FHA - The New Subprime
I HOPE NOT! This statement angers me more than anything else I am hearing in the mortgage industry right now. Even more than FHA not raising the HECM Limits as a part of the Economic Stimulus Package (but that’s another article all together).
Lets take a serious look at why FHA CANNOT be the new subprime but why this notion is going to wreck it anyway.
If FHA is the new subprime, FHA will end up the same fate as subprime. The difference is tax money will bail FHA out and then FHA will get so tight that it won’t serve the purpose it originally intended. This isn’t going to happen, FHA has been doing this for too long and understands risk much better than the Subprime world did.
The Lenders that underwrite and insure FHA Loans are primarily A-Paper Lenders. They have an A-Paper mentality to underwriting FHA Loans. Unfortunately lenders are currently being loaded up with crap by loan officers who think FHA is the new subprime. These files are getting DECLINED, but they are sucking up resources and costing the lenders money. Lenders must find a way to combat this, and the easiest way is to impose credit score requirements. Lenders who have gone years and years without having credit score requirements on FHA loans are suddenly having to add them. This is hurting the people who FHA was made for and eventually FHA will be put in such a small box that it fails to meet its original mission.
So why after so many years is FHA just now being flooded with so much garbage that lenders are having to put credit score requirements in place? The idea alone that FHA is the New Subprime is wrecking the system that worked so well for so long. Loans that 5 years ago no one would have dreamed of trying to get approved are being submitted as FHA loans and wrecking the system! The next time someone tells you that FHA is the New Subprime, slap them for me - Thanks.
The second big factor is Neighborhood Watch. Neighborhood Watch is just what it sounds like except the “Neighborhood” is the FHA Lending community. Any branch of any company that originates FHA loans it loaded into this system. The system compares the defaults of each company to the average defaults in the entire FHA portfolio, and if you exceed twice the average for defaults, FHA wants to know why. The actual way it compares is more complicated than this, I have analyzed it in another article, but basically that’s what it does.
So all you originators out there doing nothing but garbage loans through FHA, yes you will get 1 out of 7 approved, and yes these loans WILL DEFAULT, and yes - FHA will come knocking on your door within the next few years. Unfortunately, if you are a net branch, all you have to do it pick up and move to another company - since Neighborhood Watch doesn’t track branch managers only companies. At some point the Net Branching firms are going to have to start paying more attention to Neighborhood Watch.
Neighborhood watch will catch up with the companies who are allowing these loans to be originated. FHA is watching you, FHA is monitoring your percentage of defaults, FHA will not let this continue.
The system is very efficient, it will correct itself. Lenders will put measures in place and FHA will punish those with high default rates. Unfortunately, in the mean time, this notion is going to mess things up for the rest of us.