During the refinance and real estate boom, FHA loans were one of the few sub set of niches to experience outstanding growth. That's because niches like sub prime and Alt A loosened their guidelines so much that FHA loans became nearly obselete.
The same thing that made FHA unattractive then maybe the crux of the problems that are coming now, Mortgage Insurance Premium (MIP). It is an up front fee of 1.5% charged by FHA at closing and also a monthly fee equal to .005 of the loan yearly. (in other words a $200,000 loan would have an up front fee of $3500 and $1000 yearly or $83.33 per month) Because sub prime didn't have either an up front MIP or monthly MIP, and Alt A didn't have an up front MIP and no monthly MIP on loans below 80% loan to value, this made both attractive when compared to FHA. Furthermore, FHA didn't allow for such things as stated loans. Once those two sub sets began to offer loans with little or no money down, FHA became very uncompetitive.
Of course, times have changed and sub prime and Alt A are nearly non existent. FHA is the only resource left for folks with little or no money down. It is also the place that the Dodd/Frank mortgage bill wants to place all the troubled loans that are now in or on the brink of foreclosure. (this is the corrupt bill that is about to pass and become law) Now, as this chart shows....
The default ratios for FHA are now becoming dangerously high already. With the addition of about $300 billion in new bad loans, it will be like adding gasoline to a flame.
This brings me back to this concept of Mortgage Insurance Premium. This healthy payment is actually paid to FHA itself. This goes into a pool to act as the insurance for loans that default. When defaults are .25%-.5%, there is plenty of money in the pool. Of course, defaults are already reaching past one percent, and FHA hasn't even done any loans for any of these troubled borrowers.
Once those borrowers are added to a mix of loans already too far into default it is already a matter of time before FHA is facing default. Of course, if the insurer is facing default, that puts every bank that will be heavy in FHA at risk. After all, FHA is insuring the loan in case the borrower defaults for the bank. Most of the loans will be originated by banks that are now facing their own liquidity crisis. These banks are counting on Dodd/Frank to bail themselves out just like the borrowers. They aren't going to be able to hold on to billions if not trillions worth of loans unless they are insured. Thus, we will again be facing a situation of a mortgage entity to vital to fail much like we are now facing with Fannie Mae/Freddie Mac. Only this time, the bailout with be hundreds of billions if not trillions.
Right now, both Fannie and Freddie are both tightening up their own guidelines such that FHA is going to become more popular than it was ever intended. Furthermore, there are still at least one trillion dollars worth of Adjustable Rate Mortgages that still need to adjust. Many of these folks will also be looking to get into FHA. All of these factors will combine to make FHA almost guaranteed to fail and so vital that we, the tax payers, will need to bail it out.
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