Renaissance time for the FHA: the Congress is expected to finalize work on new FHA modernization legislation early in 2008. That would give the program a big boost just when the market needs one

Mortgage Banking, Feb, 2008 by Allen H. Jones

Since putting pen to paper for Mortgage Banking in 2006 ("FHA Means Business--and Opportunity," October 2006), the mortgage world as we knew it has changed. With the housing market turned upside-down, product has been chasing liquidity amidst a severe credit crunch. And overnight, the Federal Housing Administration (FHA) has seen the promise of a rebirth. [??] In 2006, Charlotte, North Carolina-based Bank of America's FHA retail mortgage volume consisted of roughly 2 percent of our overall retail production. In the first quarter of 2008, FHA retail mortgage production will hit double digits for Bank of America. And I predict the industry overall will see like-size growth, with upside potential. [??] The FHA of today is not your father's FHA. With dedication and resolve, FHA has unleashed an opportunistic product that has drawn attention from all quarters. With passage of pending FHA modernization legislation that will raise loan limits and simplify the down-payment calculation, peel your ears back. But be ready to follow all the rules and hearken back to the "knowledge and service matters" mantra. FHA can be a port in the storm, but without proper knowledge and training, a lender can suffer dramatic reputational and monetary risk. [??] This article shares the perspective of why you should take advantage of FHA insurance and put prime borrowers into the prime products they deserve. It is a journey, but with proper investment and leadership, consumers are the beneficiaries.

What a difference a year makes

Looking back, what a difference a year makes. Unfortunately, as we now know, late last summer several of the largest mortgage lenders announced serious delinquency problems in alternative-A products (e.g., option adjustable-rate mortgages [ARMs], stated-income and stated-asset loans). Then a major lender was forced to file for bankruptcy protection. Fears about the deterioration in the quality of all nonprime mortgages became a reality.

As the market roiled, investors lost confidence in the performance of the private mortgage-backed securities (MBS) market (including securities backed by subprime, alt-A and even high-quality jumbo mortgage assets). The private-capital markets literally seized up overnight and still remain wary.

As a result, unless a loan can be sold to Fannie Mae or Freddie Mac, be securitized with a Ginnie Mae guaranty (FHA or Department of Veterans Affairs [VA]) or be held in a financial institution's portfolio, it has been virtually impossible to originate any other type of mortgage, including high-quality jumbo loans, and sell them as part of a private security. That has been the case even if the security had a AAA rating. In other words, there is limited-to- no liquidity for the type of mortgage products that comprised more than 40 percent of the market in 2006.

The combination of these events and proactive leadership from FHA set the stage for a new cycle of growth for FHA. Total Ginnie Mae (30-year fixed) production was $6 billion in January 2007, and it was nearly $11 billion in December 2007--an increase of almost $5 billion.

Five key reasons for FHA's resurgence

1. Under the leadership of FHA Commissioner Brian Montgomery, FHA has made numerous administrative reforms to eliminate unnecessary and bureaucratic steps.

Previously, sellers and Realtors[R] avoided FHA. The two most important changes FHA has made to date are adopting conventional appraisal requirements and permitting the borrower to negotiate with the seller the loan fees that the borrower will pay.

2. The market turmoil in late 2007 has virtually eliminated the subprime and "near-prime" private MBS market, and the mortgage products (option ARMs, interest-only, stated-income, stated-assets, and subprime 2/28s and 3/27s) that made up those securities.

At this point, FHA is considered by many to be the best source of prime rate and low-down-payment financing for many first-time homebuyers and borrowers with any credit issues.

3. Regulatory tightening will make permanent the market changes that the investment community imposed in late 2007.

Federal banking regulators and state legislators have significantly curtailed nontraditional and subprime products. Loans must be underwritten at the fully indexed rate. The Federal Reserve Bank has a proposed rule out for comment now that will eliminate stated-income and no-documentation loans for subprime borrowers. And as we know, FHA requires full documentation.

4. Fannie Mae and Freddie Mac have raised prices and tightened underwriting, particularly late in 2007--making FHA a more attractive option at a lower price. For higher-risk borrowers with credit blemishes, Fannie and Freddie have raised their pricing, in some cases by more than 200 basis points. On a $150,000 loan, that translates to $3,000 in higher closing costs--a significant sum for many of these borrowers.

5. As noted, once it gets to the president for a signature, pending FHA modernization legislation will enable FHA to reach more homebuyers in high-cost areas and also simplifies its down-payment requirements. (At press time, this legislation was still in final stages of consideration by Congress, with final details being negotiated out in conference committee.)