Federal Housing Agency Ups Loan Standards

Shaun Donovan, President-elect Barack Obama's pick as head of Housing and Urban Development.
Shaun Donovan was appointed Commissioner of the New York City Department of Housing Preservation and Development (HPD) in March 2004 by Mayor Michael R. Bloomberg.

Housing Secretary Shaun Donovan announced reforms on Wednesday to reverse the tide of defaults on home loans backed by the federal government.

Testifying on Capitol Hill, Donovan told the House Financial Services Committee that the Federal Housing Administration, a branch of HUD, would impose tougher new standards to make lenders more accountable and to ensure that borrowers have more "skin in the game."

Donovan's appearance comes at a time when the FHA's presence in the U.S. home mortgage market has never been greater and amidst worries about the agency's finances.

The FHA does not grant mortgages; rather, it insures home loans made by private lenders with insurance premiums paid by the borrower in the form of an up front 1.75 percent fee tacked onto closing costs plus an additional .55 percent fee assessed as part of monthly payments.

Specifically, Donovan told legislators that FHA is considering several reforms including raising the insurance premium those borrowers pay into the FHA insurance fund and increasing the down payment that FHA-backed borrowers make on their mortgages.

The FHA has long appealed to lower-to-moderate income earners by permitting down payments as small as 3.5 percent, although 40 percent of its insured loans had down payments exceeding 5 percent.

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"The bottom line is this: the loans FHA insures must be safe and self-sustaining for the taxpayer over the long-term," Donovan told the committee.

The FHA intends to raise minimum credit scores for borrowers. Already, tighter standards imposed by the FHA this year have led to rise in the average FHA-backed borrower's credit score from 633 to 693.

The FHA allocated more than $14 billion to cover losses from defaults last year and projects to pay out another $27 billion over the next 30 years. The agency has $31 billion cash on hand.

The scrutiny of the FHA follows an unprecedented surge in its role in the housing market in the past three years.

In 2006, the FHA insured just 425,000, or 3 percent of U.S. single-family home mortgages. This year, it insured 1.8 million, or almost 30 percent of purchases and 20 percent of refinances, according to Donovan.

"With 51 percent of African Americans homebuyers and 45 percent of Hispanic families who purchased homes last year using FHA financing, FHA is far and away the leader in helping minorities purchase homes," Donovan said.

But the surge in loan volume, combined with the severe downturn in the housing and job markets has led to a rising default rate for FHA-backed mortgages. Currently, 8.5 percent of all FHA-backed loans are at least 90 days delinquent or in foreclosure proceedings.

Donovan said 71 percent of FHA losses came from existing loans, so tougher standards going forward would limit losses.

Last year, Congress barred the practice of "seller-financed down payment assistance," which is linked to the worst-performing FHA-backed loans.

"We have made the decision to exercise our authority to increase the up-front cash that a borrower has to bring to the table in an FHA-backed loan - to make sure that FHA borrowers have more 'skin in the game' and a stronger equity position in their loans," Donovan said.

Despite its rising default rate and sinking cash reserves, FHA officials for months have bristled at the notion that the agency is filling the vacuum left by the collapse of the "subprime" home loan market. The FHA sticks to 30-year, fixed rate loans with lenders expected to verify borrowers' income and employment.

"FHA is not the next subprime, as some have suggested," Donovan said.

The FHA has more than 13-thousand participating lenders, but the agency is short-handed on staff to police them, with fewer than 200 staff members reviewing both new lender applications and a sampling of loan applications.

"We clearly need an increase in personnel," FHA Commissioner David Stevens told the committee.

Stevens said all lenders are subject to monthly reviews. FHA plans to develop a lender scorecard and publish its ratings in its website. It will also require lenders to indemnify the FHA fund for any failures to fulfill lender requirements.

Meanwhile, Lend America, a New York-based lender with one of the fastest-growing volumes in the FHA program, appears to be going out of business.

"Effective immediately the company has ceased it loan origination and operations. The company will continue to operate to fulfill its obligations to past and current borrowers," Lend America announced on its website.

The firm had 600 employees. FHA-insured home loans comprised 90-percent of its business.

Lend America is the 270th lender to have its FHA authorization cancelled this year. The FHA has suspended approvals from seven other lenders, including Florida-based Taylor, Bean, and Whittaker, which had a $25 billion portfolio and later went out of business.