The last time the housing market was this bad, Congress set up the Federal Housing Administration to insure Depression-era mortgages that lenders wouldn't otherwise make.
This decade's housing boom rendered the agency irrelevant. Americans raced to aggressive lenders, seduced by easy credit and loans with no upfront costs. But the subprime mortgage market has crashed and borrowers are flocking back to the FHA, which has become the only option for those who lack hefty down payments or stellar credit. The agency's historic role in backing mortgages is more crucial now than at any time since its founding.
With the surge in new loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans. In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency's overall growth in new loans, according to a Washington Post analysis of federal data.
Many industry experts attribute the jump in these instant defaults to factors that include the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders looking to make a quick buck.
If a loan "is going into default immediately, it clearly suggests impropriety and fraudulent activity," said Kenneth Donohue, the inspector general of the Department of Housing and Urban Development, which includes the FHA.
The spike in quick defaults follows the pattern that preceded the collapse of the subprime market as some of the same flawed lending practices that contributed to the mortgage crisis are now eroding one of the main federal agencies charged with addressing it. During the subprime lending boom, many mortgage brokers and small lenders milked the market for commissions and fees by making as many loans as possible with little regard for whether they could be repaid.
Once again, thousands of borrowers are getting loans they do not stand a chance of repaying. Only now, unlike in the subprime meltdown, Congress would have to bail out the lenders if the FHA cannot make good on guarantees from its existing reserves. And those once-robust reserves are showing signs of stress, raising the possibility that taxpayers may have to pick up the tab for the first time since the agency was established in 1934.
More than 9,200 of the loans insured by the FHA in the past two years have gone into default after no or only one payment, according to the Post analysis. The pace of these instant defaults has tripled in one year. By last fall, more than two dozen FHA home loans on average were defaulting this way every day, seven days a week.
The overall default rate on FHA loans is accelerating rapidly as well but not as dramatically as that of instant defaults.
The agency's share of the mortgage market is up from 2 percent three years ago to nearly a third of the mortgages now made, its highest level in at least two decades, according to Inside Mortgage Finance, an industry trade publication. The FHA does not lend money directly. It provides mortgage insurance for borrowers working with FHA-approved lenders and uses the premiums to cover its losses. If the premiums are not enough, taxpayers could be on the hook.
At the same time, Congress has substantially increased the amount a homeowner can borrow on an FHA loan in pricey areas, thrusting the agency into markets it was previously shut out of, such as California, where plunging home prices have made people more vulnerable to foreclosure. Moreover, lawmakers last year put the FHA in charge of a program created to address the roots of the financial crisis by helping delinquent borrowers refinance into new mortgages.
On top of all these strains, the agency now faces this swell of loans that default almost immediately.
Under the FHA's own rules, there's a presumption of fraud or material misrepresentation if loans default after borrowers make no more than one payment. In those cases, the lenders are required by the FHA to investigate what went awry and notify the agency of any suspected fraud. But the agency's efforts at pursuing abusive lenders have been hamstrung. Once, about 130 HUD investigators teamed with FBI agents in an FHA fraud unit, but this office was dismantled in 2003 after the FHA's business dwindled in the housing boom.
At the same time, the FHA office responsible for approving and policing new lenders has not expanded even as the number of active lenders doing business with the FHA more than doubled to 2,300 in the past two years.
Although the FHA insures mortgages issued by lenders, it leaves these companies to conduct their own business. If a lender writes a lot of bad loans, that's when the agency can eject it from the program. Experts in housing finance warn, however, that the FHA has inadequate staffing and technology to keep up.
William Apgar, senior adviser to new HUD Secretary Shaun Donovan, agreed that early defaults are a worrisome sign that a lender is abusing FHA-backed loans.
Malfeasance is of such concern to the Obama administration, he said, that Donovan's first meetings at HUD were about ramping up measures to combat fraud.
"We have to make sure people don't scam the system and when they do, they are held accountable," Apgar said.Pressure to 'Get These Loans Done'
For those still looking to write loans in volume, the only game in town is government-backed mortgages, mostly those guaranteed by the FHA. But unlike with subprime business, lenders in the FHA program are asked to follow agency rules requiring borrowers to document their income, put up a modest down payment and commit to live in the homes.
"With the onslaught of FHA lending that's going on right now, they're bringing in lenders who are not familiar with FHA guidelines," said David Hail, a vice president of Allied Home Mortgage of Houston, one of the nation's largest FHA partners. He said the lenders are "under pressure from their builders or buyers to get these loans done. They're approving loans that they should not be."
The Palm Hill Condominiums project near West Palm Beach, Fla., exemplifies the problem. The two-story stucco apartments built 28 years ago on former Everglades swampland were converted to condominiums three years ago. The complex had the same owner as an FHA-approved mortgage company Great Country Mortgage of Coral Gables, whose brokers pushed no-money-down, no-closing-cost loans to prospective buyers of the condos, according to Michael Tanner, who is identified on a company Web site as a senior loan officer.
Many of the borrowers were first-time home buyers and were unable to keep up their payments. Tanner said he complained to his company that extending loans without any money down lured borrowers who either didn't understand or take seriously the payments they'd have to make. Great Country's owner, Hector Hernandez Jr., could not be reached for comment.
Eighty percent of the Great Country loans at the project have defaulted, a dozen after no payment or one. With 64 percent of all its loans gone bad, Great Country has the highest default rate of any FHA lender, according to the agency's database. It also has the highest instant default rate.
In Reston, Access National Mortgage has watched its default rate climb in three years to 6 percent from 4 percent, and the firm has had more than three dozen FHA loans go into instant default, according to federal data.
The lender is among a growing number that market FHA mortgages to borrowers through direct mail, telemarketing and the Internet, practices approved by the agency in 2005 as it tried to compete with the thriving subprime market. By the end of 2008, more than 5,200 of the agency's defaults were on loans promoted with these techniques, a sevenfold increase in one year, accord to the review of federal data. This includes, in particular, a small but rapidly growing percentage of loans that instantly defaulted.
Dean Hackemer, president of Access National Mortgage, defended direct marketing, saying it increases competition among lenders and thus forces down interest rates for borrowers. He blamed his firm's rising defaults on a bleak economy that has cost some borrowers their jobs. But he added that many of the lenders now running into trouble with FHA loans were previously selling subprime loans and related Alt-A mortgages, which required no documentation.Refinanced Back Into Trouble
Among FHA loans with instant defaults, the upward trend is especially pronounced in refinanced deals. The number of refinancings that defaulted after zero payments or one have more than quadrupled since then end of 2007 and now represent two-fifths of all instant defaults.
The FHA is attractive to borrowers looking to refinance, in part because the agency allows for cash-out refinances, a practice Apgar called "particularly problematic." It has become rare among conventional lenders, who fear that borrowers will take the cash and walk away from the loan.
The FHA also permits "streamlined" refinancing, in which established FHA borrowers get lower rates without verifying their income. The thinking is that borrowers who are on time should stay that way if their rate drops.
Karmen Carr, a housing finance consultant for the FHA, said some mortgage brokers have been known to game the system. They coax homeowners to refinance repeatedly even though it's a costly process for the borrower, she said.
"The broker makes money on every transaction," said Carr, a former executive at mortgage financier Freddie Mac. "They're not going to turn away an application if they can get it through. There have been situations where people refinance and refinance to avoid making payments and the broker just keeps getting the fees. What do they care?"
For one homeowner in Spotsylvania, Va., it took only a month to fall behind on a new FHA-backed mortgage after she took it out in November 2007. The homeowner, a retired federal worker who asked not to be named because she's embarrassed, said she soon refinanced into another FHA loan as a way of slightly delaying a subsequent payment. Then, she refinanced again. Now, she's in default on that third loan, which she said requires two-thirds of her monthly income. Still, the mortgage pitches keep coming.
"The mortgage broker just called me again to say rates have fallen, do I want to refinance?" she said in an interview last month.
Some of the country's largest and most established lenders are so concerned about this new threat to the credit market that they are not waiting for the FHA to tighten its requirements. Instead, they are imposing new rules on the brokers they work with. Wells Fargo and Bank of America, for instance, now require higher credit scores on certain FHA loan transactions and better on-time payment history.
"We have some self-preservation methods," said Joe Rogers, executive vice president at Wells Fargo.
These large lenders often buy home loans from smaller mortgage originators and in turn bundle them as securities, which they sell to investors. The lenders typically take a fee for servicing the loans, collecting monthly payments from borrowers. If too many loans default, the lender can suffer a loss because it must keep paying the investors until the loans go into foreclosure and the FHA pays the lender for the bad loan. That can take more than a year in some states and may not fully compensate the lender.
Some experts who track FHA lending say the agency should not wait for lenders to take the lead on toughening the rules, especially given the mortgage industry's poor track record for policing subprime and other risky home loans.
"Even if the market eventually gets these guys, they shouldn't have to wait for the market to do it," said Brian Chappelle, a former FHA official who is now a banking industry consultant. "The most frequent question I get asked by the groups I talk to is: 'Is FHA going to implode?' . . . They haven't seen HUD do anything significant in the past two years to tighten up its lending."