FHA betting on housing rebound

In Honolulu, on the southern coast of the island of Oahu, there’s a four-bedroom home priced at $785,000 that has views of the sun setting over the Pacific Ocean. The beaches of Waikiki are 15-minutes away.

Starting this month, the property is available to buyers with a subprime credit score, limited cash reserves and a 3.5 percent down payment using a loan backed by the Federal Housing Administration. Without the agency, a buyer would need a 20 percent down payment and an unblemished financial history for a jumbo mortgage.

The FHA is betting housing can recover enough to expand financing and earn bigger fees to revive its record-low capital levels. The agency increased the size of mortgages it’s willing to insure to as high as $793,750 in Hawaii and $729,750 in the costly real estate markets of states including California, Florida, and Virginia. In his State of the Union address on Jan. 24, President Barack Obama proposed a new refinancing program that may expand FHA’s responsibilities, and risks, even further.

It’s “not the best time to begin guaranteeing houses that the average American couldn’t afford,” said Anthony Yezer, director of the Center for Economic Research at George Washington University. “It may be that the insurance fund even now is insolvent.”

Obama told Congress he would send it legislation that would allow all homeowners to refinance their mortgages to take advantage of record-low interest rates. The proposal, and the congressional mandate, come a year after officials vowed to shrink the role of government in the mortgage markets.

The initiative would apply to all borrowers, whether or not their loans are currently government-backed, with details still to be worked out, according to senior administration officials, who asked not to be named. Neither Obama nor the officials specifically said FHA would insure the private mortgages that refinance, though that was a conclusion drawn by analysts including Mahesh Swaminathan of Credit Suisse Group in New York.

“Our preliminary interpretation is that the program is aimed at refinancing borrowers with underwater private label mortgages into FHA loans,” he said in a note to clients this week.

About 12 percent of FHA loans had payments a month or more overdue in the third quarter, compared with 8 percent for the overall market, according to the Mortgage Bankers Association in Washington. In Florida, the rate was 13 percent and in Virginia the rate was 11 percent.

Slight declines in home prices could wipe out equity for a home bought using the FHA’s 3.5 percent minimum down payment, increasing the risk of a default. Michelle Meyer, Bank of America Corp.’s senior U.S. economist, last month forecast a 3.5 percent drop in home prices this year.

In the case of a default, larger home loans put taxpayers on the hook for bigger payouts on luxury properties many can only dream of owning, Yezer said. In Hawaii, home prices in the third quarter dropped 2.3 percent from a year earlier, according to the Federal Housing Finance Agency. In California, where cities such as Los Angeles, San Jose, and San Francisco have a cap of $729,750, prices were down 5.4 percent.

“We’re already at the point where the FHA is raising fees on current borrowers to make up for past mistakes, and these loans have the potential for much bigger losses,” said Yezer. “If people really want to buy a $700,000 house, maybe they should save the 20 percent down and not rely on taxpayers, or else they could buy something smaller.”