According to American Enterprise Institute Fellow, Edward Pinto, the FHA mortgage insurance program is helping to destroy the neighborhoods that FHA is most heavily involved in. A detailed study of FHA lending practices and default rates shows that lower income borrowers and home owners with FHA loans are much more likely to default on their loans. And when these borrowers, their home, and their FHA loans are concentrated within a specific zip code, the result tends to be drastically higher foreclosure rates, leading to lower home values and loss of equity across the entire area.
This helps to explain why some cities such as Atlanta and Detroit are still struggling to recover from the housing market melt-down. An excellent overview of the problem, along with maps that show foreclosure rates and FHA participation levels down to individual zip codes can be found at NightmareAtFHA.com There are very high concentrations of FHA loans in many of the most troubled zip codes in the nation. In these areas, even property owners who have their property paid for may suffer a significant loss of equity due to the foreclosure of dozens or hundreds of neighboring homes. In some zip codes the default rate on FHA insured mortgages is as high as 25%. Compare that to a private sector default rate of less than 4%.
The problem is with the high number of loans approved by FHA for borrowers who are not actually able to afford to own and maintain a home or cannot afford the price of the home they have chosen to purchase with an FHA insured mortgage. Lenders have little incentive to curb the use of these loans, because they are insured by the taxpayers. This means that if a borrower with an FHA loan does default, the lender can recover the entire value of their loan from the Federal Housing Administration. (FHA)
Another reason for the much higher rate of default is due to the way in which FHA loans are underwritten, using a benchmark known as the “debt-to-income-ratio”. This ratio uses the gross income amount, and therefore it does not take into account the actual amount of take home pay that is available for a mortgage payment. The result is that FHA borrowers tend to borrow too much money. Buyers are commonly encouraged to purchase “as much home as they can qualify for” rather than thinking about other expenses such as home maintenance and repairs, along with other big unplanned expenses such as an emergency car repair.
FHA mortgages are notoriously expensive, in spite of their reputation as the mortgage of choice for lower income borrowers. There are a number of fees attached to this loan. Even at today’s lower interest rates, FHA loans carrying a 30 year term with a 5% down payment will cost the borrower about 2.5 times the total amount borrowed over the life of the loan.
This means that a $100,000 home with a 95% Loan to Value will cost about $250,000 by the time you pay your last payment in 30 years. Of course, the vast majority of borrowers do not keep their home long enough to pay off a 30 year mortgage with 360 payments. And when they move, they are often shocked to find out how much they still owe on their home loan. In today’s market it can be very difficult to sell a home for enough to pay off an existing FHA loan that was created in the last 10 years.
It takes more than 12 years of monthly mortgage payments before you actually begin to pay more on your loan principle than you pay in interest each month, if you only pay the required mortgage payment. If you are a typical lower income borrower, you’ll pay virtually the entire value of your home in loan interest expense over the first 15 years of your FHA loan.
This is hardly affordable housing, yet the FHA product has been sold as the loan of choice for “affordable housing” for over 50 years. But the high costs of this loan are one of the primary reasons why lower income borrowers are more likely to get foreclosed on. They pay and pay for years with little accumulation of equity in their homes. By the time you add in the up front costs for origination fees, appraisals, taxes and insurance, virtually all 95% FHA loans are in a negative equity situation from day one, even in a normal housing market.
Today we are in a situation where FHA is insuring virtually 90% of all new mortgage loans, even as default rates continue at crisis levels in neighborhoods with a high percentage of lower income FHA borrowers. This is leading to a situation in which FHA could default on it’s insurance obligations, requiring another big bail out for a program that is “too big to fail”. Without FHA mortgage insurance, the housing market would come to a virtual standstill in terms of new loans for the majority of lower income home buyers.
FHA has now been over 3 years without an official director, as congress, the administration and the professional real estate industry fear what would happen if someone actually had to face the problems at FHA. The National Association of Realtors lobbied heavily to push FHA into more lending activity after the housing melt-down destroyed the vast majority of private mortgage insurers and lenders. FHA is under capitalized to the tune of some 46 billion dollars and is headed for a fiscal cliff of it’s own in the near future. For more details and research data, check out FHA Watch.
Donna S. Robinson is a real estate investor, author, and housing market analyst located in Atlanta, GA. Follow her on twitter at donnaconsults. Her latest book is now available on Amazon.com. It’s called Basics Of Real Estate Investing