The truth about FHA

While the federal loans are good for certain buyers, some mortgage brokers are pushing them to make more money

New York /
Jul.July 01, 2010 07:00 AM

backed by the Federal Housing Administration, or FHA, have been getting
a lot of hype in New York lately, even getting credit for jump-starting
the city’s real estate market.

“FHA, for my firm, really, really saved us,” David Maundrell, the
president of brokerage, told the crowd at Green Pearl
Events’ Brooklyn Real Estate Forum last month. “It allowed us to bring
back that first-time buyer.”

But buyers beware: Some say FHA could become the new subprime.

FHA loans are popular because, in a tough lending environment, they
require down payments as small as 3.5 percent, and allow buyers more
flexibility on income and credit scores. Perhaps most important, in
late 2009, the FHA lowered its presale requirements for new condos from
51 to 30 percent, making it one of only a few sources of financing
available for New York buildings with small numbers of units sold.

But FHA loans are riskier and more expensive for buyers than other
kinds of loans. And most consumers don’t realize that FHA loans can be
significantly more profitable for both banks and mortgage brokers than
conventional mortgages, because of the way that banks are compensated
for servicing them. As a result, some unscrupulous loan originators are
steering buyers in the direction of FHA loans, experts say, even when
those buyers could qualify for conventional loans.

“Because FHA can be more profitable, they put people into FHA loans
when they really shouldn’t,” said Michael Moskowitz, president of
Equity Now, a New York-based direct mortgage lender.

As Congress takes steps to reform the FHA, some mortgage
professionals — who feel their industry has been sullied enough by the
subprime crisis — are sounding the alarm.

“Many of the people who were doing subprime are now doing FHA
loans, because they’re highly profitable,” said Alan Rosenbaum, the CEO
of GuardHill Financial, noting that some lenders are paying originators
five times more for FHA loans than for conventional loans. “We need to
expose the potential problem with FHA loans to make sure it doesn’t
blow up again.”

With an FHA loan, the Federal Housing Administration provides
insurance on a mortgage made by an FHA-approved lender, insulating the
lender against losses in the event that the homeowner defaults.
Borrowers are held to less-strict standards to qualify, but pay an
up-front mortgage insurance premium of 2.25 percent of the loan amount,
and also an annual premium of 0.55 percent of the loan, paid each

FHA reform legislation passed last month by the House of
Representatives would raise the cap on the annual premiums to 1.5
percent in an effort to stabilize the agency’s finances.

“FHA is great for a certain segment of the population,” said Brooke
Jacob, the CEO of Everest Equity. But the additional premiums required
for FHA loans can add up to “a huge expense over the life of the loan,”
she cautioned, so buyers who have the option of getting a conventional
mortgage should generally avoid FHA loans.

“If a buyer doesn’t need [FHA], they’re overpaying,” she said.

Still, FHA loans have exploded in popularity in recent years. With
few other lending sources available in the wake of the subprime
mortgage crisis, FHA loans now make up roughly one-third of all loans
originated nationwide.

Until recently, FHA loans were rare in New York because most homes
here cost more than the agency’s maximum loan limit. For the same
reason, New York developers generally avoided the costly and
time-consuming process of seeking FHA approval for their new condos
(like Fannie Mae approval, this process often involves making changes
to a project’s budget and bylaws).

But the FHA raised its maximum loan limit here to $729,750 as part
of the national stimulus package, and in 2009 reduced its presale
requirement from 51 percent to 30 percent.

At first, it was mostly buildings in the outer boroughs and Upper
Manhattan that got FHA approval, including Toren in Downtown Brooklyn,
the Edge and 80 Metropolitan in Williamsburg, and PS90 in Harlem.

Now, Manhattan buildings like 99 John Deco Lofts in the Financial
District and 505 West 47th Street in Hell’s Kitchen have started
getting into the game.

Rolan Shnayder, director of new development lending at Home Owners
Mortgage, said in new condos with only a small percentage of the units
sold, many developers will offer to pay up-front mortgage premiums to
make FHA loans more attractive for buyers.

Still, experts said, buyers should comparison shop for loans and
watch out for originators who promote FHA loans for self-serving

“Part of the hype about FHA has to do with compensation,” Jacob
said. “There’s a lot of money to be made for lenders and brokers. … If
you’re a salesperson and you’re hungry, which one are you going to

The fee paid by the government to lenders who service FHA loans —
44 basis points — is roughly double the servicing fee paid for
conventional loans. In theory, that’s because it’s more costly to
service an FHA, especially since foreclosures and delinquencies — the
most expensive part of the servicing process — are more common for FHA

In other words, FHA loans “are heavily subsidized by the
government,” explained Frank Tamayo, a mortgage loan officer in New
York City. “It takes more work to service those loans, so they pay us

But these subsidies reimburse banks more than the extra expenses
they incur, experts say. Moreover, FHA loans are considered to be
virtually risk-free because of their government backing, making them
valuable commodities.

As a result, “FHA has always been considered a more profitable
loan for a lender to originate,” explained Guy Cecala, the publisher of
Inside Mortgage Finance. “They make more than they do on comparable

In turn, lenders are willing to pay mortgage brokers and mortgage
bankers higher so-called yield spread premiums (read: fees) for
bringing them FHA loans.

Mortgage brokers typically make about 1 point — 1
percent of the loan amount — or $4,000 on a $400,000 loan, Rosenbaum
said. But some banks are currently paying brokers four to five points
for originating FHA loans, he said. That means the broker can make
$20,000 on only one transaction.

This sets up an incentive structure that makes it tempting for mortgage brokers to push borrowers toward FHA loans.

“There are definitely brokers out there who would convince a client
they have to get an FHA loan because they know they’re going to make
more money,” Shnayder said. Despite today’s tough lending climate, he
added, there are “plenty of mortgages” for qualified borrowers, even in
buildings with few presales, though they are harder to find (see “A new holy grail for loans”).

said the high earning potential on FHA loans attracts unethical brokers
to the industry, and makes it more tempting for them to commit fraud or
shoehorn unqualified buyers into FHA loans, leading to more defaults
down the road.

“When you pay such high compensation, you attract loans from
brokers and banks who thrive on a higher level of compensation because
they have a lower volume of quality loans,” he said. “It brings in a
lot of undesirables, and then our industry gets a bad name.”

In February 2009, Long Island-based Lend America ceased operations
after losing its approval to do FHA loans. The FHA claimed the company
engaged in abuses such as submitting false documents and making loans
that did not meet requirements.

Until now, the government hasn’t regulated what lenders can pay
originators. But that may change in the coming months. The Federal
Reserve is considering a rule change that would restrict the use of
yield spread premiums, and the House FHA reform bill would strengthen
the agency’s powers to withdraw its approval from lenders with high
default rates.

“I like the fact that FHA is making financing available for new
condos that can’t get Fannie money,” Rosenbaum said. “If it’s not
abused, it’s a great program. [But] we have to make sure it doesn’t get
abused, because then everybody loses.”

Related Articles

Matt Lauer exposes Hamptons estate to the market
Matt Lauer exposes Hamptons estate to the market
Matt Lauer exposes Hamptons estate to the market
 Fredrik Eklund and the property (Getty, Steve Frankel)
Fredrik Eklund lists Bel Air mansion for rent as family moves to “forever home”
Fredrik Eklund lists Bel Air mansion for rent as family moves to “forever home”
Gordon Ramsey and his Lucky Cat restaurant (Lucky Cat)
Gordon Ramsay to open first South Florida restaurant in Miami Beach
Gordon Ramsay to open first South Florida restaurant in Miami Beach
614 Hudson Street in Hoboken (Photos via Brown Harris Stevens)
Sign of the times: Hoboken townhouse sells $1M below ask
Sign of the times: Hoboken townhouse sells $1M below ask
From left: A photo illustration of Gary Barnett and Ryan Serhant along with the Central Park Tower (Getty, SERHANT, Percival Kestreltail, CC BY-SA 3.0 - via Wikimedia Commons)
“I’m like the yin to his yang”: Why Barnett tapped Serhant to sell his crown jewel
“I’m like the yin to his yang”: Why Barnett tapped Serhant to sell his crown jewel
Airbnb CEO Brian Chesky (LinkedIn, Illustration by The Real Deal with Getty)
Here’s what Airbnb spent on federal lobbying
Here’s what Airbnb spent on federal lobbying
(Illustration by The Real Deal with Getty)
NYC’s rental market is finally cooling: report
NYC’s rental market is finally cooling: report
Leslie Alexander, 18 Gramercy Park South (Getty, Douglas Elliman)
Former NBA owner lists Gramercy Park penthouse for $49M
Former NBA owner lists Gramercy Park penthouse for $49M

The Deal's newsletters give you the latest scoops, fresh headlines, marketing data, and things to know within the industry.