Garnishing Wages for Student Loans Adds Risk to FHA Mortgages

This is a story about how Americans struggling to make their mortgage payments helped save Americans struggling to repay their student loans.

It begins with a sobering fact: Federal Housing Administration loans have a much higher delinquency rate than other kinds of mortgages. The most recent quarterly report showed 10.8 percent were delinquent, versus just 2.6 percent of conventional mortgages.

Not only that, but at year end, 3.5 percent to 4 percent were “seriously delinquent,” noted Chris Whalen of Whalen Global Advisors in his Institutional Risk Analyst newsletter. FHA loans are represented by the blue line at the top of this chart from the Mortgage Bankers Association:

FHA and Veterans Administration loans have an elevated default risk because borrowers can make very small down payments, such as 3 percent.

People borrowing 97 percent of a home’s purchase price are not likely to have a strong financial profile or rich relatives to bail them out of a jam.

They also have to pay mortgage insurance premiums. MIP costs 1.75 percent of the loan plus monthly payments, which can add hundreds of dollars to the mortgage bill without building one penny of equity. What David Caplovitz wrote in 1967 is still true: The poor pay more.

If they buy a starter home for $340,000, put 3.5 percent down and get a 30-year mortgage, the MIP would be $5,742 upfront plus $150 per month, according to BankRate. That’s $59,742 for MIP. The buyer can fold the $5,742 upfront cost into the mortgage, but interest is charged on the unpaid portion.

MIP is paid by the borrower to protect the lender, but actually makes default more likely because it’s a cost burden for people living on very tight budgets.

Adding to the default risk, delinquent FHA borrowers can walk away from their home early in the loan without losing much equity, because they don’t have much to lose.

But most don’t walk away. Instead, they get a loan modification.

There’s one problem. As Whalen notes, “Many student borrowers also have government-insured loans from the FHA and VA. If you are in default on a student loan, you are ineligible for a loan modification.”

The Trump administration has not shown much sympathy for people in arrears on their student loans. But it does not want defaults rippling through the FHA and VA loan portfolios. Loan modifications are better for all involved.

Whalen suspects that helps explain why the administration has backed off its plan to garnish the wages and tax refunds of borrowers who are delinquent on their student loans. (Another reason: The plan was unpopular.) Garnishing wages to pay old student loan arrears would leave some debtors unable to make their FHA mortgage payments.

The Department of Education — yes, it still exists — offered the official explanation:

“The Department determined that involuntary collection efforts such as Administrative Wage Garnishment and the Treasury Offset Program will function more efficiently and fairly after the Trump Administration implements significant improvements to our broken student loan system,” Nicholas Kent, the undersecretary of education, said in a statement.