A lot has been going on in the world of FHA since my last post, so there is quite a bit of catching up to do!

First, let me remind you about the changes that are happening with FHA loan limits and the down payment requirements in January. Don't let these catch you flat footed with your clients losing their loans. More on that in a separate post.

Second, one of the changes that will affect loan officers takes effect on January 16, 2009 when the 1% limit on loan origination fees on FHA loans that has been in effect forever will be removed. This is part of the same rule introducing the new "simplified" (in the George Orwell sense) Good Faith Estimate which does not have to be used until 2010.

Some consumer activists have complained that removing this limitation is an instance of HUD giving up on consumer protection. This is far from the case. First, people not directly involved in the origination and processing of an FHA loan for a customer with credit problems or other issues that cause their loan not to fit easily into the box have no idea of the work involved in getting that customer a loan.

I have worked on both the real estate broker side of the transaction as well as the loan officer side. Some may disagree, but I believe I know what I am talking about when I say that the loan officer in such a transaction really deserves at least the same pay as the real estate agent and neither deserves less than the agent is getting now. I know that, unlike with the average conventional loan, they end up doing more work. Yet many people seem to think a loan officer should be happy to split less than half the real estate agents' pay with the mortgage company, the lender, the government, the appraiser and the attorney.

No one in the transaction has to wrangle as many different people and as many different seemingly uncontrollable factors as the loan officer. Some consumer activists who think that human nature can be overridden may believe otherwise, but a person doing any difficult job does it more effectively when they are well rewarded for the effort. I think having to pay a little bit extra is a small sacrifice for a borrower who has problems it takes an expert to solve. They aren't being "ripped off" by having to pay more.

Traditionally, this has meant that FHA borrowers with difficult loans (estimates are that this group includes at least 60% of mortgage applicants today) almost always ended up paying higher interest rates which paid yield spread premiums so that a busy expert FHA loan originator would feel motivated to spend the extra time and absorb the extra stress involved in getting such a transaction closed. Now this will be pushed out into the open where it belongs. Unfortunately, this benefit will be dulled because the fee will still be limited by state regulations in most cases. Consumers need to realize that experts in a field will leave that field if their work is not well rewarded, leaving only the order takers who aren't experienced and prepared enough to solve the problems borrowers have.

Now on to the main subject. All this praise of the expert professional FHA loan officer needs to be tempered by the fact that  every day more loan officers who don't have a clue what they are doing and don't care to take the time to learn, or even worse do have a clue but have turned to the dark fraudulent side of the business are entering the FHA loan origination business.

According to the Mortgage Bankers Association, in October the percentage of total loans originated that were government insured had risen from 9.4% in January 2008 to 32.9% in October! November was the second straight month that GNMA issued more mortgage backed securities than Fannie Mae or Freddie Mac. GNMA, or Ginnie Mae, backs government insured loans in much the same way that FNMA and FHLMC (Fannie Mae and Fredie Mac) back conventional loans, with the exception of explicit backing by the FHA and VA insurance funds. Government bond issues have not been higher than conventional issues since just after the savings and loan crisis in the 1980s. The point is that FHA and VA loans are taking over the market.

In theory, according to the guidelines, FHA has a system to control abuses of the program by unscrupulous mortgage lenders, brokers and loan officers. HUD has an audit process that participants agree to when they sign up to take part in the program. HUD has a system for eliminating lenders whose default rates exceed the national average by too much. HUD insists on a written quality control plan that each FHA lender must have and follow to prevent fraud and insure quality loans. FHA insists on verifying and analyzing a borrowers ability to repay the loan. FHA has a thorough and effective loss mitigation program to help keep borrowers in their homes when they have financial difficulties.

The trouble is that enforcing and implementing these guidelines, rules and procedures requires more staff than FHA has available at a time when FHA loan numbers are increasing at a record pace. A few weeks ago, Business Week published an article entitled "FHA Backed Loans: The New Subprime". My initial response to this article was to get my nose out of joint and sit down to write a thorough rebuttal, but I was interrupted and therefore given time to really think about the situation and calm down.

My first instinct was to point out that the real numbers show that FHA foreclosure starts and delinquency rates have held steady while conventional numbers went up. In spite of FHA grabbing a larger section of the market. However, we must also take into account that, according to a recent audit FHAs insurance fund has dropped 39% from last year. The fund has dropped from $21.2 billion a year ago to $12.9 billion. Even so, the worst case scenarios still indicate that the fund will continue to remain above the legal limit or 2% of outstanding FHA mortgages. FHA just simply has an awesome loss mitigation system.

However, the Business Week article has several examples of high volume lenders who should never be allowed to originate FHA mortgages, but have wriggled through the cracks and are still going strong in spite of the rules which say they shouldn't be in business. These are the same type lenders who helped throw gasoline on the bonfire as the subprime business went up in flames. According to the article, "Thirty-six thousand lenders now have FHA licenses, up from 16,000 in mid-2007." To top that off, the government is strongly encouraging  as many lenders as possible to join the FHA program and constantly introducing more flexible programs to bail people out of foreclosure and to allow larger loans.

While this has been going on, according to the article, "FHA staffing has remained roughly level over the past five years, at just under 1,000 employees, ... The FHA unit that approves new lenders, recertifies existing ones, and oversees quality assurance has only five slots; two of those were vacant this fall, according to HUD's Web site. Former housing officials say lender evaluations sometimes amount to little more than a brief phone call, which helps explain why questionable ex-subprime operations can re­invent themselves and gain approval." (emphasis added)

To make things worse, FHA's computer systems can't even accurately track or determine which lenders and brokers have already been convicted of fraud or some other violation! This leaves the system extremely vulnerable.

Surely, a little bit of the bailout money could be directed towards making sure FHA has the resources to prevent FHA itself from needing to be bailed out.

In the meantime, remember that the vast majority of lenders and brokers are still coloring within the lines and present little potential problem. I highly encourage every loan officer to help out by holding themselves to a higher standard. Don't just be an order taker whose goal is simply to get every borrower who wants one into a house. Learn the rules thoroughtly, get all the FHA training you can, and make sure the borrowers you help will really benefit from the loans you are helping them get.

Carl Pruitt

FHA Guidelines, Analysis and Updates: http://fhaloanadvice.com