Wednesday, December 2, 2009

Inside the FHA Audit: the Disaster of Seller Financing

Inside the FHA Audit: the Disaster of Seller Financing
By Brian Collins

It was well known inside HUD that a special program where non-profit housing groups arranged downpayments for low-income homebuyers was bad news for the Federal Housing Administration mortgage insurance fund. Department of Housing and Urban Development officials tried to stop the seller-funded downpayment program (SFDP) several times over the past decade — only to be blocked by the courts or supporters in Congress.

The homebuyer assistance program allowed sellers to fund the downpayment and then turn around and inflate the home price to recoup the expense. The seller also paid a fee to the non-profit for qualifying buyers and arranging the transactions. HUD saw it as a scam, though the downpayment assistance providers denied it.

It was well documented that buyers generally paid too much for the properties and ended up in high loan-to-value loans that were generally three times more likely to default than other FHA single-family loans.

And default they did. The latest FHA actuarial report calculates the damage SFDP inflicted on the FHA Mutual Mortgage Insurance Fund in startling detail. If the government had never endorsed SFDP loans, the economic value of the MMIF would be $13.2 billion as of September 30 — instead of $3.6 billion — a difference of almost $10 billion. In other words, FHA would be in stronger financial shape today.

The government began insuring SFDP loans in 1998. Over the years the program grew steadily, accounting for nearly 20% of coverage from fiscal 2004 through fiscal 2008.

Congress finally banned seller-funded downpayments and FHA stopped insuring the loans on October 1, 2008.

"On the positive side, following the elimination of this type of high-risk loan…the performance of the FY 2009 and future FHA books of business will be much improved over what would have been case if these loans were still being endorsed in significant amounts," the actuarial report says.

The actuarial report also points out that credit scores on FHA single-family loans have improved recently. The average FICO score in September hit 689, up 10% from September 2007.

Lenders originated a record $328.1 billion in Federal Housing Administration loans in FY 2009 and 44% of the loans have FICO scores above 680 and only 13% have FICO scores below 620, which is generally considered subprime.

In FY 2007, when FHA endorsements totaled $55.5 billion, only 19% of the loans had FICO scores above 680 and 47% of the loans had FICO scores below 620.

"The improved credit quality of FHA's recent originations debunks the myth that FHA is being overrun by subprime loans," said Brian Chappelle, a mortgage banking consultant in Washington. The founding partner of Potomac Partners noted that loans with FICO scores above 680 perform four times better than loans with FICO scores below 620.

FHA still has $30.7 billion in reserves (and set asides of $27.1 billion) — but that's after auditors made a $4.9 billion positive adjustment in recognition of the improved credit quality for FHA's current originations.

"No one can dispute that FHA defaults are increasing. However, the cause is the worst housing market since the Great Depression and not that FHA is insuring poor quality loans," said Mr. Chappelle.

What is happening today in mortgage lending: Shirley Nault has been a mortgage professional for over 20 years. Visit her other mortgage web sites go to: or


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