Monday, May 10, 2010

Every Loan a Government Loan Part I

Within the last couple of weeks, the Federal Housing Administration (FHA) released guidelines regarding new rules for allowing smaller lenders and mortgage brokers to originate FHA loans. The new rules raise the minimum net worth for approved lenders from $250,000 to $1,000,000. Within three years the net worth requirement will increase to $1,000,000 plus "1% of the total loan volume in excess of $25,000,000". (Source Scotsman's Guide Volume 17 Issue 5).

For small business owners and brokers this is a huge shift. Originating FHA loans has long been a problem for extremely small brokers and originators because FHA required that the broker be FHA approved, meet net worth requirements and complete an annual audit which was very expensive. For individual companies who chose to do the work and pay the expense of approval, the ability to offer FHA gave them a distinct competitive advantage. However, over the past decade, FHA use had steadily declined. FHA, which required a 3% downpayment, did not compete favorably with conventional loan programs offered at 100% financing through Fannie Mae and Freddie Mac. These loan programs utilized private mortgage insurance, but they allowed more flexibility in appraisals than an FHA loan. Most importantly, they were readily available; any originator who sold loans to lenders who sold to Fannie Mae and Freddie Mac--which was basically everyone--offered conventional products. To compete with the other products on the market, lenders offering FHA tried to partner their 97% loan with downpayment assistance programs. But by 2005, FHA loans comprised only about 2% of the market.

Today however, government loans make up approximately 50% of all purchase applications. In a world where conventional loans require a minimum of 5%, and in most cases 10% or 20% down to secure financing, FHA, VA (Veterans' Administration loans) and USDA (US Department of Agricultural Rural Housing loans) have again become attractive options for homebuyers who want to get into the housing market but have not been able to save a downpayment.

But is the shift to government loans a good thing? According to David Stevens, Commissioner of the Federal Housing Administration in an interview that he gave to the Scotman's Guide in January of 2010, "We shouldn't be growing this fast." FHA's congressionally mandated reserve requirements have fallen below the required levels, leading some economists to argue that Congress will end up having to authorize a bailout for FHA. And according to Stevens, the FHA program was never designed to handle the type of volume it is doing today.

So what does this mean in terms of small business? No one is quite sure yet. The new capitalization requirements will exclude some smaller lenders who will not be able to meet the reserve requirements. Mortgage brokers who have always offered FHA are displeased with the changes because they have worked and sacrificed to meet the reserve requirements to offer a program that they will now be able to offer only by partnering with a major lender. Small brokers who have never been able to offer FHA hold out hope that by partnering with a lender who is willing to sponsor them, they will be able to offer FHA for the first time, but we are all aware of the warnings--by making the lenders completely responsible for the actions of each broker they sponsor, HUD (The department of Housing and Urban Development) may have killed any chance that any of us have to close FHA loans. According to Stevens, in his January interview, FHA's main plan to curb losses is to hold lenders accountable if they originate loans outside of FHA guidelines. Now that will include holding them responsible for the loans originated by brokers as well. And if that is, indeed, the case, the biggest source of financing for first time homebuyers and repeat purchasers may have just been taken away from small business owners and given exclusively to the bigger players. As refinances end due to rising interest rates, all originators will be competing fiercely for purchase loans and FHA will be an ever more important part of that competition.

The answer to this problem ultimately lies in the private sector, a fact which Stevens acknowledges as he tells Scotman's Guide that the ultimate solution is to get private capital back into the market so that FHA loans can return to their historic levels. In the end, private, free market solutions and make sense loans can meet the needs of the homebuyers and prevent Uncle Sam from having to bailout himself.

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