FHA Mortgages: Get a Good Deal While You Can

Next time you're inclined to complain about the bankers' bailout, remember that homebuyers are now on government life support as much as anyone.

This week, Federal Housing Administration chief David Stevens announced that his agency is now the largest source of home-purchase mortgages in the nation. According to the firm Potomac Partners, FHA insured $52.5 billion in purchase loans in the first three months of 2010. The government-controlled Fannie Mae and Freddie Mac purchased just $46 billion.

This is the first time in memory that FHA is the dominant player in the mortgage business, a role it hasn't really had since era of "Father Knows Best" in the 1950s.

What does FHA's new dominance mean for home buyers?

Stevens told a Mortgage Bankers Association conference that FHA's bigger role was bad news. "This is a market purely on life support, sustained by the federal government," Bloomberg News quoted him saying. "Having FHA do this much volume is a sign of a very sick system."

By contrast, as recently as 2006 FHA handled less than 4 percent of the homebuying market, and in the 15 years before the crisis it never got above about 14 percent.

Fannie Mae and Freddie Mac, along with subprime lenders, siphoned off almost the entire business of FHA by selling loans that were easier to get and usually had (at least initially) lower interest rates.

But the bad news for FHA is actually good news for home buyers.

Stevens is worried because his agency's responsibilities are just getting too big for a strapped federal government to manage. But you can still get a home for just 3.5 percent down, far less than is possible without the insurance fund's backing.

Private mortgage insurance continues to be difficult to find, and expensive, making FHA and its insurance fund -- which assures lenders of getting paid back in case you can't pay your loan -- the best way to get a low down-payment mortgage.

A big low-down-payment mortgage, I might add.

In order to provide mortgage credit during the crisis (as other options disappeared), Congress temporarily raised an FHA maximum loan size to as high as $729,750, up from just $290,319 in 2004. (It was just $160,176 for areas outside the most expensive real estate markets). Sooner or later, Congress will shrink FHA's maximum loan size once again, meaning that those low-down-payment loans will once again only be available for relatively affordable real estate -- starter homes, small houses, and so on. That was always what FHA was supposed to be for, ever since it started in 1935 – to make mortgages available for people of modest means who couldn't otherwise get them.

The right-sizing of FHA won't come a moment too soon. FHA currently has to dig itself out of a mess. In 2007 and 2008, poorly regulated lenders who signed up with the program had backed a big volume of sketchy loans. Sometimes that was done in connection with organized fraud -- that lenders pursued to generate business as the real estate market collapsed. The insurance fund now has to deal with resulting defaults.

About 12 percent of all FHA loans are currently past due, according to the Mortgage Bankers Association, second only to the rate for subprime loans and exactly double that of prime loans.

FHA recently increased the upfront fee you'll have to pay in order to get one of its insured loans, to 2.25 percent of your total loan amount. That comes in addition to annual premiums, and it's a step to make sure that foreclosures don't kill the FHA insurance fund.

But if you're looking to buy a home with a low down payment, FHA is worth every penny. That's why so many buyers are stampeding there – and why the overwhelmed head of the FHA was pleading with mortgage bankers to get the private market moving again.

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