FHA Nuance Turns Costly in Down Market

by Houston Agent

An unexpected loophole in an FHA-backed loan is costing lenders money.

A particular mortgage from the Federal Housing Administration (FHA) has suddenly become costly for private lenders, as the weak housing market has exposed an unforeseen loophole in the mortgage’s distinguishing feature.

According to a HousingWire article, the loan, called the Home Equity Conversion Mortgage, or HECM, allows a borrower of at least 62 years in age to convert a portion of the home’s equity into cash. Though the lender does not require immediate repayment, if the cash cannot be repaid, the lender or the Department of Housing and Urban Development repossess the home.

“The estate has six months to meet the payment requirement until a foreclosure proceeds, and often the estate sells the home,” writes HousingWire’s Jon Prior.

But the repayment process is not the problem; rather, the costly dimension of the HECM comes in after the home is repossessed and enters REO status.

The terms of the loan, as dictated by the FHA, state that the outstanding balance of the home loan will be guaranteed if the home sells within six months of repossession. Once that six-month period expires, the FHA orders a fresh appraisal of the home, upon which it bases its reimbursement.

With home values falling as much as they have in recent years (recent projections put home values at 32.5 percent below their 2005 peak), lenders are often receiving less money back than they initially put into the home.

According to research by Moody’s Investors Services cited by Prior, 7 to 10 percent of FHA-backed reverse mortgages were in REO status for more than six months, and as a result, investors have lost, on average, 20 percent for those loans sold afterward.

“The weak housing market has increased the potential for losses to the trust both because long liquidation timelines have increased the incidence of properties remaining in REO for longer than six months and because falling home prices have increased the likelihood that liquidation proceeds will not meet or exceed the appraisal amount,” Moody’s said in a report released Tuesday.

Ironically, as Prior points out, the loophole actually creates some breathing room for the FHA, as the lenders, not the agency, are forced to take haircuts the loans. In recent weeks, concerns have been raised for the FHA’s finances, and some members of Congress have even begun warning of eventual bailouts for the agency.

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