Trump Has Taken a Lot of Crap for His Recent Move with FHA…
Which, if you missed it, was to repeal a never-enacted rate cut to FHA buyers for mortgage insurance premiums. In his last days in office, president Obama issued an order to cut the annual mortgage insurance premium from .85% of the loan balance to .60%. This rate cut didn’t go into effect until January 27th, so no home buyers had actually taken advantage of it yet, and for the median FHA buyer, the cost savings would have been around $500/year, or around $42 a month.
This mortgage insurance serves as a user-paid safety net for FHA; remember, thanks to massive defaults on mortgages insured by the program during 2007-2009, the American taxpayer is now footing the bill for the interest payments on a $1.7 trillion dollar bailout of the program in 2013. I say the interest payments because, let’s face it, we borrowed that money and are likely to never actually pay it off.
The Obama administration argued that FHA had largely recovered and has adequate reserves to cover defaults now, and that the savings should be passed on to the borrower; the Trump administration has said that it wants to look more closely at that reserve and
insure that it’s adequate to avoid another bailout (or complete failure of the program) should another recession cause a spike in mortgage defaults.
The question that no administration in the past 80 years has wanted to address is this: is a program that makes it so easy to buy a house that someone with a 580 credit score (a score that almost certainly points to past bankruptcies and/or more than one unpaid account) AND as little as 3.5% down can become a homeowner good for the country, or good for the homeowners themselves?
There’s a longstanding maxim in this country that homeownership is good for everyone. There’s a heartwarming but little-remembered scene in “It’s a Wonderful Life” where good guy George Bailey (who was, if you’ll remember, the president of his family’s small savings and loan) hands over the keys to a brand-new home to an immigrant family that’s literally moved to tears by the achievement of becoming homeowners. The setting makes it clear that this family is a member of what we’d probably call the lower middle class or working poor today; their new home is small and modest; and the whole point of the scene is to further the plot line that George has made a lot of lives a lot better just by being alive.
The thing that goes unsaid in this little vignette is that the Martini family was only able to buy this luxurious 4-room house because of a new-ish government program that insured their loan with just a 5% down payment and a 30 year term, rather than the 50% down payment and 5 year balloon they would have had to deal with a decade earlier.
In fact, the housing policy of the Federal Government since the FDR administration has been to encourage (and by encourage, I mean use tax payer money, the tax code, and regulation to fund programs and subsidies for) as many people as possible to become home owners.
The arguments for a homeownership society go like this: it’s good for neighborhoods, because homeowners don’t tolerate crime and filth and bad behavior in the place they’ve put down roots. It’s good for the owners, because it forces an investment that will eventually be owned free and clear, and creates an asset for the future. It’s good for families, because children have a sense of permanence and don’t get shuffled around from school to school, constantly trying to catch up (or being ahead) when they find themselves in another new classroom. It stabilizes local property values and the tax base, since homeowners tend to pay more money for properties than do investors. And on and on it goes.
And I myself was firmly in this camp, until I realized that government interference in the housing market was encouraging people to buy homes that they Just. Can’t. Afford.
Which brings us back to those FHA-insured loans. FHA isn’t actually a lender; it’s an insurer that guarantees to banks that they can make loans to people who have marginal credit and not much money, and that if these loans default (which they do at a much higher rate than conventional loans, which require a larger down payment and higher credit score), the owner of the loan will be reimbursed a large chunk of the losses (and won’t have to carry the resulting REO on their books).
As a result, FHA-insured loans are far less risky for the lender than a non-insured loan for 96.5% of the value of the property (look around you and try to find a bank willing to take 3.5% down on a loan that they have their own money in, or have to sell in an open market situation. Go ahead, I’ll wait), and thus also carry lower interest rates.
The concept behind FHA, of course, was to grant access to home ownership to people on whom a normal bank, risking its depositor’s money and its own profits, wouldn’t consider creditworthy enough to make a loan to—or, to put it another way, to borrowers whose past credit history indicates might be high risk borrowers.
In a less-regulated market, such borrowers would be subject to HIGHER down payment and interest rate requirements; that’s called “pricing the risk” and it’s exactly what you’d do if it were YOUR money on the table. But FHA acts counter to the market by making down payments and interest rates LOWER for the highest-risk borrowers in the market.
For borrowers who bother to think about it, this probably seems like a real gift: with current high rents and low interest rates, the monthly payment on any given house at current FHA rates—INCLUDING taxes, insurance, and his mortgage insurance premium—is well under the amount that the same house would rent for.
The problem is, of course, that all of this ignores the financial realities of homeownership. Specifically, the fact that houses are expensive to own, and keeping them in a condition where they’re safe, livable, and likely to appreciate with the market, requires cash and/or credit, and starting the adventure of homeownership with limited access to both makes the chances of failure pretty high.
“Replacement reserves” are a concept that shouldn’t be applied only to rental properties. Think about it: over the course of 20 years, even with no updating of the cosmetics, at a MININUM, the following will more than likely have to be replaced:
Furnace and central air $5,000
Water heater, probably twice $2,000
Concrete surfaces $3,000
Carpet, probably twice $3,000
Prep to sell $5,000
And this doesn’t count all of the “little things” that have to be repaired or replaced—the ceiling fan that mysteriously stops working, the outlet that develops a short, the gutter that pulls away from the house, the drain that gets full of roots—or the catastrophic, unexpected problems like foundation issues following an especially dry
summer or the complete collapse of an old sewer line. Nor does it leave any budget for updating of the kitchen, baths, and other cosmetics that go out of style over the decades and should be replaced in order to maximize the value.
So, the owner of this imaginary house can expect to spend a minimum of $1,500 a year, on average, to keep his home maintained. Which SHOULD be no problem, since he’s saving, at least in my market, about $150 per month, or $1,800 a year, over what he’d be paying if he rented the same house. At today’s hyper-low rates, he could do all the work the house needs and still come out ahead.
The problem is, most Americans aren’t wired to budget, save, or otherwise manage their money. Remember: the whole reason this particular homeowner is an FHA buyer is because he could only scrape together $3,250 down. If he’s like most subsidized homeowners (and that’s the right word), he’s going to ask the seller to pay every other closing cost just so he can “afford” the house. So how is he going to pay for that $5,000 roof when it’s time? The same way he paid for the house—by financing it.
I am not judging people who buy houses without understanding or being prepared for the actual costs of ownership.
Nor am I saying that such people shouldn’t “be allowed” to buy homes.
I’m just saying that in 20 years of dealing with tens of thousands of owners (and houses they’d lost to foreclosure), I can tell you that owning a home (as opposed to renting, where the landlord takes care of such issues) is NOT a positive experience for many of these folks. In fact, it’s a source of stress, ruined credit, and loss—and when it ends up being an eyesore or yet another boarded-up foreclosure, it’s not a positive thing for the neighborhood, either.
The government is not qualified to judge who should and shouldn’t own property.
Neither are activist groups, nor are you and I.
But you know who is? The free market.
And what’s the best measure of how the free market evaluates the risk of a home owner defaulting on his mortgage, allowing the condition of the property to degrade, or otherwise having a generally negative experience in the world of homeownership? Look at what banks who are operating in the free market (as opposed to under regulations and regulatory financial incentives promoting or discouraging particular actions).
Lenders that don’t participate in the FHA loan program, that don’t sell their loans to the (also highly-subsidized) FNMA or FHLMC secondary market—that, in other words, lend their depositor’s money and have only the qualifications of the borrower to insure that this money will be paid back—make loans based on a balance between attractiveness to the consumer and safety for them. And you’ll note that in order to get a
loan from one of these banks, a homeowner has to have significant skin in the game, good credit, reserves, etc.
“But that’s not fair”, I can hear affordable housing advocates all over the U.S. whining. “That means that an entire class of people are shut out of the American Dream just because they don’t have a lot of money, or have bad credit, or can’t save because they’re pooooooor…There should be law to force those banks to loan to people who can’t afford it, but deserve it”.
If you believe that owning a home is a RIGHT, and a net social positive, and something that’s inevitably good for the homeowner, and that it’s relative income vs. good personal financial management that these banks are “discriminating against”, this is a very reasonable train of thought.
But the reality is that what everyone has the absolute “right” to do what they need to do to make themselves qualified and attractive as a borrower for the property and loan that they can reasonably afford.
If this entails living below their means—whatever those means are—until they can reach a reasonable threshold of down payment, so be it.
If it means pooling resources with other family members to get the cash and credit they need, so be it.
If it means getting a higher-risk, higher-rate loan from a private investor to own a home, so be it.
But if it means that they simply can’t pull it together to become what free market capital considers an “acceptable risk”, then I question whether you and I should be involuntarily subsidizing the “American Dream” for people who, by any practical measure, shouldn’t be home owners at all.
What do you think?