Economist's Commentary: April 17, 2008

FHA Revival

By Lawrence Yun, Chief Economist

Mortgages backed by the Federal Housing Administration (FHA) are seeing a revival. FHA loans, which had historically accounted for about 20 percent of mortgage originations, have fallen steeply over the recent years. In 2007, less than 3 percent of mortgage originations had FHA backing. Homebuyers had moved away from FHA and into subprime loans. Subprime loans, which were virtually non-existent 10 years ago, took market share away from FHA and had accounted for about 20 percent of originations in recent years — right up to the credit crunch in August 2007.

FHA loans have traditionally catered towards people with blemished credit and low-to-moderate income households. The interest rates on FHA loans are substantially lower than on subprime loans (if accounting for higher resetting rates after the teaser period and prepayment penalties), yet it lost out to the subprime market.

With subprime loans no longer available, a greater number of people are turning to FHA loans. And that is a good thing. The simple fact that there are lower interest rates on FHA loans will help consumers better handle monthly payments. Furthermore, the infrastructure of FHA loan programs that include better counseling and loss-mitigation work out plans is helping to lower foreclosure.

Consider the following data. At the end of 2007, there were 447,154 FHA loans with payment delinquencies. Because many of the delinquent borrowers eventually make payments, the foreclosure cases are much lower than delinquencies and were 74,156 on FHA loans. The ratio of foreclosure-to-delinquency is 17 percent, which also can be interpreted as a chance of a foreclosure among those who are late on their payment. I know this is not the true probability due to lagged impact from delinquency to foreclosure, but is a rough estimate. For subprime loans, the probability of a foreclosure was whopping 46 percent among those who were late on their payment.

The differences in loan performance between FHA and subprime mortgages are substantial. The fact that subprime loans are not being originated in the current environment is pointing towards a healthier housing market conditions going forward. The past subprime originations will surely apply continuing stress, but not for homebuyers who are entering the market today.

Home sales are very soft — though stable — currently. That reflects 20 percent of mortgage originations suddenly leaving the market place. But the FHA is making a strong comeback. FHA applications rose 95 percent in the fourth quarter of 2007 from a year ago. To originate FHA loans, lenders first need to get certified from the HUD. Many are trying and steadily more will get approved. Expect an even bigger rise in FHA loan usage in 2008.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.  Read more commentaries >

Comments?  Questions?  E-mail NAR Research.

NAR members, learn how you can add this commentary to your Web site, blog, or newsletter.  Read more >