Only Game In Town

Credit: David Plunkert

Bill Renner knows exactly when access to government-­insured mortgages became essential to the survival of home building companies around the country. That would be March 2008, when Congress passed an economic stimulus bill temporarily raising the loan ­limits for FHA-insured loans to as high as $729,750 in some parts of the country, more than twice as high as before.

“Because loan limits had become so far away from prices in markets like California, builders did not even think of FHA,” says Renner, director of single-family finance at the NAHB. “This opened these markets back up to the use of FHA, and I got calls from builders turning to FHA, asking, ‘What are these new requirements?’” That’s a reasonable question—but it also indicated just how much FHA’s market share had shrunk during the boom. “FHA hadn’t added any new requirements since 1996,” Renner says. “These guys hadn’t used FHA since the ’80s.”

Times have changed. Subprime loans have slunk back into the darkness, but with banks clinging to cash like a lifeline, conventional mortgage financing has disappeared even for creditworthy borrowers. “This is the tightest lending environment I’ve ever seen, and I’ve got 27 years in the business,” says Dan Klinger, president of K. Hovnanian American Mortgage, the ­financial services division of public builder Hovnanian Enterprises.

That tightening has resulted in a tremendous expansion of FHA in terms of the number of home loans endorsed, dollar value of mortgages insured, and its share of the overall mortgage market. For better or for worse, FHA has become an essential source of mortgage financing during this housing slump, nearly tripling the dollar volume of home mortgages that it insures between 2007 and 2008 alone, to more than $102 billion. Such growth worries industry watchers who aren’t persuaded that builders, lenders, and others have truly sworn off the practices that created the now-deflated housing bubble.

Irrelevance to Dominance

As recently as 2004, though, FHA’s sinking market-share numbers had even government employees questioning whether their agency, established in 1934, had ­become unnecessary.

“Our market share was dropping precipitously,” remembers Meg Burns, director of FHA’s office of single-family finance. “We thought, ‘If people can get prime-rate financing without government insurance, that’s a great thing.’”

So they decided to research the issue. What FHA uncovered—that borrowers who could have qualified for FHA loans at prime-level interest rates were instead choosing more-expensive subprime products—was largely ignored in 2005, when agency staffers testified at a hearing about their subprime findings and concerns. Meanwhile, FHA market share continued to fall, sliding to a low of 5 percent in 2006 for new-home purchases.

What a difference two years can make. For 2008, FHA projects a new-home market share of almost 13 percent, and the percentages are much higher for some home building firms. At CTX Mortgage, which serves Centex Homes buyers, 60 percent of its loans are FHA-insured. Klinger expects even higher figures at Hovnanian, where he says 60 percent to 68 percent of his loans will be FHA. “During the boom, we did 90 percent conventional and 10 percent government loans,” says Kim Shelpman, president of Holiday Builders in Melbourne, Fla. “Now it has completely flipped.”

The current prevalence of FHA and other government-backed loan programs has influenced many builders’ construction and sales decisions. American Dream Development, a small private builder based in Junction City, Kan., has reduced the size of its homes by almost 200 square feet, to 1,750 square feet. “We’re shrinking square footage in order to get into the price range where more people can qualify,” says company president Jeff Burton. Other builders are also paying attention to FHA loan limits. In Raleigh, N.C., Mungo Cos. is using the FHA loan limits as a pricing benchmark, with FHA plus 5 percent to 10 percent as the target, according to company president Steven Mungo.

Builders Get a Refresher

As Renner learned last spring, the FHA revival has meant a refresher course for builders on this government-backed financing. Borrowers must have a down payment of 3 percent, which rises to 3.5 percent on Jan. 1 under legislation passed last summer. And, thanks to that same legislation, builders may no longer provide that down-payment money to buyers via a nonprofit group.

Most importantly, borrowers must actually demonstrate to lenders that they have the ability to repay their home loan. “With subprime, they didn’t verify income or whether people paid their bills on time or whether they had reserves in the bank or the source of the cash for the down payment,” Klinger says. “For FHA, you must document [borrowers’] income, their reserves, and make sure the payment is at an acceptable level. It’s lending the way lending was supposed to be.”

That doesn’t mean every buyer has a perfect credit report; FHA is designed to provide affordable mortgages to riskier, less affluent borrowers who may have credit blemishes that require extra research or documentation. “You can manually underwrite a government loan, so if there are any quirks, you have a person looking at it ­versus a computer,” Shelpman says.

But the approval—or rejection—process doesn’t take as long as builders might expect. “If you are a direct-endorsed lender by HUD, it doesn’t add to the work, because you are set up operationally to make decisions,” Klinger says. “We can get buyers answers quickly and do all the paperwork behind the scenes.”

Smaller builders who don’t maintain their own direct-endorsed lending operation should build extra time into the schedule. “There is more paperwork to fill out,” says Burton. “It adds perhaps five to 10 days to the closing date. It just depends on how familiar lenders are with the program.”

Builders who haven’t used FHA in years probably will find other aspects of the program simpler than they remember. “It got to the point that the laws had to change for the program to move forward,” explains Renner, who says the program had a number of outdated and redundant requirements that have since been abolished.

For example, FHA no longer requires individual HUD approvals for detached single-family homes. “The best thing we did for new construction was in 2001 … when we [changed the rules and] deferred to the local jurisdiction, [considering the housing acceptable] if they issued a building permit and a certificate of occupancy,” Burns says.

Projects that are considered multifamily, including mid-rise, high-rise, or condo townhomes, are a different story. Before a single condo unit in a multifamily project can be purchased with an FHA loan, the entire property must be FHA-approved by HUD. “For the longest time, builders didn’t bother with [FHA community approvals], because in some areas you didn’t need government financing,” Klinger says. “Now we are working feverishly on this.”

Credit: David Plunkert

Among the requirements: 51 percent of the project must be presold. That’s undeniably difficult in the current housing market; but attempting to sell homes not eligible for FHA financing is nearly impossible, and builders know it. “[CEO] Ara [Hovnanian] has emphasized to the company presidents that you better make sure you make this a priority,” Klinger says. “If you don’t meet the presale requirements and get FHA community approval for your project, stick a fork in it—it’s done.”

FHA’s Burns knows the multifamily for-sale side of the FHA approval needs ­attention. “We are still negotiating about how streamlined we can make the program, and unfortunately builders are being caught up in that transition,” she says.

The situation illustrates the ongoing challenge for a government program such as FHA, where requirements can quickly get out of sync with market realities. “FHA and VA need to operate as close to a conventional [financing] basis as they can, because when a builder builds a house on a spec ­basis, he doesn’t know how the buyer is ­going to finance it,” Renner says.

But when conventional financing practices have resulted in jaw-dropping numbers of foreclosures across communities poor and affluent alike, how close to conventional should FHA get?

Calculated Risks

Even during the boom, housing analyst Ivy Zelman tended to huddle with the bears rather than run with the bulls, and she has not changed her habits during the downturn. To her, the rapidly growing FHA is not a lifesaver for builders and buyers during the current credit crunch, but the likely source of the next subprime-like shock.

“Just look at [FHA’s] default rate and loose lending criteria—no credit score, only 3.5 percent down payment, and front and back-end ratios at 38 percent and over 50 percent,” Zelman says, referring to the percentage of a borrower’s pre-tax monthly income dedicated to their home loan and total debt payments, respectively. “Maybe it’s not as bad as subprime, but a lot of [buyers with] weak credit and with no money down are purchasing homes in a deflationary environment. It’s not a good recipe for success.”

Burns disagrees strongly with the characterization of her agency as a subprime bubble just waiting to pop. “That comes up over and over,” she says fiercely. “We actually make borrowers qualify. They have to show they have income to repay the loan. We validate their employment; it isn’t just fictional income. As for us being the ‘new subprime,’ we’re not subprime. We give people access to prime financing at cost.”

But the recent explosion of FHA business has caused alarm in some quarters. Direct-endorsed FHA lenders have the ability to review and manually approve government loans, an authority which some may be abusing. A recent Business Week story highlighted aggressive FHA lenders and questioned the government’s ability to adequately review the large number of people applying for FHA lending credentials.

Shelpman finds such news “disturbing.” “Unfortunately, there are always vultures looking to make a quick buck, and these types of lenders should have their licenses revoked immediately or should never have been approved for FHA lending in the first place,” she says. “If this program is abused by these unscrupulous individuals, it will invariably provide negative impact on builders both in the short- and long-term by changing or restricting the standards to which the program has operated effectively for several generations.”

HUD spokesman Lemar C. Wooley says the agency is addressing the problem. “HUD’s Office of Single Family Housing added over 100 new staff this past fiscal year, to help FHA handle the increased number of lender applications and increased volume of business,” he says. That increase also translates into more files to review ­during the agency’s annual audits of FHA lenders; the new employees will also be involved in that work.

Finally, Burns rejects the idea that the recent growth of FHA translates into riskier lending decisions, asserting that FHA is simply playing its traditional counter-­cyclical role and stepping in to provide credit when the private sector cannot. “Our borrower base right now is better than our traditional FHA borrower because of the contraction,” she asserts. “People who couldn’t qualify for FHA ­before still can’t qualify for FHA.”

Recent FHA Changes

• Loan limits are calculated on local market data from where the home is located. That means FHA will back loans that are as high as 115 percent of the area median home price, with the lowest possible limit set at $271,050 and the maximum at $625,500.

• Minimum down payment required for an FHA loan: 3.5 percent as of Jan. 1, 2009.

• No seller-funded down-payment assistance as of Oct. 1, 2008. Source: NAHB

Alison Rice is senior editor, online, at Builder magazine.