Who will win and who will lose with FHA loan limits that were reduced as of October 1st?
The answer may be surprising.
In general terms there has been considerable support for lower FHA loan limits for several reasons.
First, lower FHA limits mean more opportunities to sell private-sector loans.
Second, the FHA has long been considered a program for entry-level and middle-income borrowers. Huge mortgage amounts suggest that the program has evolved into a financing vehicle for the upper class, something which doesn’t quite pass the sniff test for a program that evolved from the Great Depression.
Third, it’s thought that the FHA should not be making big loans because such financing is inherently more risky than smaller loans.
The first two items are matters of opinion and preference, but what about the third? Are big loans really so risky?
We asked HUD to provide the latest delinquency and foreclosure figures by loan amount. As of mid-September 2011 the results were probably not what most people expect.
If we’re going to discuss “risk” we must ask how the term should be defined. The best approach is to look at different stakeholders.
Borrowers: Bigger loans for borrowers are only “more” risky than smaller mortgages if financial qualifications are missing. If Smith can comfortably afford a bigger loan there’s no problem. If Jones has a small loan but can’t pay, then that’s a concern.
Lenders: Lenders love the FHA program for a very simple reason: The loans are 100% guaranteed by the FHA. If a loan goes bad the lender knows it will get back its principal as well as other costs. Thus, on the matter of risk, you would have to say lenders have little to none.
The FHA: For the FHA loan size is not really an issue as long as the borrower is properly qualified. It’s true that a $600,000 FHA mortgage is a bigger loan than a $100,000 mortgage, but it is also true that the FHA will collect a bigger up-front mortgage insurance premium and a larger amount in terms of the annual mortgage insurance premium (MIP). In effect, there’s a balance between size and insurance premiums.
Where matters get dicey is when things go wrong. You can objectively lose a lot more dollars with a big loan. The catch is that the threat of loss does not exist in a vacuum, you also have to also look at marketplace results.
In other words, what’s the failure rate for FHA loans by mortgage size and what percentage of the FHA loan portfolio is represented by loans of a given size?
|Loan Amount||Inventory Share|
|90+ Days Late (%)||In Fore-|
|Seriously Delinquent (%)|
|Sources: Data: HUD; Chart: OurBroker.com|
A look at the chart shows that big loans are not a big deal in terms of FHA risk for two reasons:
First, big loans are a tiny percent of the overall FHA portfolio. Loans for $500,000 or more are just .75 percent of all FHA mortgages outstanding.
Second, few big loans fail. Only 1.32 percent of all loans above $500,000 have been foreclosed, compared with an overall average of 2.47 percent.
You see the same thing with bankruptcies: The percent of FHA borrowers in bankruptcy is 1.22 percent. The percent of big borrowers in bankruptcy is just .27 percent, about one-fourth the rate of other borrowers.
Why are there relatively so few foreclosed borrowers with big FHA loans? Most probably the answer is that borrowers with big loans have big incomes and presumably better savings and more assets than entry-level borrowers.
One question raised by the FHA figures is this: If big loans represent relatively little risk then why do lenders charge higher mortgage rates for “jumbo” mortgage products? Combine big loans with above-market rates and below-market risk and lenders have a sweet deal.