In the past, the Federal Housing Administration (FHA) has traditionally refused to insure mortgages on homes resold within 90 days. This rule discouraged “flipping” of property by speculators who sandwich themselves between seller and buyer; behavior which artificially drives up prices by the amount of the profit they extract. As an incentive to clear the market of the vast unsold housing inventory, the FHA is now temporarily removing this restriction, and will insure mortgages on less-than 90-day resales. This waiver will go into effect on February 1, and will remain effective for one year.

At the same time, the FHA will increase its lending standards, an action which will, implicitly, reduce home sales. FHA is raising its mortgage insurance premium from 1.75% of the loan to 2.25%. This is a non-recurring closing cost that sellers have been paying when the buyer’s financing is an FHA-insured loan. However, beginning in summer 2010, sellers will be forbidden to help buyers pay more than 3% of their non-recurring closing costs (down from the current 6%).

Lenders who fund FHA-insured loans will find that information about their performance is posted publicly to provide lender transparency and promote honesty and fair play. The FHA’s minimum qualifying down payment will remain at its current level of 3.5% of the purchase price paid by the FHA-insured buyer, but FHA borrowers will now need a credit score of at least 580 (still considered a relatively low score) to qualify for FHA insurance with a down payment at this low level. Buyers with lower credit scores will need a higher down payment to qualify.

first tuesday take: In the one-year waiver period, FHA-insured homebuyers will find more homes available to them, as increased financing for qualified buyers allows them to purchase flipped homes from speculators. In the short term, this may help to put more homes on the market and out of decrepitude, but the cost will be great. The relaxation of the FHA’s 90-day lending standards is likely to increase the number of predatory speculators who enter the market looking to make quick money by flipping homes; behavior that leads to artificially-inflated property values and increased volatility in the housing market. For more information on the harm that can be done by speculators, and the reason the FHA needs to be diligent in regulating them, see first tuesday’s January 2010 article “Homebuyer beware: the real estate game lacks fair play.”

The FHA has made some positive changes, however. Increased insurance premiums and closing costs are a small but helpful step in monitoring the high-risk buyers who, by necessity, turn to the FHA for financing. Increased down payments will eventually be essential to prevent future defaults, but the newly increased credit limits will stop at least a fraction of the most likely defaulters from obtaining FHA-insured loans. These measures will increase the long-term strength of the FHA, and help restore sane lending practices, but the cost will be reduced sales volume, as buyers are less able to obtain financing.

In California, FHA insured loans made up around 38% of loans in California last year. Any tightening of standards, by an increase in the buyer’s down payment and the burden of non-recurring closing costs to reduce defaults, is certain to hurt sales volume. Any loosing of the restrictions on speculation, in a misguided effort to help clear out the coming real estate owned (REO) inventory, is just as certain to drive up prices. These are conflicting situations, in an uncertain real estate market that needs stability to find itself again. The 90-day rule was one source of such stability, and the FHA would be wise to reinstate it.

Re: “Waiver ok’d on flipping houses” from the Press Enterprise; “FHA to raise standards on mortgage insurance” from the New York Times