The housing industry is still making its way into national headlines this year — this time, it’s the Federal Housing Administration’s lending program. In January, the administration announced policy changes to strengthen lending guidelines: higher mortgage insurance, bigger down payments and increased enforcement for lenders.
Last year, more than 25 percent of home loans used FHA financing in Sacramento County and West Sacramento, according to the Sacramento Association of Realtors, up from less than 1 percent in 2005. The numbers are similar across the Capital Region, and it’s still unclear what some of the long-term effects will be for housing inventories.
Lenders statewide, however, reacted positively to changes that FHA officials hope will allow the agency to remain a player in the lending industry, a position that’s become more important with the collapse of the subprime mortgage industry.
The changes, which include minimum credit score requirements and increased mortgage insurance rates, mostly serve to bring the agency’s requirements in line with what lenders are already asking for in Northern California.
“[The FHA] has become essentially the 800-pound gorilla in housing finance,” says Lawrence Green, a professor at UC Davis School of Law and the former executive vice president of the California Land Title Association.
“I would say they’re just acting prudently and responding to what the marketplace is today and what they expect it to be in the future,” Green says. “I think that due to the issues with Fannie Mae and Freddy Mac, and due to the issues of the securities market, the FHA has gotten a much bigger share of the mortgage market.”
The number of FHA loans nationwide — and across the Capital Region — exploded in the past couple of years as prospective homebuyers with low credit and little cash for down payments could no longer qualify for subprime loans. In 2006, the FHA endorsed 351 loans in the 10-county Capital Region, totaling more than $87 million. By 2009, those numbers rose to more than 27,400 endorsements totaling nearly $6.1 billion.
The volume of these loans and the FHA’s reserves dipping lower than federal guidelines permit have prompted the government to weed out bad lenders, a goal that the lending industry as a whole supports, says Dustin Hobbs, spokesman for the California Mortgage Bankers Association.
“There are always going to be lenders taking risks they shouldn’t be, and if they’re an FHA lender, they’re posing a risk to the market by definition,” Hobbs says.
FHA Commissioner David H. Stevens told Congress last year that about 20 percent of FHA-insured loans faced problems and possibly foreclosure. With the prospect of the agency facing serious problems, the FHA made the move to shore up reserves, a safeguard that many say would benefit the lending industry and possibly reduce the inventory of foreclosed properties sitting in lenders’ hands.
In the Sacramento-Roseville metro area, Bank of America and Wells Fargo were the largest FHA lenders by volume and outstanding loans last year, according to data from the U.S. Department of Housing and Urban Development. Wells Fargo awarded 1,425 loans totaling $311.82 million, and Bank of America awarded 926 loans totaling $221.68 million. Representatives from both banks declined to comment.
“For the lending industry, I think the effects are positive to the extent the FHA has tried to balance supporting home ownership with managing their credit risk,” Green says.
Changes to the new rules won’t be a deal breaker for most lenders, Hobbs says, because many were already using prudent standards. “A lot of our members are FHA lenders, and we didn’t hear an outcry one way or another from them,” he says. “It was kind of a collective shrug of the shoulders.”
When conventional lending options dried up for many people, the FHA increased lending limits, which contributed to the increase in FHA-insured loans. Over time, lenders learned to require higher standards.
“At that time, initially, most lenders did go pretty much by the books of what FHA allowed them to do,” says John Holmgren, owner of Holmgren and Associates in Oakland and the spokesman for the California Association of Mortgage Brokers. “But with increasing experience with FHA and realizing that FHA sometimes doesn’t approve the lending decision that was made by a lender, they started utilizing internally more stringent standards than technically what FHA would allow them to do to reduce the possibility that they were going to have to buy back loans from FHA.”
Last year, more than 25 percent of home loans used FHA financing in Sacramento County and West Sacramento.
Because of this, several changes that would increase borrowers’ upfront contributions would make it more difficult to obtain loans for some borrowers.
“As far as they’re concerned, their standards were tightened months ago,” Hobbs says. “The only change would be for some of their borrowers, they have to put a little more down or make sure their credit worthiness was a little higher than it was previously.”
For example, the government hadn’t required borrowers to have a minimum credit score, but lenders in the Sacramento area rarely offered loans to prospective homebuyers with credit below a 620 FICO score.
“Most lenders’ standards are higher than FHA’s,” Hobbs says. “FHA is more or less bringing theirs more in line with what has become industry standard, so in effect it has the result of weeding out some lenders that are posing a risk to the market, and that’s a good thing.”
Requiring would-be homebuyers below 580 to put 10 percent down wouldn’t be a bad idea for lenders, according to those in the industry.
“Somebody who has shown a spotty record of paying credit obligations on a timely basis probably should have more skin in the game than 3-and-a-half percent minimum requirement that’s been in effect up until now.” Holmgren says.
Another change would have a similar effect, requiring borrowers to pay more in mortgage insurance, from 1.75 to 2.25 percent, which would require slightly higher monthly payments because the amount is typically wrapped into the loan cost.
“When the FHA tightens their standards, if they clip off some lenders that are more risky than they should be, that’s a good thing,” Hobbs says. “That’s why the industry has been more or less supportive of this bill.”
Shortly after a January announcement describing more stringent regulations on home loans insured by the Federal Housing Administration, the agency swiftly issued penalties to several lenders in a move to weed out bad lenders, none of which were based in California.
Those who work with FHA homebuyers say the majority of people qualifying for loans today — mostly first-time homebuyers — won’t be shut out of the Northern California market.
“With any loan these days, it’s just going to take more planning,” says Erin Newington, a mortgage planner with First Priority Financial in Elk Grove .
An increased mortgage insurance premium and decreased potential seller concessions with an FHA loan — from 6 to 3 percent — would affect the potential FHA clients’ initial upfront costs. In addition to the possibility of a higher down payment, this could prevent some buyers from purchasing a home.
“Both of those make it not as pleasant to look at buying within FHA, but the people buying with FHA can’t buy conventional, so their other options are, depending upon their income, whatever local programs are available,” says Mary Willett, a Realtor with Lyons Real Estate in Sacramento. “People might just have to wait longer to buy a home.”
“Somebody who has shown a spotty record of paying credit obligations on a timely basis probably should have more skin in the game than 3-and-a-half percent minimum requirement that’s been in effect up until now.”John Holmgren, spokesman, California Association of Mortgage Brokers
The new FHA guidelines are expected to have a measurable impact on developers too. Eighty-seven percent of builders surveyed expect to lose sales due to the new FHA guidelines, according to John Burns Real Estate Consulting, which has an office in Fair Oaks, and about half expect to lose at least 10 percent of sales.
Others in the residential market worry lenders could end up raising standards even higher than FHA requirements, as happened before.
“What I would be looking for is now that a minimum (credit score) has been determined by HUD, will the lenders up their overlay,” Newington says.
Another provision could open the market up to borrowers who were shut out, says George Eckert, the president of the California Mortgage Association and a partner at the Money Brokers in Sacramento.
“Most of my association members have inventories of foreclosed properties, and one of the biggest problems we have in selling those properties these days is the inability of borrowers to qualify for financing,” Eckert says. “By relaxing the qualifications and allowing people who might otherwise have been frozen out of the market because of poor credit scores by allowing them to get into the market, I think that might actually start some of the inventory that’s been held back because there’s no buyers for it.”
For example, homebuyers can now use FHA-insured loans to purchase homes that had been sold within the previous 90 days, which increases the likelihood that FHA borrowers can buy recently foreclosed homes or investor-purchased homes after foreclosure. The provision could be especially useful to areas with high rates of foreclosures, but Green says it’s too early to tell how large of an impact it could have on foreclosed properties.
“To the extent that we may have a higher level of foreclosed home inventory, it will probably help California and Northern California more than areas that don’t have a high level of foreclosed homes,” Green says. “And it will allow people who own those homes that were purchased out of foreclosure to go ahead and sell them quicker, with respect to a group of buyers who can now qualify for FHA loans who couldn’t maybe before because of the rule.”
The FHA policy recommendations also include shifting approval for originating FHA loans from an objective, in-depth government-approval process to putting that responsibility on lenders, which concerns brokers who consider that lenders will want to do everything possible to ensure FHA approval of those involved in the process.
“There’s a lot of concern that smaller brokerage shops won’t have access to FHA lending because lenders aren’t going to want to run the risk of approving small companies,” Holmgren says. “They’re going to want to impose real tough net worth requirements that a small company typically won’t be able to meet. It could reduce the ability of brokers, especially smaller businesses to offer that product.”
Green says the strategy will work to achieve the FHA’s goal to shore up reserves, to reduce risk and do what officials say is necessary while still allowing some to buy homes.
“FHA has been very aware of their role in the housing finance market, and they’re also very risk-assessment oriented,” Green says.
As the economy continues to struggle, finance and banking lawyers across the country are seeing an increase in commercial loan workouts, which range from simple loan modifications to complicated bankruptcies.
This year could provide some of the first expansions in bank lending since 2008. So is the market back up to speed? No. But banks are slowly and smartly increasing their appetites for commercial lending, and the Capital Region will see its share of transactions.