Who Floats FHA Losses?

Question:

When a home financed with an FHA loan is foreclosed who covers the loss? Is it the taxpayers?

Answer:

The Federal Housing Administration insures low down payment loans for first-time buyers and lower income buyers with weak credit. Unlike Fannie Mae and Freddie Mac, which received taxpayer bailouts to the tune of $150 billion, FHA has received no such help.

The basic FHA program, 203(b), provides insurance for residential borrowers purchasing homes with one to four units. To qualify you must live in at least one unit and meet various income and credit requirements. If you qualify for FHA financing you can then buy with as little as 3.5 percent down.

That's not a lot down. However, lenders allow borrowers to get FHA financing with little up front because such loans are insured.

Under the FHA program you'll pay an up-front mortgage insurance premium equal to 1 percent of the loan amount for 30-year financing. Most borrowers also will pay a monthly MIP equal to 1.15 percent of the remaining loan balance divided by 12.

So, what about FHA losses?

Imagine you had a house that was insured against fire and theft. If the house burns down the insurance company will pay all covered claims. Where does the insurance company get money? From reserves. Where did the reserves come from? From premium payments and the interest they earn over time.

In a similar sense the FHA has reserves that are collected from borrower insurance premiums and the interest earned from those premiums. The FHA's Mutual Mortgage Insurance fund - a reserve account - actually grew by $2.65 billion in fiscal 2010. The fund is expected to increase by $9.76 billion in fiscal 2011 and $5.01 billion in fiscal 2012.

Notice that all claims are being paid from reserve funds. Reserve funds come from borrower insurance premiums and the reserves are increasing. No claims are being paid by taxpayers.

In the past few years the FHA has prevented larger losses by tightening standards for lenders, raising the annual MIP and prohibiting seller-funded down payments. The result is an enormously successful program, one that in 2010 provided more than 40 percent of all mortgage financing, according to the National Association of Realtors.