How Has the Government Hidden a Potential Mortgage Crisis?

Executive Summary

The Wall Street Journal article entitled “Biden’s Mortgage ‘Relief’ Fuels Higher Housing Prices” sheds some light on how housing prices have remained high in a rising interest rate environment. According to the article, the FHA instituted a program (as COVID relief) where missed payments are added to the principal without interest, while the FHA pays the servicer. Another feature is the FHA pays the servicer who cuts delinquent borrowers’ payments by 25% for three years, with reductions added to principal. The result is that underwater borrowers are not foreclosed on, thus keeping the inventory of homes for sale lower. Historically home prices have tracked CPI, otherwise housing is unaffordable (see first graph). However, these policies appear to have impacted prices, with more drastic results than in 2008. Historically, a good rule of thumb was not to maintain a DTI over 25%. Last year almost 64% of FHA borrowers maintained a DTI over 43%. (see second graph). It appears there is much brewing under the hood of the residential real estate market.

For further analysis, continue to read The Details below for more information.

“Chains of habit are too light to be felt until they are too heavy to be broken.”
–Warren Buffett

The Details

Thanks to “behind the scenes” maneuvering, the current mortgage situation has been kept hidden from the public. Many people have been scratching their heads wondering how housing prices have continued to increase as interest rates rise. A recent article in The Wall Street Journal entitled “Biden’s Mortgage ‘Relief’ Fuels Higher Housing Prices” sheds some light on the subject. In a nutshell, the FHA, Federal Housing Administration, has propped up borrowers preventing foreclosures and resales.

FHA is part of the U.S. Housing and Urban Development and allows lower down payment loans, often to overleveraged borrowers, backed by the Federal Government. Borrowers with credit scores as low as 580 are able to purchase a home with a downpayment as low as 3.5%. I will review some of the potential consequences of an overleveraged borrower putting only 3.5% down in the most overvalued housing market in history. But first, how has this been going on for so long without negative outcomes? The FHA has been “secretly” bailing out borrowers as payments are missed.

As stated in the WSJ article mentioned above, “Under the guise of Covid relief, the Biden administration masked the growing troubles in the housing market by paying off borrowers and mortgage servicers to prevent foreclosures. Of the 52,531 FHA loans last year that went seriously delinquent within their first year, only nine resulted in foreclosure.

The FHA instituted a program that pays mortgage servicers to make borrowers’ missed payments for them. Missed payments are added to the loan’s principal [do you see a problem brewing], but without [additional] interest. The FHA also pays servicers to cut monthly payments for delinquent borrowers by 25% for three years, with the payment reductions also added to the principal without interest.” This is merely delaying the inevitable.

“The FHA made 556,841 ‘incentive payments’ to servicers over the past year to prevent foreclosures – nearly as many as the new mortgages it insured.”

As shown in the graph below from VettaFi, home prices are more overpriced than ever before. Home prices historically tracked the CPI, because otherwise no one could afford a home. That was before the government created ways to manipulate the market. Notice below how much higher the change in prices is than the change in the CPI.

Now, if someone with existing debt and a low credit score decides to buy a house at a price more overvalued than ever before, and only puts 3.5% down on the house, what happens if house prices fall? This borrower becomes underwater. Now, if they happen to miss a few payments and FHA makes up for those payments, adding them to the mortgage balance, the “homeowner” becomes even further underwater.

Notice in the graph below, from The Wall Street Journal article mentioned above, that only about 25% of borrowers using FHA loans in 2000 had a debt-to-income (DTI) ratio above 43%. Historically, a good rule of thumb was not to maintain a DTI over 25%. Last year almost 64% of FHA borrowers maintained a DTI over 43%.

More FHA mortgages issued last year became seriously delinquent within 12 months than did during the subprime real estate bubble in 2008. For some perspective, according to real estate expert Nick Gerli, there are about 7.8 million FHA mortgages outstanding. This represents about 15% of all mortgages outstanding. And there are about 400,000 backlogged foreclosures. And the Biden administration created similar “retention” programs for Fannie Mae and Freddie Mac loans.

If the new administration removes or changes these programs allowing the normal foreclosure process to proceed, the number of homes for sale will surge. The number of FHA mortgagors holding excessive debt, with many owing more than their house is worth even before the likely downturn in housing prices, portends serious problems for the real estate market. Also, the taxpayers will be forced to pay for these mortgages as they are backed by the government.

The numbers are staggering and have been covered up by secretly “deferring” payments and foreclosures under the guise of Covid relief. Change could be coming soon.

The S&P 500 Index closed at 5,770, down 3.1% for the week. The yield on the 10-year Treasury Note rose to 4.32%. Oil prices decreased to $67 per barrel, and the national average price of gasoline according to AAA fell to $3.09 per gallon.