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‘Gifted’ loan down payments come back to haunt FHA

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POSTED February 15, 2013 12:13 a.m.

Uncle Sam’s failure to practice tough love is creating more foreclosures.

Housing and Urban Development data shows FHA backed mortgage default rates have soared, specifically with loans originating between 2007 and 2009.

That’s when the FHA was insuring roughly one out of every three existing home purchases. While that was good news in one sense as it helped stabilize housing prices somewhat by slowing the decline, it did so by allowing people who either did not really have the means or did not have the wherewithal to manage mortgage payments.

What happened during those three years was Congressional action that required the FHA to allow buyers to use “gifts,” even from the sellers that tended to be banks to make the 3.5 percent down payment required to secure an FHA loan. It meant you could buy a house with no skin in the game. If that sounds familiar, it is just like the zero down loans with balloon payments - along with liar loans - that helped trigger the housing collapse in the first place.

The down payment gift program started some movement in housing sales but not much in 2007. Congress then upped the ante by offering the $7,000 tax credit. It opened the floodgates in 2008.

While it seemed like a good thing at the time to many, it is now coming back to bite the housing market.

Historically, FHA loans more than three months past due have been as low as 2 percent.

That isn’t the case for loans originating in 2008. Today, roughly one out of every four loans issued in 2008 are now three months or more past due. It hit 5 percent just 12 months after loans were originated and then soared. By then the $7,000 tax credit was spent and many buyers who had their down payments gifted failed - or were unable - to set aside enough money for housing-related expenses. The default rate with three or more monthly payments lagging for loans originating in 2009 is just under 10 percent. After the tax credit expired and the FHA convinced Congress to drop the 100 percent gift option for down payments, the default rate for loans originating in 2010 dipped below 5 percent. They are near the historic 2 percent for 2011.

The overall number of FHA loans in default now exceeds 750,000. That is triple the 2007 level.

It is also worth noting that households with loans originating in 2010 and 2011 took 23 months to surpass or reach the historic default rate for FHA insured loans. That compares to nine months for loans originating in 2008.

The down payment gift and tax credit programs had unintended consequences that underscore the pitfalls of stepped-up government manipulation of the housing market.

That said, the housing recovery would not have started as quick as it did without the FHA making loans.

Even so, one lesson can be learned from zero down payment loans whether they were the ones that fueled the housing bubble or the FHA spike in defaults. Not requiring someone borrowing significant amounts of money for 30 years to buy a home to have any skin in the game is akin to planting a time bomb.

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