FHA Financing…Ignore the Media Scare

Westcoe Realtors, Riverside California…Effective October 1, 2008, FHA financing will be eliminating a certain, very specific loan program…and if you read some of the latest media stories, one would think that indeed, the lending “sky must be falling.”  Oh my goodness, what are we all to do now?

Well, in reality, the specific program FHA is eliminating was a very small facet of the FHA loan programs, and not one that was used very often.  In fact, in our Inland Empire area, it was very hard to get an existing repo lender to even consider this program…SO WHAT IS THE FUSS?  But then, “fuss” sells papers or brings in viewers, so if you have read any of what we have written here, then you would know that sometimes the media stirs that which does not need stirring.

For the record, the program that has been eliminated are those loans in which a third party “charity” actually makes the down payment for the buyer, instead of the buyer making it for themselves.  This program, while looking good on paper, had been subject to widespread abuse from those lenders who seem to think it is OK to do so, and also has one of the highest rate of foreclosures of all the loan programs FHA insures.  Why?  Well, here is how the program worked in reality.

In almost every case, the buyer makes their offer, and in that offer, they request the seller to pay as much as $10,000 (or more) to a third party charity in return for the buyer to purchase the seller’s home.  Most of these offers are made at either full price, or the price is bumped upward to cover the money the seller is being asked to pay to the charity.   The charity will then make the down payment for the buyer (keeping some of the seller’s money for their efforts), and everyone is happy.  The seller gets his home sold, the charity makes some money, and the buyer gets the home.  However, as the saying goes “the plot thickens.”

First, while there were some very solid, reliable, charities that made this program work by being fair, there were just as many “scams” where someone was going to get hurt…that someone being the lender, or the buyer.  In some cases, the price of the home was inflated so much to compensate the seller for what they had to give the charity (we saw some offers in the crazy market of a few years ago where the price was bumped by over $40,000-50,000), that the home was overvalued, and ultimately the home wound up as one of today’s foreclosures.  It also didn’t hurt that the “charity” kept a massive amount of money for themselves as well.

The other problem here is that in essence, the buyer had none of their personal money in the transaction…the down payment was coming from the charity via the seller.  This is a no-down sale, and these type of loans have the highest foreclosure rate there is because when things get tight, the buyer has absolutely no money of their own into the house.  Yes, they have made the payments, but there is a far cry from having zero money in a down payment, as opposed$50,000 of your own money.  It is far easier to walk away from zero than it is $50,000.

The other thing to note here is that for the reasons sited above, most existing repo lenders who are now sellers were totally unwilling to pay any sum of money on the buyer’s behalf…they are already losing ten’s of thousands or more, so why would they incur even more losses just to get the house sold?  Especially when there are generally multiple offers on almost every well priced repo.   Also, existing repo lenders are not generally overjoyed to see an FHA offer come their way from a buyer, because FHA guidelines may require the home to be fixed up better than it currently is…another cost the repo lender they will try to avoid.  All of the above led to the very little use of the “third party” loans that FHA is now discontinuing.

In the end, this is just another reminder to be very aware of anything you read/see in the media.  In this case, there has been much ado about basically nothing.  FHA is still a very viable loan program, and they still make a ton of loans for only 3.5% down payment from the buyer.  All they doing is simply getting out of the 100% financed loan business…and given what has happened in our current lending market, who can blame them?