Red-Ink Fears Prompt Mortgage Backer to Raise Fees

The Wall Street Journal

Red-Ink Fears Prompt Mortgage Backer to Raise Fees

 By NICK TIMIRAOS Aug 24th 2010

 The country’s most popular federal mortgage-insurance program is set to raise fees to borrowers in a bid to avoid burning through its dwindling reserves as home prices come under renewed pressure.

The move reflects new threats facing the Federal Housing Administration, a New Deal-era agency that has taken a central role in the housing market since mortgage markets seized up three years ago. The FHA, which doesn’t make loans but rather insures lenders against losses, guaranteed $857 billion in loans at the end of June, up 24% from a year ago.

The FHA offers among the easiest lending terms available, with minimum down payments of 3.5%, and it has backed nearly half of all home-purchase loans during the first half of the year, according to research firm Zelman & Associates. Many housing analysts attribute stronger-than-expected annual price growth in many California housing markets over the last 18 months to the FHA, which backs loans as large as $729,750, more than double the limit three years ago.

But playing savior to the housing market has come at a big cost. The agency’s reserves are falling sharply as many of those loans have defaulted at a rapid clip. While fees from new business have, for now, boosted the agency’s cash on hand, the FHA has set aside nearly 90% of that money to pay for projected expenses over 30 years. That has left just $3.5 billion to cover unanticipated losses, down from $10 billion one year ago.

“We still hold out a lot of concern about the portfolio,” said David Stevens, the agency’s commissioner, in an interview.

The biggest risk facing the agency would be a new round of home-price declines amid an economy showing signs of slowing. That would almost certainly lead to higher losses. Most borrowers make minimal down payments, so are particularly at risk of losing their homes if prices drop and they fall behind on their mortgages.

This fall, an annual audit will forecast the amount of money needed by the FHA to cover 30 years of projected losses. If home-price forecasts used in projecting those losses are particularly bearish, the report could show the agency will become insolvent, which would require the Treasury to cover any shortfall.

So far, the agency is ahead of last year’s forecasts and has paid out $3.7 billion less than anticipated to lenders when borrowers default, in part owing to aggressive efforts to modify loans and to processing delays on foreclosures.

Beginning in October, the FHA will raise the annual fees it charges new borrowers, adding about $300 million a month to its reserves.

The agency will raise annual insurance premiums to as high as 0.9% of the loan amount, up from 0.55%. For new borrowers, that would translate into an average monthly payment increase of $40. At the same time, it will drop the upfront premium that borrowers pay when they take out a mortgage to 1%, from 2.25%.

While many loans made as the housing bust accelerated have performed badly, newer loans are doing better. In June, the share of loans nationwide that were 90 days or more past due stood at 8.3%, down from a peak of 9.4% in January. The agency hopes such improvements, along with increased fees, will be enough to keep it from running into the red.

“The numbers are still higher than they should be in a normalized marketplace, and they clearly are higher than they should be on a going-forward basis,” Mr. Stevens said.

The moves are also designed to align the agency’s fee structure more closely with those of private mortgage insurers, in an effort to help those companies back into the market as it recovers. Private insurers have largely ceded the market to the FHA in recent years, unable to compete with its relatively liberal terms.

In addition, the agency is finalizing steps to limit the amount of cash that home-sellers can kick in for buyers’ closing costs. The change will reduce maximum seller contributions to 3% of the purchase price, down from 6%, bringing the FHA into line with the rest of the market. That could reduce sales by as much as 15% among builders of entry-level homes, which rely heavily on FHA backing, said John Burns, a housing consultant in Irvine, Calif.

Separately, the agency has stepped up efforts to weed out lenders whose activities are seen as resulting in above-average delinquencies. The FHA has already taken more than 1,500 sanctions against its lender-partners this year. In a letter to the industry last month, Mr. Stevens warned against “activities that reflect an overexuberance in the marketplace” and that seek to increase loan revenue by exploiting the agency’s underwriting systems.

The letter was prompted by signs that some lenders are focusing their marketing efforts on riskier borrowers or that they are offering premiums for certain FHA-backed loans, which could be red flags for predatory lending or fraud. Mr. Stevens said the mortgage industry needed to be “on notice that this is a program we need to protect,” particularly because the agency’s reserves are “precariously on marginal ground.”

While Congress this month signed off on the new fee structure, a larger overhaul package that would give the agency greater flexibility to eject lenders hasn’t passed the Senate.

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