The current subprime bust can be attributed primarily to 2/28 and 3/27 ARMs. With these adjustable rate mortgages, which became extremely popular in ’04 and ’05, the borrower pays a fixed rate for 2 or 3 years, respectively, and then their interest rate fluctuates annually for the remainder of their 30 year loan. Well, what seemed like a great idea has turned sour when many borrowers found themselves unable to pay the higher interest rates and some mortgage companies have even gone out of business. With many of the 3/27 ARMs beginning to change rates in the autumnal months, things are not looking bright.

Not only can FHA loans potentially serve as a refinancing option for those in subprime trouble, but FHA also will make itself a viable and less risky ARM options for initial borrowers. Although the 30-year fixed is the FHA mainstay, FHA also offers a variety of ARMs. Plus, the FHA protects lenders with annual caps between 1% and 2% percentage points, and life-of-loan caps between 5% and 6%. So not matter what FHA ARM you choose, your interest rates will never go up more than 2% a year and 6% over the full loan term.

A recent study done by the American Financial Services Association and the Center for Statistical Research examined the effects of legislation to potentially deny credit to millions of Americans. You can read a release about the study here or view the actual study here. I’d go with the release because it’s 2 pages long and the study is 28 pages long. Or if you want the really really really abridged version stay right here.

Foreclosures on subprime up.
FHA loans up.
Foreclosures bad.
But not terrible.
Keep giving credit.
To those who need it.

These days Kenneth Harney is the busiest FHA writer around (after me, of course). Check out this piece on the FHA improvement proposal that focuses on the same broad topic as his previous article posted here, but more closely examines issues not brought up in his other article. Of particular interest, is the FHA’s potential to help out those facing foreclosure because of sub-prime loans that have sky rocketing interest rates and the political side of the issue. Harney closes with:

Bottom line for reform: Slam dunk? No way. But the bill has a shot - either in its current form, or by having essential provisions transplanted into an appropriations bill that can sidestep the land mines buried and waiting in the Senate - without blowing up.

This point really stuck with me because with all this talk about FHA reform sometimes it feels like the general sentiment is that these changes are a given. With the wonders it could do for the FHA program, it’s almost impossible to think about what could become of the program if this does not pass…

Oh, forget about the doom and gloom, FHA’s been around since 1934! Whether or not this legislation makes it through, the FHA loan will soldier on and continue to grow in popularity, especially as a result of the sub-prime bust.

I was reading an article entitled “Mortgages Go Back to Basics” by Rick Munch of Market Street Mortgage, Fairfax, VA, and was thinking about if mortgages were our friends who would be who. Mr. Munch’s point that led me down this thought process was:

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The changes bode well for consumers, since traditional mortgages are safer and rates are relatively low at present. Mortgages are now focused on solid long-term fundamentals that are sustainable, limiting the risk for both the home buyer and lender. In effect, the mortgage industry is shifting back to a less-frenzied market reminiscent of five years ago, where pragmatism was more acceptable.

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Well, we all know who the sub-prime mortgage is. The sub-prime mortgage is that kid you meet the first week of freshman year of high school who has some kind of piercing, no curfew, and skips a lot of class. And the traditional mortgage (an FHA loan, we’ll say) is the best friend you’ve known since kindergarten who overuses his inhaler and carries his rock collection in his oversized book bag.

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As I’m sure everyone knows, you hang out with Sub-Prime for awhile, end up with a .087 GPA and on probation. Then you realize the error of your ways, rekindle your friendship with FHA (who’s remained loyal while patiently waiting for you to come to your senses), and have a wonderful (but not-so-risky) remaining three years in high school. It’s just like that.

Banking and finance expert Alex J. Pollock had some pretty compelling testimony for the Subcommittee on Domestic Policy of the Committee on Oversight and Government Reform. He addresses five points, which are all interesting and I encourage you to read, but I really only want to focus on one today: Information Asymmetries. The situation, in a banking context, is explained as such:

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“Information asymmetries” is an academic way of describing a common problem in financial and other transactions when one party knows a lot more about the relevant matters than the other–or stated the other way, when one party is naïve and uninformed and the other is the opposite… To help address the shortcomings of the subprime market which have become evident, I believe a new, superior disclosure approach is needed, whether or not we do anything else. The key is to realize that complex, lengthy statements in regulatoryese and legalese do not achieve the goal.

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It’s a bit wordier than my point yesterday, but Mr. Pollock and I are on the same page. The more people really understand (in direct terms) about their loans, the less likely they are to end up in trouble. Knowledge is power.

For some reason whenever I think of down payments, the cult classic The Wedding Singer comes to mind. It’s the scene were lovable-but-heartbroken-hearted wedding singer Robbie Hart is trying to get a job at the bank in a sweetly misguided attempt to win the heart of lovable-but-engaged Julia. Our hero tells the bank manager, “…I’m a big fan of money. I like it, I use it, I have a little. I keep it in a jar on top of my refrigerator. I’d like to put more in that jar.”

With the current issues regarding FHA down payments – be it loophole gifts or the proposed legislature to change the minimum down payment from 3% of the cost of a home to 0% - I’ve been thinking a lot about the importance of the money in the jar (or wherever it may be. I see a bank as more practical). I think it’s terrific that the FHA is looking at giving people who don’t have the cash for a down payment the opportunity to buy a home. On the other hand, I just don’t want people to neglect their jars on the refrigerator. Just because there is a minimum, doesn’t mean you have to settle for it.

HUD and the FHA are presenting themselves with an opportunity and a challenge. There is the chance to make the FHA loan the subprime darling of yesteryear and an invitation to educate. Stressing the importance of putting down a payment (when possible) and the other subtleties related to lending that many first time homebuyers aren’t aware of will be the key to breathing life back into the FHA.

I came across an article by Kenneth Harney of the San Francisco Chronicle that perfectly assesses the FHA situation today. Harney takes a brief and sensible look at what good, the bad, and the ugly when it comes to the facts about FHA and subprime loans. Although Mr. Harney sees FHA as an excellent alternative, he doesn’t sugar coat things. A difference he neutrally points out is about income statements:

Additional differences between FHA mortgages and subprime: You can’t just “state” your income and get a loan. You’ve got to show proof that you earn what you say. The FHA never has offered “payment option” plans that allow borrowers to send in almost nothing while adding to their debt through negative amortization.

He doesn’t classify it as a pro or a con, just a fact. This, of course, got me thinking, “Is it a pro or a con?” After some deep thinking and half of a turkey sandwich I decided on “Pro.” Yes, it is a bit of a hassle, but the FHA is looking out for everyone’s interests. They want to give you the largest mortgage you can afford and make sure you don’t end up over your head. These days, with many subprime lenders being characterized as vultures, the FHA is a borrower’s guardian angel.

In the current shakedown with FHA down payment gifts a number of the intermediary non-profits are looking to lose their tax exempt status. So far only two organizations have officially had their status revoked, but with potentially many more on the horizon, I decided to take a look at one of the biggest: The Nehemiah Program.

According to its website, The Nehemiah Program is “The Most Trusted Name in Downpayment Assistance.” Well, according to spell check and Merriam-Webster, down payment is two words, so I’m already a little leery. The next interesting tidbit comes from the Sellers section. It begins innocently enough:

The Nehemiah Program provides gift funds for downpayment and closing costs to qualified homebuyers who use an eligible loan product such as an FHA insured mortgage or conventional loan.

A gift, one might think. How nice. Let’s look at the end of the paragraph:

For the buyer to be eligible for the gift, the seller must make a contribution to Nehemiah Corporation of America that is equal to the gift amount, plus pay a small processing fee.

What? A few sentences ago The Nehemiah Program was providing a gift that never had to be repaid. Right below that I’m reading that it’s actually a gift provided by the seller plus a processing fee. Now, that’s a horse of a different color.

In Charlotte, NC, officials are taking a closer look at home builders selling to FHA borrowers. According to a recent story in the Charlotte Observer, there are some shady deals going done all over the country, especially in Charlotte. Since 2000 about 15,000 Charlotte residents have put down a down payment on an FHA loan with money given as a gift by the seller.

Now, according to the Department of Housing and Urban Development this is strictly not allowed UNLESS (of course, there is always an “unless”) the gift is indirect. That’s correct; a seller may not give a direct gift to a buyer, but by using an intermediary the seller may give an indirect gift to be used as a down payment. In turn, sellers hike up the price of the house and sell it for more than its worth. If the buyer happens to fall upon hard times, they’re stuck with a house that they are paying too much for and is nearly impossible to get rid of.

In the Charlotte area 60% of FHA borrowers made down payments with money provided by the seller and 40% of failed FHA loans involved a seller’s gift. You do the math.