FHA Mortgages Experiencing Instant Defaults

Once ignored by buyers, FHA-backed mortgages have enjoyed a dramatic resurgence in popularity. They're considered safer, more affordable, and easier to manage than many other kinds of loans. Despite that reputation, mortgage default rates on newer FHA loans have tripled.

The Washington Post recently ran a story that shocked the real estate world, because it described how FHA mortgages-usually considered safe-are going into default at an alarming pace. What's more disturbing is that the mortgage defaults are immediate, not delayed. People are taking out FHA loans and not even making one monthly payment before becoming delinquent. The only reasonable explanation for such irresponsible behavior on behalf of large numbers of FHA loan borrowers is that their credit is so bad that they should never have been offered mortgages in the first place. HUD's Inspector General told reporters that if a loan goes into default immediately, "it clearly suggests impropriety and fraudulent activity."

Unscrupulous mortgage brokers

The blame, it seems, is with inexperienced or downright unscrupulous mortgage brokers. Just when regulations and more stringent oversight were starting to gain traction to rid the mortgage industry of predatory lenders who steer consumers with bad credit into the wrong kinds of loans, a whole new generation of unqualified lenders has cropped up. As demand for FHA mortgages accelerated, and consumers turned to them for new loans or to refinance existing ones, brokers who have experienced a severe loss of business suddenly found themselves a whole new way to make money.

Many mortgage brokers are prudent and ethical, but may lack the knowledge and experience necessary to properly understand the complex FHA loan guidelines and underwriting factors. Others-the bad apples in the industry-have seized upon a chance to get back to selling loans to people with bad credit, just as they did when subprimes were their loans of choice. Although they had to close up shop when the subprime bubble burst, many of the same unsavory characters have subsequently reinvented themselves by pushing FHA mortgage products on people with bad credit who can't possibly repay them.

Policing FHA mortgages

Somewhere in the middle of all the action are the regulatory agencies that are supposed to police the business. But they're overwhelmed and understaffed, due to an unprecedented volume of bad loans, failing banks, foreclosures, and constantly changing rules and laws governing the financial sector. A special FHA fraud unit that worked with the FBI was, for example, dismantled under the Bush administration.

Within the past two years, nearly 10,000 FHA loans have defaulted after the borrower made one payment or less. Last fall, as the economy crashed, more than two dozens "instant" defaults were happening every single day, on average, at the FHA. If defaults continue to accelerate at the current pace, taxpayer funds may have to rescue the FHA for the first time in its history. The FHA was established in the wake of the Great Depression, an event that we are dangerously close to revisiting.