Play it again, Sam (The FHA and scary times ahead)

During a Happy Hour last week in Brooklyn, I struck up conversations with several real estate brokers who I know and trust.  They have their ear to the street and hustle harder than anyone I know.  They have absolutely no idea why in the world the Real Estate market seems to be heating up.  Same conversations with a few mortgage brokers.  We’re being asked to represent mor eNew York City purchasers and sellers than ever.  Something isn’t making sense.  And, all the while, the FHA is now insuring more loans than ever, while the rate of default on those loans keep going up and up.

In 2006, the FHA originated 1.6% of all mortgage loans in the Country.  If a borrower couldn’t afford to pay the the FHA insured mortgage, the federal government would step in and make sure the bank issuing the loan was made whole if and when the borrower defaulted.  Basically a safety net for the bank.  In the second quarter of 2010, just 4 years later, the FHA was insuring almost 50% of all new mortgages in the United States.  In less than 4 years, the federal government has gone from being involved in 1.6 mortgages out of 100 to almost 50 out of 100.  That’s insane.  That’s absolutely insane.  It’s as if you had opened up a Lemonade stand on your corner in 2006 and by 2010 you were responsible for 50% of the lemons imported into the United States.  But wait, there’s more.

According to a report in the New York Times: “Loans insured by the F.H.A. require only a 3.5 percent down payment for borrowers with a credit score above 580; those with a score of 500 to 580 need at least 10 percent down. Some lenders require higher scores. For instance, Somerset Hills Bank in Madison, N.J., looks for a score of at least 640 for an F.H.A loan, according to Jody Tobia, a senior vice president.”   A score of 500-580 is really bad.  I’m talking really bad.  A score of  640 is average on a good day.  Many of these individuals would never qualify for a conventional mortgage.

On a typical home, you are required to put down a 20% down payment.  On an FHA backed loan, your down payment can be as little as 3.5%.  Factor in “seller concessions” and the FHA loan may in fact mean that the purchaser is financing over 100% of the purchase price.  Sound familiar?  It should  It was all too common for sub-prime borrowers to borrow more than what a house was worth.  That ended quite well.

In 2008, we came obscenely close to having the entire financial system collapse.  Obviously, the Federal Government stepped in and propped up the real estate market with a ton of free money (at 3.5% interest, it’s likely not even keeping up with inflation–it’s free money).  You can take sides one way or the other, but the big issue now is what happens when these FHA loans begin defaulting.  Oh wait….they already have. The number of seriously delinquent FHA loans has skyrocketed 23% from last year.  In total, more than 11% of FHA mortgages are now delinquent.  The FHA holds over $1.1 trillion dollars in mortgage debt across the U.S.  The FHA now has a pilot program to actually pool together all of the distressed (no one is paying) loans and sell them.

So what does the FHA do when their mortgages become delinquent?  The FHA sells the notes to investors for less than the note is worth (in many instances).  Let me repeat that:  The FHA is now insuring a vast amount of mortgage debt in this Country (may also need a bailout)  and, because so many loans are delinquent, they are selling the notes for less than what they are worth to “investors” who will try and modify the homeowner’s mortgage so they can stay in the home.  We know how that story ends.

Look, I’m not saying that just because unemployment numbers haven’t really changed in the slightest and the economy hasn’t gotten better and median income remains stagnant and mortgages are being given to sub prime borrowers (in many instances with little to no money down) and insured by the Federal government doesn’t mean we’re going to have a problem in the next 5 or so years.  I’m just saying don’t be surprised when we have a massive problem in 5 years when interest rates inevitably go up.  It feels a little too much like 2006 these days.  And that’s not a good thing.