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growing-equity mortgage

Federal Housing Administration

The Federal Housing Administration (FHA) is a United States government agency created as part of the National Housing Act of 1934. The goals of this organization are: to improve housing standards and conditions; to provide an adequate home financing system through insurance of mortgage loans; and to stabilize the mortgage market.

History

During the Great Depression, the banking system failed, causing a drastic decrease in home loans and ownership. At this time, most home mortgages were short-term (three to five years), no amortization, balloon instruments at loan-to-value (LTV) ratios below fifty to sixty percent. The banking crisis of the 1930’s forced all lenders to retrieve due mortgages. Refinancing was not available, and many borrowers, now unemployed, were unable to make mortgage payments. Consequently, many homes were foreclosed, causing the housing market to plummet. Banks collected the loan collateral (foreclosed homes) but the low property values resulted in a relative lack of assets. Because there was little faith in the backing of the U.S. government, few loans were issued and few new homes were purchased.

In 1934, the federal banking system was restructured. The National Housing Act of 1934 was passed and the Federal Housing Administration was created. Its intent was to regulate the rate of interest and the terms of mortgages that it insured. These new lending practices increased the number of people who could afford a down payment on a house and monthly debt service payments on a mortgage, thereby also increasing the size of the market for single-family homes. (Garvin 2002)

The FHA calculated appraisal value based on eight criteria and directed its agents to lend more for higher appraised projects, up to a maximum cap. The two most important were "Relative Economic Stability," which constituted 40% of appraisal value, and "Protection from adverse influences," which made up another 20%.

Data on the geography of actual FHA loans was mostly kept secret, but when data has been released, scholars have found that FHA's generous programs were targeted disproportionately and almost exclusively to white Americans building homes in suburbs. Between 1935 and 1939, 220 out of 241 loans in St. Louis (91%) were located in the suburbs. From 1934 to 1960, the county of St. Louis received five times more FHA loans than the city of St. Louis, despite greater economic need in the city. Similarly, the average resident of Bronx County New York received just $10 in home mortgage loans from the FHA during its first 25 years, while the average resident in the wealthy Nassau County received $601 (Jackson 1985, Chapter 11).

Overall, the FHA has been accused of an anti-urban bias, and its practices precipitated the decline of many important American cities, by subsidizing the departure of white middle class Americans and refusing to give nearly as many loans for rental units, which would have been necessary to house low income workers. In 1968, Senator Paul Douglas of Illinois summed up the federal role in home finance: "The poor and those on the fringes of poverty have been almost completely excluded" (Jackson 1985, Chapter 11).

The FHA Today

In 1965, the Federal Housing Administration became part of the Department of Housing and Urban Development (HUD). Since 1934, the FHA and HUD have insured over 34 million home mortgages and 47,205 multifamily project mortgages. Currently, the FHA has 4.8 million insured single family mortgages and 13,000 insured multifamily projects in its portfolio. The Federal Housing Administration is the only government agency that is completely self-funded. It operates solely from its own income and comes at no cost to taxpayers. This department spurs economic growth in the form of home and community development.

During budget planning for 2008 HUD had been projecting $143,000,000 budget shortfall stemming from the FHA program. This is the first time in three decades HUD had made a request to Congress for a taxpayer subsidy. Even though FHA is statutorily required to be budget neutral, the GAO is projecting taxpayer funded subsidies of half a billion dollars over the next three years, if no changes are made to the FHA program.

Currently new budget numbers are projecting "windfall revenues" for FHA due to the collapse of the subprime market and a flood of new loans being originated with FHA.

FHA Mortgage Insurance

FHA loans are insured through a combination of a small upfront mortgage insurance premium (UFMIP), as well as a small monthly mortgage insurance premium. The UFMIP is often financed into the loan. Unlike other forms of conventional financed mortgage insurance, the UFMIP on an FHA loan is prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of his loan, he is entitled to a partial refund of the UFMIP paid at loan inception. If the LTV is 85% or greater (in other words, if the borrower has less than 15% equity in his or her home), then the monthly mortgage insurance premium paid is less than a borrower with a conventional mortgage and excellent credit would pay. In instances where the home owner has a poor to moderate credit history, his monthly mortgage insurance premium will be substantially less expensive with an FHA loan than with a conventional loan regardless of LTV - sometimes as little as one-ninth as much per month depending on the borrower's exact credit score, LTV, loan size, and approval status. The monthly mortgage insurance premium on an FHA loan has the ability to save a credit-challenged homeowner thousands of dollars per year depending on the size of his home loan, his credit score, and his LTV.

A borrower with an FHA loan always pays the same mortgage insurance rate regardless of her credit score. This is especially of benefit to borrowers who have less than 22% equity in their homes and credit scores under 620. Conventional mortgage insurance premium rates factor in credit scores, whereas FHA mortgage insurance premiums do not. When a borrower has a credit score under 620, conventional mortgage premiums spike dramatically. If a borrower has a credit score under 575, he may find it impossible to purchase a home for less than 20% down with a conventional loan, as the majority of mortgage insurance companies no longer write mortgage insurance policies on borrowers with credit scores under 575 due to a sharply increased risk. When they do write mortgage insurance policies for borrowers with lower credit scores, the annual premiums are sometimes as high as 4% to 5% of the loan amount. Based on this, if a consumer is considering purchasing a new home or refinancing her existing home, she would often be well-advised to look into the FHA loan program.

When a homeowner purchases a home utilizing an FHA loan, he will pay monthly mortgage insurance for a period of five years or until the loan is paid down to 78% of the appraised value - whichever comes first.

Mortgage insurance is available for housing loan lenders, protecting against homeowner mortgage default. For a small fee, lenders can obtain insurance for a value of ninety seven percent of the appraised value of the home or building. In the event of a mortgage default, this value is transferred to the FHA and the lenders receive a large percentage of their investment. The other three percent is received from the original down payment for the home.

A borrowers downpayment may come from a number of sources. The 3% requirement can be satisfied with the borrower using their own cash or receiving a gift from a family member, their employer, labor union, non-profit or government entity. Since 1998, non-profits have been providing downpayment gifts to borrowers, that purchase homes where the seller has agreed to reimburse the non-profit and pay an additional processing fee. In May 2006, the IRS determined that this is not "charitable activity" and has moved to revoke the non-profit status of groups providing downpayment assistance in this manner.

This has led to a new downpayment program conducted by a tribal government,[The Grant America Program] This program is exempt from IRS regulations and essentially works similarly to the non-profit programs.

FHA Mortgage Loans

The Federal Housing Administration offers various types of housing loans. These include:

In order to qualify for an FHA housing loan, applicants must meet certain criteria, including employment, credit ratings and income levels. The specific requirements are:

  • Steady employment history, at least two years with the same employer.
  • Consistent or increasing income over the past two years
  • Credit report should be in good standing with less than two thirty day late payments in the past two years
  • Any bankruptcy on record must be at least two years old with good credit for the two consecutive years.
  • Any foreclosure must be at least three years old
  • Mortgage payment qualified for must be approximately thirty percent of your total monthly gross income

Effects

The creation of the Federal Housing Authority successfully increased the size of the housing market. By convincing banks to lend again, as well as changing and standardizing mortgage instruments and procedures, home ownership has increased from 40% in the 1930s to nearly 70% today. By 1938, only four years after the beginning of the Federal Housing Association, a house could be purchased for a down payment of only ten percent of the purchase price. The remaining ninety percent was financed by a twenty-five year, self amortizing, FHA-insured mortgage loan. After World War II, the FHA helped finance homes for returning veterans and families of soldiers. It has helped with purchases of both single family and multi-family homes. In the 1950s, 1960s and 1970s, the FHA helped to spark the production of millions of units of privately-owned apartments for elderly, handicapped and lower income Americans. When the soaring inflation and energy costs threatened the survival of thousands of private apartment buildings in the 1970s, FHA’s emergency financing kept cash-strapped properties afloat. In the 1980s, when the economy didn’t support an increase in homeowners, the FHA helped to steady falling prices, making it possible for potential homeowners to finance when private mortgage insurers pulled out of oil producing states.

The greatest effects of the Federal Housing Administration can be seen within minority populations and in cities. Nearly half of FHA’s metropolitan area business is located in central cities, a percentage that is much higher than that of conventional loans. The FHA also lends to a higher percentage of African Americans and Hispanic Americans, as well as younger, credit constrained borrowers. Because some feel that these groups include riskier borrowers, it is believed that this is part of the reason for FHA’s contribution to the homeownership increase.

As the capital markets in the United States mature, FHA has had less and less of an impact on the US Housing market. In 2006, FHA made up less than 3% of all the loans originated in the US. This has some members of Congress wondering why the Government is still in the mortgage insurance business. A vocal minority of Congressional Leaders are now calling for the end of FHA. While many Members support reforming FHA in order to make it more competitive to the for-profit industry. Several analysts question whether the taxpayers should be on the hook for a government run "for-profit" business.

Notes

To date, FHA is one of two mortgage programs available to home buyers that will allow a purchase with only 3% (or 0%) down payment. That is legislated to change to 3.5% as of October 1st, 2008. FHA also has the most affordable monthly mortgage insurance available, and as mentioned previously in this article, mortgagees that do not have 20% for a down payment may be required to pay a monthly mortgage premium that is quoted by private (for profit) mortgage insurance companies. The monthy mortgage insuarnce premiums offered by private mortgage insurance companies can quickly make a home unaffordable to a less than perfect credit borrower.

References

  • Monroe, Albert. “How the Federal Housing Administration Affects Homeownership.” Harvard University Department of Economics. Cambridge, MA. November 2001. http://www.jchs.harvard.edu/publications/governmentprograms/monroe_w02-4.pdf
  • Homes and Communities. “The Federal Housing Administration.” U.S. Department of Housing and Urban Development. http://www.hud.gov/offices/hsg/fhahistory.cfm
  • Brown, Christopher C. “Federal Housing Administration.” The Virtual Reference Desk. http://www.virtualref.com/govagency/364.htm
  • Garvin, Alexander. The American City: What Works, What Doesn’t. 2nd Edition. McGraw-Hill, New York. 2002.
  • Jackson, Kenneth. Crabgrass Frontier: The Suburbanization of the United States. Oxford University Press, Oxford. 1985.

See also

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