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FHA Reforms Bringing New Risks as Well as Rewards

Easing restrictions should drive increased volume, but spot loans will challenge insurance fund stability

Jacqueline Doty    |    Housing Policy

Now that President Obama has signed Federal Housing Administration condominium reforms into law, it is time to make a clear-eyed assessment of the risks and rewards that HR 3700 will bring.

It’s great that Congress has acted to ease regulations that made FHA condo loans more difficult to get. But are the proposed rules being discussed during the current comment period the best way to do this? There might still be opportunities for adjustments to provide greater insight into these risks and to standardize project approval from lender to lender and across various government agencies.

What’s changing?

In a recent press release, the National Association of Realtors, which championed the passage of the bill, said that changes include “efforts to make FHA's recertification process substantially less burdensome, while lowering FHA's current owner-occupancy requirement from 50 percent to 35 percent. The bill also requires FHA to replace existing policy on transfer fees with the less-restrictive model already in place at the Federal Housing Finance Agency” for condo lending at Fannie Mae and Freddie Mac.

Less burdensome rules are good. But prudent assessments have to be made on whether the rewards outweigh the risks. Take the subject of spot loans. The law allows spot loans to individual buyers of non-FHA certified condo projects. FHA rules have gone back and forth on this topic over the years but now they will be allowed again. Spot loans will increase the risk to the FHA insurance fund, because they will provide guarantees on units in less financially stable projects.

The Department of Housing and Urban Development, during its 90-day window to comment on the new regulations before they automatically go into law, has endorsed the return of the spot loan.

But at the same time, HUD also has recommended a change in the owner-occupancy rate of 35 percent set out in the bill to a range between 25 percent to 75 percent. NAR doesn’t agree with this change and has asked its members to weigh in on it.

The last time NAR reached out to its membership on HR 3700, Realtors® flooded Congress with more than 140,000 comments on that bill.

Congress in drafting and passing HR 3700 clearly recognized the need for easing standards but wasn’t overly prescriptive in how to do it. Instead it gave FHA latitude to make decisions on prudent underwriting. Ideally, these decisions should incorporate as much relevant data and analysis as possible.

One of the challenges in assessing condo lending risk is the lack of standardization. For example, there is still no standardized questionnaire used in determining project approval, and there should be.

It’s true that condos often represent the most affordable alternatives for first-time and low-to-moderate income borrowers, and seniors. There’s no question that some reforms are necessary to improve the ease of both buying and selling condos, as the number of FHA-insured condo loans has fallen dramatically in recent years. In fact, FHA condo lending in the first three months of this year dropped 8.6 percent from the previous quarter, according to Inside Mortgage Finance, which said in the fourth quarter of last year, volume declined by 20.3 percent from the third quarter.

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