Equity Now

The truth about FHA

While the federal loans are good for certain buyers, some mortgage brokers are pushing them to make more money

July 01, 2010 07:00AM

(Excerpts)

Loans backed by the Federal Housing Administration, or FHA, have been getting a lot of hype in New York lately, even getting credit for jump-starting the city's real estate market.

"FHA, for my firm, really, really saved us," David Maundrell, the president of brokerage aptsandlofts.com, told the crowd at Green Pearl Events' Brooklyn Real Estate Forum last month. "It allowed us to bring back that first-time buyer."

But buyers beware: Some say FHA could become the new subprime.

FHA loans are popular because, in a tough lending environment, they require down payments as small as 3.5 percent, and allow buyers more flexibility on income and credit scores. Perhaps most important, in late 2009, the FHA lowered its presale requirements for new condos from 51 to 30 percent, making it one of only a few sources of financing available for New York buildings with small numbers of units sold.

But FHA loans are riskier and more expensive for buyers than other kinds of loans. And most consumers don't realize that FHA loans can be significantly more profitable for both banks and mortgage brokers than conventional mortgages, because of the way that banks are compensated for servicing them. As a result, some unscrupulous loan originators are steering buyers in the direction of FHA loans, experts say, even when those buyers could qualify for conventional loans.

"Because FHA can be more profitable, they put people into FHA loans when they really shouldn't," said Michael Moskowitz, president of Equity Now, a New York-based direct mortgage lender.

As Congress takes steps to reform the FHA, some mortgage professionals -- who feel their industry has been sullied enough by the subprime crisis -- are sounding the alarm.

With an FHA loan, the Federal Housing Administration provides insurance on a mortgage made by an FHA-approved lender, insulating the lender against losses in the event that the homeowner defaults. Borrowers are held to less-strict standards to qualify, but pay an up-front mortgage insurance premium of 2.25 percent of the loan amount, and also an annual premium of 0.55 percent of the loan, paid each month.

FHA reform legislation passed last month by the House of Representatives would raise the cap on the annual premiums to 1.5 percent in an effort to stabilize the agency's finances.

Still, FHA loans have exploded in popularity in recent years. With few other lending sources available in the wake of the subprime mortgage crisis, FHA loans now make up roughly one-third of all loans originated nationwide.

Until recently, FHA loans were rare in New York because most homes here cost more than the agency's maximum loan limit. For the same reason, New York developers generally avoided the costly and time-consuming process of seeking FHA approval for their new condos (like Fannie Mae approval, this process often involves making changes to a project's budget and bylaws).

But the FHA raised its maximum loan limit here to $729,750 as part of the national stimulus package, and in 2009 reduced its presale requirement from 51 percent to 30 percent.

At first, it was mostly buildings in the outer boroughs and Upper Manhattan that got FHA approval, including Toren in Downtown Brooklyn, the Edge and 80 Metropolitan in Williamsburg, and PS90 in Harlem.

Now, Manhattan buildings like 99 John Deco Lofts in the Financial District and 505 West 47th Street in Hell's Kitchen have started getting into the game.

Still, experts said, buyers should comparison shop for loans and watch out for originators who promote FHA loans for self-serving reasons.

The fee paid by the government to lenders who service FHA loans -- 44 basis points -- is roughly double the servicing fee paid for conventional loans. In theory, that's because it's more costly to service an FHA, especially since foreclosures and delinquencies -- the most expensive part of the servicing process -- are more common for FHA loans.

But these subsidies reimburse banks more than the extra expenses they incur, experts say. Moreover, FHA loans are considered to be virtually risk-free because of their government backing, making them valuable commodities.

As a result, "FHA has always been considered a more profitable loan for a lender to originate," explained Guy Cecala, the publisher of Inside Mortgage Finance. "They make more than they do on comparable loans."

In turn, lenders are willing to pay mortgage brokers and mortgage bankers higher so-called yield spread premiums (read: fees) for bringing them FHA loans.

Mortgage brokers typically make about 1 point -- 1 percent of the loan amount -- or $4,000 on a $400,000 loan, Rosenbaum said. But some banks are currently paying brokers four to five points for originating FHA loans, he said. That means the broker can make $20,000 on only one transaction.

This sets up an incentive structure that makes it tempting for mortgage brokers to push borrowers toward FHA loans.

In February 2009, Long Island-based Lend America ceased operations after losing its approval to do FHA loans. The FHA claimed the company engaged in abuses such as submitting false documents and making loans that did not meet requirements.

Until now, the government hasn't regulated what lenders can pay originators. But that may change in the coming months. The Federal Reserve is considering a rule change that would restrict the use of yield spread premiums, and the House FHA reform bill would strengthen the agency's powers to withdraw its approval from lenders with high default rates.