The Federal Housing Administration’s (FHA’s) insurance fund does not contain the minimum reserve mandated by Congress. The FHA, which now insures over 35% of California home loan originations, is desperate to find ways to pump up its meager reserves in the event another or continuing wave of foreclosure pummels the nation.

Further FHA insurance fund losses are a certain prospect, considering 17% of FHA-insured borrowers are behind one month or more on payments. Most solutions to replenish the FHA insurance fund result in negative consequences for future homebuyers and refinancers.

The minimum required cash down payment could be increased to 5% or 10%, up from the current 3.5%. This would force homebuyers to have a greater vested interest in the properties they purchase, making default and foreclosure less likely, but reducing the number of tenants who could become homeowners.

To generate instant revenue, the FHA could increase its mortgage insurance premium to the maximum limit of 2.5% paid upfront by the homebuyer; or similarly increase its annual insurance premium to 3%, up from the current 0.5% or 0.55% depending on the borrower.

Revenue could also be generated by the FHA if it became stricter with its treatment of seller concessions to homebuyers. To limit the FHA’s exposure to risk, and thereby decrease expenditures from the insurance fund reserve, the maximum seller concession allowed could be reduced to 2%, down from the current 6%.

Additionally, before the FHA even agrees to insure a loan, it could tighten its credit standards to levels consistent with private insurers (PMI).

However, some argue these additional burdens placed on homebuyers and refinancers would defeat the very purpose of the FHA – to serve homebuyers and refinancing by owners of modest financial means.

first tuesday take: The FHA plays an important role in encouraging tenants to become owners. It guarantees loans with high loan-to-value ratios (LTVs) and low down payment requirements.  As a government agency, FHA would do well to raise its down payment requirement if it is to prevent future negative equity epidemics, especially in this conceptually opportunistic market where speculation in particular, and fraud as a matter of principle, are both rampant.

However, any steps taken by the FHA to replenish its insurance fund reserve and reign in fraudulent activity will come at the expense of future legitimate homebuyers and refinancers. The impact of these changes will especially be felt here in California where the use of FHA insurance has grown dramatically over the last few years as private insurers have basically left California. In Southern California, FHA-insured mortgages accounted for 38.3% of all loans made in October, up from 32.5% a year ago and just 2% two years ago.

With so much of the mortgage loan business coming to it for insurance, the FHA has become a market maker for low-end and first-time homebuyers. It is these members of society which the government, through HUD and FHA, wants out of rentals and into housing as a matter of the nation’s housing policy. However, government housing agencies are meant to supply starter loans and are not to be relied on as a market maker. For good reason, as a response to the financial crisis, we are now seeing an improper overuse of these programs.  Thus, the time to cut back at least gradually has come, if not passed.

FHA is presently stepping in as a provider of last resort (as governments must) to guarantee loans that normally would be privately insured (PMI) but for the risks of financial losses. We see dangerous conduct in allowing investors and seasoned homebuyers to join with the intended beneficiaries of FHA – the first timers – to get in on the low down payment situation. With good fundamentals of lending on homes in place, those other than first time buyers should be putting up the 10% to 20% down payments. Housing is making a slow return from the bottom and needs to be groomed for reentry into a non-government subsidized market place on which recovery will appear and eventually take on surprising strength.

But are the FHA’s efforts to remain solvent a bad thing? Absolutely not. These changes are part of a sweeping recalibration of lending and purchase practices aimed to ensure only legitimate homebuyers enter the market – and tenants-by-nature stay tenants. A return to the market fundamentals is eminent, and this is certainly a step in the right direction.

Re: “FHA looking for ways to pump up its reserves,” from the San Francisco Chronicle.