded by greed and the misguided belief that easy wealth was being created by the use of ridiculous amounts of cheap credit.  Now, at a cost of almost an entire year’s GDP, we know better – at least until next time.

Government Support for Financial Assets and Liabilities Announced in 2008 and Soon Thereafter ($ in billions)
Important note: Amounts are gross loans, asset and liability guarantees and asset purchases, do not represent net cost to taxpayers, do not reflect contributions of private capital expected to accompany some programs, and are announced maximum program limits so that actual support may fall well short of these levels
Year-end 2007 Year-end 2008 Subsequent or Announced Capacity If Different
Treasury Programs
TARP investments1 $0 $300 $700
Funding GSE conservatorships2 $0 $200 $400
Guarantee money funds3 $0 $3,200
Federal Reserve Programs
Term Auction Facility (TAF)4 $40 $450 $900
Primary Credit5 $6 $94
Commercial Paper Funding Facility (CPFF)6 $0 $334 $1,800
Primary Dealer Credit Facility (PDCF)5 $0 $37
Single Tranche Repurchase Agreements7 $0 $80
Agency direct obligation purchase program8 $0 $15 $200
Agency MBS program8 $0 $0 $1,250
Asset-backed Commercial Paper Money Market Mutual Fund
Liquidity Facility (AMLF)9 $0 $24
Maiden Lane LLC (Bear Stearns)9 $0 $27
AIG (direct credit)10 $0 $39 $60
Maiden Lane II (AIG)5 $0 $20
Maiden Lane III (AIG)5 $0 $27
Reciprocal currency swaps11 $14 $554
Term securities lending facility (TSLF) and TSLF options program(TOP)12 $0 $173 $250
Term Asset-Backed Securities Loan Facility (TALF)13 $0 $0 $1,000
Money Market Investor Funding Facility (MMIFF)14 $0 $0 $600
Treasury Purchase Program (TPP)15 $0 $0 $300
FDIC Programs
Insured non-interest bearing transactions accounts16 $0 $684
Temporary Liquidity Guarantee Program (TLGP)17 $0 $224 $940
Joint Programs
Citi asset guarantee18 $0 $306
Bank of America asset guarantee19 $0 $0 $118
Public-Private Investment Program (PPIP)20 $0 $0 $500
Estimated Reductions to Correct for Double Counting
TARP allocation to Citi and Bank of America asset guarantee21 – $13
TARP allocation to TALF21 – $80
TARP allocation to PPIP21 – $75
Total Gross Support Extended During 2008 $6,788
Maximum capacity of support programs announced throughfirst quarter 200922 $13,903

More on this topic:
FDIC Lists Root Cause For Failed Banks – Lax Regulation

Filed Under: Bailout, FDIC, Government spending, Greenspan, Housing Tagged With: ,

Banks Loss Reserves Can’t Keep Pace With Troubled Loans

June 2, 2009 by Leave a Comment

The latest FDIC Quarterly Banking Profile reveals that banks increased loan loss reserves by 11.5% and the ratio of reserves to total loans increased to 2.5%, an all time high.   Despite the large loan loss reserves, the ratio of reserves to noncurrent loans fell for the 12th consecutive quarter to 66.5%, the lowest level in 17 years.   This low reserve ratio, despite large increases in loan loss provisions  indicates that the banking industry’s estimates of future delinquencies has consistently been too low.

Reserve Coverage Ratio

Reserve Coverage Ratio

Even if the amount of noncurrent loans level off, the implications for future banking profits is a dismal picture.   In order to establish an adequate coverage ratio for noncurrent loans, loan loss provisions will have to rise dramatically.

Prime Mortgage Defaults – Another Black Swan

The banking industry’s low estimate for loan delinquencies may be due in large part to the unexpectedly large increase in default rates seen on prime mortgages.   Prime mortgages were never expected to have a default rate above the historical ratio of around 1% since these were mortgage loans made to the best customers.  In the past, the only defaults typically seen on prime mortgages were due to unexpected job loss, a divorce, illness or other factors beyond the control of the borrower.

The rapid increase of delinquencies on prime mortgages  has caught the banks off guard.   The default rates on prime mortgages is now almost 5% (5 times normal),  a true Black Swan event for the banking industry.  In addition, the  default rate could rise even higher since 25% of prime mortgage holders now have negative equity, a situation which enhances the odds of  delinquency and defaults.

Based on the rapidly deteriorating numbers for prime mortgages, loan loss reserves need to be increased significantly.  The myth that most of the smaller community banks are not exposed to the risks that afflicted the bigger banks is only partially true.   Banks of all sizes have significant exposure to the mortgage market and the growing number of defaults  by prime mortgage borrowers will cause significantly higher than expected losses at all banks.

Prime Mortgage Delinquencies

Prime Mortgage Delinquencies

Courtesy of:  moremortgagemeltdown.com

Problem Banks, Failed Banks Increasing Rapidly

The 36 failed banks we have seen this year has expanded dramatically from 25 for all of 2008, but has remained very low considering the extent of the losses in the banking sector.  Many very weak banks have apparently been allowed to stay open under the misguided hope that mortgage defaults would decrease as the economy improved.  The number of banks classified by the FDIC as “Problem Banks” has risen to 305 from 90 last year.  The latest surge in mortgage defaults due to job losses,  declines in real estate  prices and negative income trends will have a devastating effect on an already weakened banking industry.

The FDIC’s line of credit with the Treasury was recently increased to $100 billion from $30 billion.  The FDIC can borrow up to $500 billion with Federal Reserve and Treasury Department approval.  Expect to see the FDIC draw down significantly on their expanded line of credit with the Treasury as the FDIC is forced to close increasing numbers of insolvent banking institutions.

Filed Under: Bailout, Banking Industry, FDIC, Housing, Mortgages, Problem banks Tagged With: , ,

FHA’s New Mortgage Program – Free Home Plus Trip To Vegas

May 20, 2009 by 2 Comments

100% Plus Financing Available

The American Recovery and Reinvestment Act of 2009, passed early this year, provides up to an $8,000 tax credit for first time home buyers.   The tax credit refund would be given to the home buyer after filing the 2008 or 2009 tax return.

It was only a matter of time before someone would realize that this tax credit was not helping the prospective FHA home buyers who had difficulty raising the required down payment of 3.5% for an FHA purchase.  The solution seemed obvious – let the home buyer receive the tax credit money upfront to be used for the down payment.

Last week, use of the tax credit for a down payment was officially endorsed by Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development (HUD).  Mr. Donovan stated that “We all want to enable FHA consumers to access the home buyer tax credit funds when they close on their home loans so that the cash can be used as a down payment”.   Mr. Donovan noted that this is one of the ways that the government is working to “stabilize” the housing market.

Mr. Donovan’s plan may actually do more than just stabilize housing – it may set off a buying stampede, multiple offers and bidding wars at the lower end of the housing market.  Consider the following example  of a home purchase using FHA guidelines and the $8,000 home buyer tax credit.

Loan Scenario

On the purchase of a home priced at $80,000 the buyer needs the FHA required down payment of 3.5% ($2,800).  In addition to the down payment, the home buyer needs money for closing costs and prepaid items, which could easily amount to 6% of the property’s purchase price ($4,800).  The FHA also charges an upfront mortgage insurance premium of 1.75%  ($1,400).  The total amount theoretically needed by the purchaser totals $9,000.

In the real world here’s how this deal will be structured:

  • Down payment of $2,800 covered by tax credit – cost to purchaser – ZERO
  • Closing costs and prepaid items of $4,800 can and usually are worked into the purchase price since the FHA allows up to a 6% seller concession – cost to purchaser – ZERO
  • Mortgage Insurance Premium of $1,400 is added to the purchaser’s loan amount and financed by the FHA – cost to purchaser – ZERO
  • Total cash out of pocket by purchaser – ZERO
  • Cash due to purchaser for unused portion of tax credit – $5,200 – enough to easily cover a couple of weeks vacation in Vegas.
  • Based on the FHA’s default rate, approximately 15% of the new home buyers will default shortly after closing. Considering foreclosure freezes and  loan modification attempts, many purchasers can look forward to enjoying payment free housing for 2 to 3 years.

Program Benefits/Limitations

Benefits for FHA home purchaser:   Zero cash outlay to own a home,  FHA financing provided at an all time low interest rate, $5,200 cash bonus to purchaser,  plus a free long term call on the price of housing.  With these types of buyer incentives,  expect to see an increase in home purchases by the first time home buyer.

Higher incomes groups excluded:   For single taxpayers with an adjusted gross income over $75,000 and for married couples with income over $150,000, the tax credit is reduced or eliminated.

Filed Under: FHA, FHA Defaults, Housing, Mortgages, Too Good To Be True Tagged With: ,

FHA 203k Program – Financing Uninhabitable Homes

May 1, 2009 by 3 Comments

Good Intentions Gone Astray?

Vacant - Please Destroy

Vacant - Please Destroy

The Federal Housing Administration (FHA) currently provides over one third of all mortgage financing.  One unique mortgage program the FHA offers is the “Rehabilitation Loan Program (203k)”.

The benefits and features of the 203k program according to the FHA are as follows:

Funds for Handyman-Specials and Fixer-Uppers

The purchase of a house that needs repair is often a catch-22 situation, because the bank won’t lend the money to buy the house until the repairs are complete, and the repairs can’t be done until the house has been purchased.

HUD’s 203(k) program can help you overcome this obstacle by enabling you to purchase or refinance a property plus the cost of making the repairs and improvements in one mortgage.

A potential homebuyer locates a fixer-upper and executes a sales contract after doing a feasibility analysis of the property with his/her real estate professional. The contract should state that the buyer is seeking a 203(k) loan and that the contract is contingent on loan approval based on additional required repairs by the FHA or the lender.

If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs.

An iron clad rule that I have observed is that government programs once enacted never end even after they serve no useful purpose. In a different time, the 203k program made a lot of sense by revitalizing a community. It also allowed a home buyer the opportunity to acquire a property at a low price and through “sweat equity” rehabilitate the property and increase the value of the home.

Does The 203k Program Still Make Sense?

The collapse in home values and the wave of foreclosures require a reassessment of the FHA 203k program due to the huge number of vacant homes in the country.

(Bloomberg) — A record 19 million U.S. homes stood empty at the end of 2008 and homeownership fell to an eight-year low as banks seized homes faster than they could sell them.

The U.S. had 130.8 million housing units in the fourth quarter, including 2.23 million empty homes that were for sale, the Census report said. The vacancy rate was 3.5 percent in urban areas and 2.6 percent in suburbs, the report said.

U.S. banks owned $11.5 billion of homes they seized from delinquent borrowers at the end of the third quarter, according to the Federal Deposit Insurance Corp. in Washington. That’s up from $5.4 billion a year ago.

Many of the vacant homes that the FHA is lending on through the 203k program are currently empty due to the fact that they are uninhabitable (no utilities, gutted interiors, major damage, etc)  and being sold for little more than the value of the land they sit on.   Do we as a nation really need to allocate more of our limited resources to housing when we already have millions of existing vacant homes?  Would it not be more cost effective to tear down the gutted houses and put potential homeowners into a vacant home that needs minimal repairs?

Of course, once the vacant home is rehabilitated via the 203k, there is more than a 1 in 10 chance of the borrower defaulting on the new FHA loan and the home potentially becoming vacant again (See FHA – Ready To Join Fannie and Freddie.)

Filed Under: Banking Industry, FHA, FHA Defaults, Housing Tagged With: , ,

Why Does The FHA Approve Loans That Borrowers Can’t Afford?

April 16, 2009 by 4 Comments

pie

FHA Delinquency Rate Raises Questions

The latest delinquency rates reported by the FHA are troubling and raise serious questions about the qualification process for approving FHA  borrowers.   The latest FHA numbers focus on the number of borrowers defaulting within the first year of the loan as detailed in the Wall Street Journal.

Nearly 10.2% of borrowers who took out FHA-backed loans in the first quarter of 2008 had missed at least two consecutive monthly payments within the first 10 months. That was up from 2007, when 9.4% of FHA-based borrowers missed payments within the first 10 months.

But loans with seller-funded down payments, which have higher default rates, were “clearly adding to the overall losses,” said William Apgar, a senior adviser to HUD Secretary Shaun Donovan.

Congress ended the seller-funded down-payment program last fall. Loans made in 2007 with seller-funded down-payments were 60% to 70% more likely to have a 60-day default than loans made without the 100% financing, Mr. Apgar said. HUD officials told Congress that down-payment assistance programs accounted for 30% of all FHA foreclosures but just 12% of all loans.

Dubious FHA Approvals

There is obviously something very wrong with the FHA mortgage approval process when over 10% of newly approved borrowers default on payments  within the first ten months of the loan.  These borrowers should have never been approved in the first place.

The basic flaws in the FHA mortgage program have been discussed previously and center on low down payments and low credit score borrowers – see FHA – Ready To Join Fannie and Freddie. The FHA delinquency rate has exceeded 10% since 2001.  The high default rate cannot be blamed on the poor economy but rather the loose FHA underwriting standards.

The FHA goal of helping Americans to achieve home ownership is commendable but should not be done at the expense of bailouts by the American taxpayer.  The FHA is not helping those “lucky” homeowners  approved for mortgages who then discover that the financial obligations of home ownership are far greater than expected.   In this situation, the home owner becomes the loser when he should have been the winner.

By not providing long term affordable housing finance to homeowners the FHA is failing its basic mission.  To its credit, the FHA has taken some small steps to mitigate future loan losses by eliminating the seller-funded down payment program,  increasing the down payment requirement  to 3.5% and limiting cash out refinances to 85%.  In addition, the FHA has always made only full income verification loans.  The high FHA default rate, however, indicates that further initiatives are necessary.

Recommended Action To Reduce FHA Defaults

Two major initiatives that the FHA should undertake to ensure that they are not trapping potential home owners into becoming mortgage slaves are as follows:

1. Initiate a mandatory education program for first time home buyers on the risks and costs associated with home ownership.  A detailed proforma budget of all projected income and expenses should be put together to give the potential home buyer a detailed view of how realistic the goal of home ownership is and what sacrifices may be required in order to meet their payment obligations.  See Long Term Housing Stability Based On Strong Borrowers.

2.  There are many statistics and arguments being put forth as to why FHA borrowers are experiencing sky high default rates.  After cutting through the fog of confusing variables, the basic fact is that borrowers are defaulting for a very simple reason – inadequate income.   If the borrower does not have sufficient income, the odds of default increase.   Why has the  FHA not examined the correlation of income levels to default rates?

The qualifying debt ratio for a mortgage borrower is simply the the housing expense (principal, interest, taxes, insurance and mortgage insurance) divided by the borrower’s gross monthly income.  Recently, HUD Secretary Donovan stated that HUD has decided that they would seek mortgage modifications to bring a borrower’s debt ratio down to 31%, a “standard that is truly affordable for borrowers.  31% debt-to-income ratio is the right standard”. Secretary Donovan is correct and is essentially saying that the monthly housing expense should not be excessive in relationship to monthly income which is only basic common sense.

The paradox related to Secretary Donovan’s pronouncement is that FHA loans are routinely being approved at debt ratios considerably higher than 31%.  It is not unusual to see debt ratios on FHA loans well above 40% and sometimes as high as 55 to 60%.   Debt ratio approvals above 40% almost guarantee that the borrower is going to be under severe financial stress, leading to late payments and default.

The FHA is not unique in approving high debt ratio loans.  It is also routinely done by Fannie Mae (FNM) and Freddie Mac (FRE) – see Mortgages Still Being Approved For Unqualified Borrowers.

Unless the government lending agencies take a closer look at a borrower’s ability to repay, expect the cycle of mortgage defaults, foreclosures, bailouts and bank failures to continue.

More On This Topic

10 Mistakes First-Time Home Buyers Make

The Next Hit – Quick FHA Defaults

Rate of Default is Rising Among FHA Backed Loans

Filed Under: FHA, FHA Defaults, Housing, Mortgages Tagged With: , ,

Banks Offering 3.875% Fixed Rate Mortgages

April 8, 2009 by Leave a Comment

3.875%

TARP Dollars Deployed

Two Washington State banks are now offering 30 year fixed rate mortgages at 3.875%.

SPOKANE, Wash. — Spokane-based Sterling Savings Bank and Walla Walla-based Banner Bank are offering mortgages at interest rates below 4 percent to stimulate sales and help builders move homes.

Bank officials said the low rates benefit buyers and builders, and demonstrate the banks are putting federal government bailout money to work in the Northwest.

Banner received $124 million from the federal Troubled Asset Relief Program, or TARP, while Sterling collected $303 million.

Sterling is working with Golf Savings Bank, its mortgage lending subsidiary, to offer qualified borrowers either a 3.875 percent fixed mortgage rate or a 3 percent lender contribution, up to $20,000.

Golf Executive Vice President Donn Costa said the program helps reduce the inventory of unoccupied homes and firms up prices in markets where sales activity have been slow.

Sterling has set aside $25 million of its federal bailout money to the program, which has allowed it to do 10 times more loan volume than it would have without that money, Costa said.

Expect Mortgage Rates To Continue To Decline

To some extent, this low rate lending program is political theatrics and a public relations effort.   Although the banks in question are offering below market rates, Sterling Savings Bank is only allocating $25 million of its TARP funds to this program after receiving $303 million.  In addition, Sterling is accepting applications for this low rate program only from March 25 to April 15, 2009 and most borrowers will need a 20% down payment to qualify.  The program applies only to new home purchases and not refinances.

Nonetheless, expect to see more offers of low mortgage rates for the following reasons:

-The government is actively pushing  banks to lend TARP funds.

-Both the Federal Reserve and Congress are convinced that reviving the housing market is key to economic stabilization and recovery and will supply the banks with whatever amount of funds is necessary to achieve this goal.

-Continued purchases of mortgage backed securities by the Federal Reserve  (theoretically), will keep mortgage rates low.

-Banks are currently parking massive amounts of excess reserves in low yielding treasury securities.  At some point, especially if the housing market appears to be stabilizing,  funds should start flowing  from treasuries into mortgages. This asset reallocation  would be highly profitable for the banks, given the wide spread between cost of funds and mortgage yields.

In the long term, free market forces will ultimately determine the level of mortgage rates and housing prices.  In the short term,  I would view any  chance to refinance in the mid 3% range as the opportunity of a lifetime.

Filed Under: Banking Industry, Housing, Interest Rates, Mortgages Tagged With:

Feds Say FHA May Need Taxpayer Bailout

April 3, 2009 by 1 Comment

big bag of indeterminate moneyFHA Bailout Appears Likely

Government officials said that a taxpayer bailout of the FHA appears likely based on increased mortgage defaults.  The FHA has traditionally had higher default levels than Fannie Mae or Freddie Mac due to more lenient underwriting standards.  For those familiar with the FHA lending program, a taxpayer bailout comes as no surprise (see FHA – Ready to Join Fannie and Freddie).

FHA Losses Spur Talk Of A Taxpayer Bailout

WASHINGTON — Rising mortgage defaults could force the Federal Housing Administration to seek a taxpayer bailout for the first time in its 75-year history, housing officials and lawmakers said during a Senate hearing Thursday.

If defaults drain the FHA’s insurance fund, the Obama administration will have to decide whether to ask Congress for taxpayer money or raise the premiums it charges to borrowers. That decision will be spelled out in President Barack Obama’s 2010 budget, Housing and Urban Development Secretary Shaun Donovan told lawmakers.

“We are looking very closely at that issue — at the premiums that we charge, at the losses that we have,” Mr. Donovan said.

Rising defaults are now eating through the FHA’s cushion of reserves. Roughly 7.5% of FHA loans were seriously delinquent at the end of February, up from 6.2% a year earlier. The FHA’s reserve fund fell to about 3% of its mortgage portfolio in the 2008 fiscal year, down from 6.4% in the previous year. By law, it must remain above 2%.

Asked at the hearing whether the FHA would need a bailout, HUD Inspector General Kenneth M. Donohue said he couldn’t predict. “Based on the numbers we’re seeing, I think it’s going in the wrong direction,” he said.

The FHA often finds itself balancing two sometimes competing goals: fulfilling its mission of providing affordable loans for first-time home buyers while remaining self-funded.

Bailout Or FHA Mortgage Insurance Increase?

The alternative to a taxpayer bailout is to raise the mortgage insurance premiums for FHA borrowers.  FHA mortgage insurance premiums are already quite high and  can significantly increase the total monthly mortgage payment.  The insurance premiums were increased last year on a risk adjusted scale so that borrowers with lower credit scores or higher loan to values would pay an increased premium.

There are two components to FHA mortgage insurance premiums for a borrower – a one time upfront mortgage insurance premium (UFMIP) and a continuing monthly mortgage insurance payment (MI).  The rates can be as high as 2.25% up front (UFMIP) and .55% monthly (MI) depending on credit score and loan to value.  On a $250,000 mortgage a borrower could be charged as much as $5,625 for the UFMIP and $114.58 per month for the MI.

Instead of making the FHA program more restrictive and expensive for every borrower, it would make more sense to reduce the mortgage insurance premiums and tighten underwriting guidelines.  Increasing the mortgage insurance premiums only serves to defeat the FHA’s mission of making first time home ownership affordable.   Turning down less qualified applicants who are more likely to default would reduce the FHA’s losses and allow a reduction in the mortgage insurance premiums.

The FHA is currently the only viable option to purchase or refinance a home for  those who do not qualify under Fannie or Freddie guidelines, but the large FHA losses indicate that lending standards became far too lenient.

Whether or not insurance premiums will be raised remains to be seen, but a federal bailout of the FHA at this point is almost a certainty.

Filed Under: FHA, Housing, Mortgages Tagged With: , ,