Is the FHA at Risk?

New York City bus driver Steven Mitchell is two months behind on mortgage payments for a home loan guaranteed by Uncle Sam and part of a growing first-time home owner population at risk of foreclosure.

"It is embarrassing to lose your home," Mitchell told CBS News.

His home in the Far Rockaway section of Queens, New York, has a mortgage insured by the Federal Housing Administration, known as the FHA, which does not grant home mortgages, but insures them.

FHA loan volume has soared - quadrupling in the past three years. In 2006, 425,000 borrowers acquired FHA-backed loans.

This year, nearly half of all first-time home buyers in the U.S., a total of 1.8 million, used FHA-insured financing to refinance or make a new purchase.

Part of the appeal is the FHA allows a down payment as low as 3.5 percent of the purchase price.

"The current degree of FHA predominance in the market is unparalleled," Department of Housing and Urban Development Inspector General Kenneth Donahue told Congress earlier this year. FHA is part of HUD.

Mitchell has a monthly payment of $3,200, hefty for a bus driver earning $47,000 a year, but his brother and a friend who live with them were helping with the payments until they lost their jobs, leaving Mitchell juggling the household bills by himself.

"As long as everything was still being paid, everybody was doing a part, it could have been done," Mitchell said.

Mitchell's home is one of 5.5 million purchases or refinances worth a total of $696 billion currently insured by the FHA.

Watchdogs worry that eight-and-half percent of those loans are at least 90 days delinquent or in foreclosure proceedings, half a percent above the national average, and well above FHA's traditional two-percent of home loans that are seriously delinquent.

"I call it FHA insurance Armageddon," Gary Lacefield, a former HUD investigator, told CBS News.

"Sometime in the next 15 to 18 months you're going to see a major hit on the FHA insurance fund," Lacefield says.

In fact, the FHA projects it could pay out $27 billion over the next 30 years to cover expected defaults, leaving it with only $4 billion of its $31 billion cash on hand.

That would sink the FHA's capital reserves below the congressionally-mandated two-percent of its loan portfolio, but the agency says no bailout is in the offing.

"When you compare FHA to any other player in the mortgage finance system, we're the last institution standing supporting the housing market with capital on our own, not asking for any congressional subsidy or taxpayer subsidy," FHA Commissioner David Stevens said.

Since taking over the FHA in July, Stevens has raised borrower standards. For example, the average borrower's credit score has risen from 633 in 2007 to 693 today, as the FHA business has expanded from traditionally lower-income borrowers across the income spectrum.

FHA-insured loans are for single-family owner-occupied properties with 30-year fixed rate mortgages. But it's up to the loan underwriters to verify borrower income and assets.

Responding to the FHA foreclosure spike, Congress banned the practice of some lenders making the down payment for FHA-insured borrowers, and the FHA itself limited the amount of cash borrowers could take out in a refinance.

Critics say as the pool of FHA-authorized lenders has grown from 10,333 three years ago to 13,419 today, the FHA's ability to police them has lagged, specially with only 10 staffers dedicated to reviewing lenders.

At the same time, the FHA may be overwhelmed by the sheer volume of loans. It has only 172 staffers assigned to review loan applications, and they look only at a sample.

Even with 30 more lenders, the FHA points out the new lenders account for only five-percent of current loan originations.

After lenders repackage and sell the portage debt, 10 institutions service 90 percent of all FHA loans, according to mortgage banking consultant Brian Chappelle of Potomac Partners LLC.

Just two institutions, Bank of America and Wells Fargo, service over half the FHA loans, Chappelle said.

Fraud investigator Lacefield is surprised certain lenders - with borrower default rates in double digits - are still doing FHA business.

"I mean 10 percent would be high, but when you see 20 and 22 percent," Lacefield says, "These companies are still active and originating loans, which is pretty scary."

The FHA has sanctioned 593 lenders this year for violating rules, according to HUD press secretary Melanie Roussell, and has revoked the license of some, including Great Country Mortgage Bankers of Coral Gables, Fla., Madison Home Equities Inc. of Carle Place, N.Y., and Taylor Bean and Whitaker Mortgage of Ocala, Fla.

Taylor Bean and Whitaker was the FHA's fifth-largest loan underwriter with $25 billion in outstanding loans and $600 million in default.

HUD's Inspector General has noted that some problem lenders have regained admission into the FHA program. After its license was suspended, First Magnus "restitutions under a different name but operates in the same location" as Stonewater Mortgage, according to the IG's office.

"We look at every institution that underwrites loans using FHA mortgages. We look at them on a monthly basis, and we look at every outlier," Stevens said.

One of the biggest outliers is Lend America of Melville, New York, which aggressively marketed its services with TV ads that looked like a newscast.

"Reduce monthly payments, reduce adjustable rates loans, consolidate debt, one low monthly payment, or take cash out for any reason," the announcer bellowed in the ads. "Close in a little as 10 days."

In a civil complaint filed last month, federal prosecutors alleged forty instances of fraudulent loans and accused Lend America of repeatedly inventing borrowers' income information to close loans.

Assistant United States Attorney Edwin Newman later told a federal judge that Lend America's mounting losses were "a loaded gun pointed against the FHA insurance fund."

Neither the company nor its attorneys replied to requests for comment from CBS News.

But in a court hearing last month, Lend America attorney Mitch Kider told the judge the most recent alleged fraud had occurred in May 2008 and the firm had since "revamped" its loan operations "from top to bottom."

"We going to make sure that Lend America and every other lender in America behave according to the standards that we expect," said Stevens, who had appointed the FHA's first chief risk officer. "If they don't they will be out of the system."

HUD Secretary Shaun Donovan may discuss further reforms when he testifies before the House of Representatives Financial Services Committee on Wednesday.

At 51, bus driver Steven Mitchell is trying to stay in the place he has called home since 2003. He has sought the help of the non-profit Rockaway Development and Rehabilitation Corporation to obtain refinance and a lower monthly payment.

"The longer it takes, the more I continue to fall behind," Mitchell said. "I'm a fighter; I'm not going to give up."

If he succeeds, he may avoid becoming another FHA foreclosure statistic.