FHA, The REAL Shadow Inventory!

Shadow Inventory is a term used to describe all of the homes either owned by lenders, or currently in latter stages of mortgage default. Much of this is attributed to sub-prime loans that were all the rage in the early to mid-2000s. During the unprecedented upswing in the real estate market, borrowers had the ability to purchase or refinance property up to four units with little or no money down, questionable credit and almost no income documentation. The loans were sold to Wall Street, insured by AIG and well, here we are! Now, mortgage lenders have really tightened up the way they do business. Stated income loans are no more. Underwriters are working diligently to verify a borrower's ability to pay back the money they're borrowing. Numbers are being crunched, financial data verified and all is right in the world. It looks like the new guidelines that lenders have put into place represent a pretty good safeguard against history repeating itself, right? WRONG!

The government body known as FHA, or the Federal Housing Administration, is the largest mortgage insurer in the world. The FHA insures loans for their approved lenders up to a regionally adjusted loan amount of $729,750 on single family homes with a down payment of as low as 3.5%. On its website, FHA states, "Unlike conventional loans that adhere to strict underwriting guidelines, FHA-insured loans require very little cash investment to close a loan. There is more flexibility in calculating household income and payment ratios." In fact, a minimum FICO score of only 620 is required to qualify for FHA financing, and debt-to-income ratios can exceed 50%. Add to that the requisite pre-paid mortgage insurance premium (2.25% of the loan amount!), and a borrower has a loan amount equal to 98.75% of the purchase price. Did I fail to mention that FHA allows the seller to contribute up to 6% of the purchase price for closing costs?!

This is no joke! There are hundreds of thousands of borrowers who have purchased homes in the last year banking on receiving a tax credit from the United States of $8,000. In California, there is an additional $10,000 tax credit for first-time homebuyers ($3,333.33 each year for three years.). With the median sale price of homes in Southern California just a shade over $300,000, that means that the average FHA homebuyer is actually being paid to purchase a home! Since the announcement of the Federal Homebuyer Tax Credit, prices have risen by double digit percentages. I am already seeing significantly lower activity and decreasing home sale prices in just the last couple of months. Virtually all major employers in the United States are waiting to see what kind of effect new taxes and the health care law are going to have on their bottom line before looking at hiring again. If we see any kind of marked reduction in home values or employment conditions, what are these FHA borrowers going to do with almost no reserve funds and nothing invested in their homes? It is a scary thought!

In my opinion, we are on the cusp of a smaller version of the mortgage meltdown. The FHA loans that have been so popular with entry level homebuyers are going to be a part of the foretold shadow inventory. Despite that, there is no reason to panic. Current homeowners with stable employment and ample reserves have very little to worry about. Homeownership is a long term investment. As long as you they are not in a position of being dramatically upside down (>20%) in the value of their home, they should just "hunker down" and weather the storm. As always, I advise my clients to pursue a short sale if they are significantly underwater. I don't see that situation getting better anytime soon, and it is far better to get it over with now than to miss out on this opportunity to buy in the next few years. Rules are more liberal for debt relief than ever before. The "Real Shadow Inventory" is coming! Are you ready?