Subprime Lending & the FHA
- "One of the key financial developments of the 1990s was the emergence and rapid growth of subprime mortgage lending," said a speaker at a housing policy meeting in 2004. Defined simply as lending that involved elevated credit risk, subprime mortgages seemingly had benefits, but they also came with many costs and challenges, such as high levels of delinquency, foreclosure and abusive lending practices. Congress created FHA, the predecessor to the Department of Housing and Urban Development (HUD), in 1934. The Great Depression had left the housing market flat and mortgage lending standards extremely tight. FHA remained popular for decades, making Americans arguably the best housed people in the world, according to HUD.
- Subprime lending allowed cash-strapped borrowers and those with bad credit to purchase and refinance homes at higher prices -- opportunities they previously did not have with FHA, which had more conservative limits on the amounts it insured. For example, subprime lending adhered to a conforming loan limit of $417,000, which was more than FHA's highest loan limit of $362,790 for a one-unit home in a high-cost area. Subprime lending also helped borrowers obtain jumbo loans over $417,000 with no down payment and little equity in their home. The apparent advantage of both subprime and FHA loans are the expanded opportunities for credit and homeownership.
- Subprime lending afforded borrowers 100 percent financing, while FHA required at least a 3 percent down payment prior to 2008. The subprime underwriting process required minimal income and employment documentation, whereas FHA requires full disclosure of income, assets and their source in the form of income tax documents, pay stubs and bank statements. A popular feature of subprime lending made it easier for self-employed and other borrowers to qualify for a mortgage. The "stated income" and "stated asset" loans, when coupled, allowed borrowers to qualify with virtually no proof of stable employment or reserves. A well-exploited feature of subprimes was the low introductory or teaser rate, which increased the borrower's interest rate and payment after a specified amount of time. FHA also carries this feature on its adjustable rate loans, but the 30-year fixed loan is its most widely used program.
- FHA loans made up approximately one-third of American mortgages as of 2010, according to American Public Media. In 2006, the FHA insured only 3 percent of mortgages, says the Smart Money website. The rapid increase in government-insured loan volume could prove disastrous for HUD and the U.S. economy, say critics of the program. Like subprime mortgages, FHA's relatively flexible underwriting guidelines and minimal down payment requirement increase the risk of default, and subsequently the number of claims FHA will have to pay to lenders in the future.
