The Federal Housing Administration announced today a tightening of its lending standards for borrowers.
A little background is in order. The FHA provides an alternative financing option for borrowers who are short on cash. While private market lenders historically expected down payments in the 10-20% range of the sale price, the FHA underwrote loans with down payments of 3.5%. FHA interest rates are very competitive.
The agency has an interesting and pivotal history itself. Founded in 1934 as part of the New Deal, the FHA primed the housing market and accelerated middle class wealth accumulation and home ownership. Basically, the agency does not fund loans as much as it indemnifies private lender against default. This makes the agency carries out a credit insurance function as opposed to a banking function. Bankers traumatized by the collapse of the American financial system were suddenly incentivized to lend since the government covered their losses.
Additionally, the FHA did not spend tax dollars. Borrowers paid for the insurance as part of their closing costs and monthly payments. This is similar to mortgage insurance for those readers who own a home.
Prior to the FHA, bankers required borrowers to bring 50%-60% of the sale price to the closing table. Loans typically lasted five years and included a balloon payment which forced homeowners to scurry to the nearest lender and re-finance. The FHA changed this reality permanently by requiring willing and conforming lenders to fiance borrowers for 20 years with reasonable interest rates. This allowed middle income Americans to enter the housing market which created a real estate explosion.
While the FHA is still very much a significant player in the housing market, the agency simply cannot afford to underwrite loans for questionable borrowers absent some assurance of re-payment. This reality forced the FHA to increase the down payment to 10% for some borrowers with low credit. This move could significantly affect the housing market since 40% of all current mortgages are FHA paper.
One final note-bankers in the 1930's and 1940's were still leery of doing business with the FHA. specifically, the 20 year term (which eventually became 30 years) scared many lenders. While the mortgage insurance against default was nice, 20 years was a long time to tie up capital. enter the Federal National Mortgage Association or Fannie Mae. Fannie Mae paid lenders cash for their existing loan which allowed the banking industry to increase the churn rate of capital. This churn provided more money to lend and contributed to the American real estate explosion.
What are the lessons here? Both the FHA and Fannie Mae have changed the way they do business. of course, Fannie Mae has bigger problems than the FHA. Also, remember these lessons when the banking industry cries fouls over government regulation and interference. The government they criticize for limiting their wealth options actually played a large role in creating the modern real estate market.
The real estate market and by default, financing for housing has been one of the top economic drivers in the country for a very long time. Unfortunately, as with anything else too many joined the speculation band wagon in the hope of making excessive profits which they did for an extensive period of time until the bubble burst which it did. That's the principal cause of today's crisis. The FHA backed mortgages contributed to increasing market participation where it would not have been possible, which is for a large part of the population. That's fine, but it had to contend with generalized lack of discipline from every stakeholder. That's the point of failure.
ReplyDeleteRichard Lefrancois