Real Estate & Mortgage Insights

The FHA Hastens Its Retreat from the Mortgage Market

After being the main backstop for U.S. home loans for the past six years ago, the Federal Housing Administration is taking bold actions to reduce its share of the market.

Starting in January, the FHA will lower its maximum loan limits in most housing markets, with the aim of forcing buyers at the higher end to turn to private sources. The new maximum in the highest price markets like San Francisco and New York will fall to $625,500, down from the current limit of $729,750. Each area has a limit tied to its median home price. Roughly 650 counties across the country will be affected by lower limits.

The FHA's mission over its 79-year history has been to help those with limited resources to realize the dream of homeownership. The agency does not make mortgages itself, but guarantees loans made by other lenders if they meet FHA loan standards. It's loans require down payments as low as 3.5 percent and the credit standards are not as stringent as conventional loans, making them the go-to loans for most first-time homebuyers.

Since the mortgage meltdown several years ago, the FHA filled the home loan vacuum created by private lenders leaving the risky market. The loan limits were raised by the Economic Stimulus Act of 2008 as "emergency measures to assure that mortgage credit was widely available during a time when private lending options were severely constrained." The temporarily higher limits were originally intended to be dropped in January 2009, but Congress extended out the deadline several times as the housing market continued to flounder. With few private lenders willing to take on the risk of low-down payment loans, the FHA's share of mortgages grew to one-third of all home loans by last year.

"As the housing market continues its recovery, it is important for FHA to evaluate the role we need to play," said FHA Commissioner Carol Galante in a press release. "Implementing lower loan limits is an important and appropriate step as private capital returns to portions of the market and enables FHA to concentrate on those borrowers that are still under-served."

Lowering the limits will also help the FHA get back on solid financial footing. The agency backed a large portion of the loans made in the first years of the Great Recession, many of which soured as well, resulting in major losses. The FHA has repeatedly raised its insurance premiums over the past few years to bolster it reserves and dig out of the fiscal hole, but those measures have been enough. The situation got bad enough that this year the FHA had to ask the U.S. Treasury for a $1.7 billion loan.

Proponents of the lower limits say that enough private capital has returned to the mortgage markets to allow the FHA to play a smaller part. And by guaranteeing fewer loans, taxpayers will not be on the hook for as much money.

Yet others say there is still reason to be concerned about the strength of the housing market. Pending home sales have fallen for the past five months, according to the National Association of Realtors and the Mortgage Bankers Association reported that mortgage applications have declined for the past five straight week, falling by double digits last week. At the same time mortgage interest rates have been rising and prices have been far outpacing income growth.

At the very least, as FHA loans become less attractive to borrowers, it gives private lenders a chance to step up and provide some competitive options to government-backed loans.

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