My Reply to a Great Question: "What’s Wrong with FHA Financing?"

Recently, Ben Nicolas, Broker in Long Beach, CA posted a great question on Trulia, which recieved really mindful responses from a broad range of perspectives. The real estate professionals made good arguements from both sides of the issue, which is namely should or shouldn’t these offers get accepted as easily as offers that contain more conventional financing. I encourage you to read the question and responses for yourself here if you like.Meantime, I am reposting my reply here, first, for the benefit of San Diego readers, and second, because, well… its my blog and I can do what I like.

I get the intent and spirit of this question, and really respect each of the answers posted. And I agree that:

-FHA gets a bad rap from the seller side of things

-It is counter-intuitive to believe (but true) that less money down may actually result in a quicker close than more money down (when MI is involved).

But I would also like to present an opinion from a totally different perspective. One that takes the question at its exact face value… and address it from the perspective of the buyer and the taxpayer.

What’s wrong with FHA financing is that it is embodies the very problem that everybody now blames as being a large contributor to “the subprime mess”. Really, it’s like I can just imagine the closed door meetings of bankers and lawmakers:

“You know “zero down loans” are so 2007… hey! let’s call them FHA loans… we’ll make people cough up 3.5% so it won’t have that “zero down” stigma… good deal, but if the government is going to be in on it, they have to get theirs too… right, right… we’ll just tack on 1.75% to the loan balance to keep Uncle Sam happy. “

Between the higher rate, the mortgage insurance premium, the upfront mortgage insurance fee of 1.75% (added to the loan balance, costing even more interest for the life of the loan), and the cost of borrowing more money than a conventional loan in the first place… all adds up to a lot.

On the ultra-low end, FHA sort of makes sense for buyers, since the percentages work out to be less severe. But in the $400k to $550k market segment the costs are extremely prohibitive… to the tune of $1,000 extra per month as compared to a conventional loan.

Of course, the counter argument is which is the lesser of the two evils? don’t buy at all because you can’t afford conventional standards? or pay a huge premium to access capital you otherwise wouldn’t get?

For the right buyer, who earns a disproportionately high income compared to their asset holdings, FHA just might be the right tool. But I’m afraid many folks who are getting these loans will be a future (government subsidized) failure in a long line of subprime failures. But not before “prime” loans join “subprime” in our more imminent failure.

So my thinking is this: it probably makes sense to just not buy yet if you can’t put down 20%. And with all the downward pressure on pricing we are about to experience, what’s the rush anyway?

I’m not saying everyone should wait for the empirical bottom, which can only be viewed in hindsight anyway… because there is much to be said for the intrinsic value these lower-end $325k homes offer… as well as the opportunities to leverage distressed situations in the $400k to $550k market. But just because FHA is available, doesn’t mean everyone should rush in to take advantage of it.

Finally, at the risk of pointing out the obvious… 20% down has been the underwriting standard for generations for a reason. And we have seen the devastation caused in part by deviating from this plan. And we are about to be collectively surprised to see how much more devastation lies ahead. Does the taxpayer need to shoulder any more risk at this point?? FHA = government insurance = taxpayer money. Sorry if this sounds cold, but as much as my income depends upon folks being able to buy homes… not everybody deserves one, and I can’t afford any more long-term effects in shouldering the burden of those who do not.

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