Loan Modification

FHA Commissioner Urges Principal Write-Offs

By Peter G. Miller

Dow Jones is reporting that FHA Commissioner David H. Stevens wants lenders to write-off principal for upside-down borrowers. The remarks were made before Women in Housing and Finance.

If I were the FHA Commissioner I’d want the same thing. If I was a lender I’d think the idea is ridiculous.

Let me explain.

Mr. Stevens heads the FHA. The FHA is a mortgage insurance program. When a lender with an FHA mortgage has a loss guess who steps in? That would be the FHA.

One way to reduce FHA claims is to have lenders forgive principal. If less is owed then claims against the FHA will be smaller. Mr. Stevens is simply making an argument which plainly benefits his program.

But the principal-reduction proposal is not going to get much lender support — if any. FHA mortgage lenders have a contractual arrangement with the FHA which says that in case of losses it’s the FHA which has to pay up. This insurance is crucial to lenders, otherwise they would not make loans to borrowers with just 3.5 percent upfront.

The FHA is right to require that lenders must property underwrite loans and process paperwork. In turn, lenders who participate in the FHA program are right to expect promised coverage when they have losses — especially for existing agreements.

Notice that no one is arguing that borrowers should pay more to lenders when home prices go up. The notion is absurd.

Why then should lenders have to give up principal when home values go down?

The Future

Let’s forget about the principal reduction idea. It’s not going anywhere. Instead, let’s talk about an idea that’s logical for everyone.

Why doesn’t the FHA says that as of a given date it’s insurance will cover a reduced level of lender losses.

Lender associations will howl and scream, but given the market share of FHA loans how many lenders will turn away from the program? Not too many, I suspect.

It’s a normal thing for insurance companies to adjust coverage for NEW policies, so why not the FHA? While the agreements in place should be honored, new agreements can contain different terms — including terms which reduce risks to the FHA program.

Truth is, FHA loans are coveted by mortgage investors precisely because of the insurance offered under the program. And consider the alternative, the toxic loans pumped out by private-sector lenders which have pushed the country into recession if not worse. Not too much demand for financing with outrageous foreclosure rates.

However, if you were a mortgage buyer — someone who supplies capital — why would you voluntarily agree to reduce the value of your assets if you didn’t have to? You wouldn’t.

Oh well, everyone is entitled to throw junk pitches just to see if the batters will swing.

Full post as published by FHA Mortgage Guide on October 20, 2010 (boomark / email).