Loan Modification

Is FHA The New Subprime?

By Peter G. Miller

According to TheStreet.com, “now that the subprime market is temporarily dead, FHA loans have become, in some respects, the ‘new subprime,’ with borrowers making down payments as low as 3.5%, and qualifying for lower rates than conventional borrowers.”

Really? Is this true?

TheStreet — for which I long ago wrote several items — goes on to compare an FHA loan with a conventional mortgage. For the purchase of a $200,000 home in Stuart, FL, says the site, “when you boil down the numbers, it’s pretty obvious why FHA loans are irresistible for many qualified borrowers. The total financing cost of $179,883 (excluding the monthly MIP amounting to less than many household cable bills) for the regular FHA loan exceeds the cost for the conventional mortgage by $19,883, but you are putting down $33,000 less at closing. And the FHA Low to Moderate is an absolute bargain, actually costing less than a conventional mortgage (again, leaving out the monthly MIP), with only a 3.5% down payment.”

Down Payments

This is an interesting comparison, but not one with which makes a lot of practical sense. The reason? A qualified borrower could get a conventional loan and not put down 20% by financing with
private mortgage insurance (MI). In fact, the National Association of Realtors reports in its 2009 study of buyers and sellers that “a median of 92 percent of the home purchase price was financed compared to 91 percent in each of the two previous years. However, the share of buyers who financed the entire home purchase, and made no downpayment, fell from 23 percent to 15 percent in the current survey. First-time buyers financed a greater share of their home purchase than did repeat buyers, and buyers of previously owned homes financed a higher portion of their home than did buyers of new homes.”

But let’s say that somehow the example offered by The Street is reasonable, then we would need to ask why — exactly — FHA loans should be regarded as “subprime” financing? Does less down make a loan subprime? A lower rate? This sure sounds like the type of financing most lucid people want.

Subprime Loans

We usually think of subprime loans as financing for individuals with weak credit, say those with credit scores below 620. In contrast, for March the FHA reported that “the (weighted average) FICO score this month was 697. For purchase cases it was 699 and 692 for refinanced mortgages.” Isn’t a credit score above 690 a lot better than a 620 credit score? Or something less?

Volume

The Street will be relieved to know that FHA mortgage applications in March fell 19.9 percent when compared with a year earlier. One hopes that the private sector is making up the volume so that homes can be financed and refinanced at low cost and with few barriers. After all, had it not been for the availability of FHA mortgages during the past two years the housing market would have completely collapsed.

Full post as published by FHA Mortgage Guide on May 17, 2010 (boomark / email).