Refinance Trouble? Think About An FHA Loan

The Orange County Register reports that the FHA is taking up the slack for subprime lending.

It's a lot of effort to get an FHA home loan (which protects lenders from loss so they are more willing to make loans to those with sub-stellar credit).

Getting an FHA loan takes a long time. There are extra costs. There's a ton of paperwork. You need to produce tax returns, proof of income and statements from your bank. Escrow may take longer.

With other lenders leaving the subprime market, the FHA is the last man standing.

This has happened before. Private mortgage insurers have left the market and left things to the FHA.

Burns likens the current market to a recession in the 1980s that hurt housing markets in Texas and other oil-producing states. Lenders tightened standards in those markets, and private mortgage insurers pulled back, leaving the FHA to step in and stabilize markets, she said.

The FHA has a history of helping consumers and stabilizing markets. Congress created the agency in 1934 to boost homeownership amid the Great Depression. In the 1940s, the FHA financed military housing as well as home loans for World War II veterans.

Today, consumers who might not have ever considered an FHA loan might find it their best option. The FHA accepts low credit scores and targets any home buyer with little in savings.

Al Hensling, head of United American Mortgage in Irvine, which brokered the Poulsens' loan, said larger FHA-insured loans compare favorably to larger loans sold to government-sponsored enterprises such as Fannie Mae, the largest U.S. funder of loans.

The FHA allows lower credit scores and lower down payments — as little as 3 percent — than Fannie Mae and Freddie Mac do, Hensling said. He said GSEs require at least 10 percent down on larger loans.

One downside: The FHA requires an insurance premium on all loans, usually 1.5 percent of the loan amount. The premium can be "financed" — added into the loan amount. GSEs require insurance on loans more than 80 percent of the value of a home.

Hensling said the recent collapse of investment banking giant Bear Stearns, a big player in mortgage-backed securities, illustrates the breakdown of a private market for loans.

"There is no secondary market right now," he said. He described the FHA as just about the "salvation for the market."

And the FHA is seen as a tool to stem foreclosures on subprime loans. President Bush has twice expanded the types of subprime loans the FHA can back. Last month, the FHA said it can insure an adjustable-rate loan after a lender slashes the principal balance to make it more affordable, even if the borrower missed two or three payments.

Still, some academic experts expressed concern over the FHA's backing larger loans. Kerry Vandell, professor of finance and director of the Center for Real Estate at UC Irvine's Paul Merage School of Business, said FHA loans tend to default more often than loans sold to Fannie and Freddie. The trend correlates with the FHA's historical push into inner cities, as well as generally to borrowers with marginal credit, he said.