Note from The Tim: Jillayne Schlicke has been a valued member of the Seattle Bubble community for quite some time, and I’m happy to welcome her as a guest poster. Jillayne has many years experience in the lending industry and offers some great insights. She currently provides continuing education for real estate professionals through her company CE Forward.
I’d like to thank The Tim for inviting me to create occasional guest posts for Seattle Bubble readers. SB’s bloggers and commenters have taught me how to critically analyze local real estate statistics. SB was a safe place I could go on a Friday night when my kids were elsewhere and I was craving an understanding of what was happening during the 2007-08 meltdown. I am honored to give back to the SB community.
The rising default rate on FHA loans is concerning but I’m not terribly surprised. It’s really no secret that the government is using Fannie, Freddie and FHA to help keep the banks afloat by allowing zombie banks to pawn off their toxic crap to the agencies. Ultimately the taxpayer is paying the price as we see Fannie and Freddie continuing to run a red balance sheet and FHA headed down the same path.
FHA originations were all but dead during the real estate bubble because so many LOs favored subprime lending where underwriting guidelines were non-existent. But long ago, in a land far, far away, when we were rocking out to Duran Duran, Echo and the Bunnyman, and Joy Division, I was processing FHA loans for a mortgage banker in Seattle. When rates came down to a low of 13% I had about 100 files in process. I was trained to pre-underwrite my files so underwriting recruited me and I became a young underwriter at age 23, just old enough to go drinking after work with the crew. I’ll never forget Barbie Owens who had the entire FHA underwriting manual embedded into her brain Matrix-style (I know Jujitsu!) She could recite entire paragraphs from the manual verbatim. Imagine 20 female underwriters, all of us smoked, and none of the windows opened. That was mortgage banking in the 80s. But I digress.
Back in the 1980s, underwriting was serious business. We were treated like gods by the loan originators who worked in fear of us declining their deal. Only David Korch knew how to play it. He brought us ice cream bars on hot, sunny days. New underwriters were given bunny files; easy conventional refinances, to cut our teeth. Then we were sent to FHA training. FHA had a field office in Seattle with real humans who would actually answer the phone and our questions. At least once a year a representative from FHA would take new underwriters through a six week FHA underwriting course called Direct Endorsement 101. After we finished we could underwrite FHA credit only (on all FHA loans the appraisal goes through a separate underwriting process) as long as a senior FHA underwriter signed our files.
If an FHA loan went into default, it was presented as a case study in meetings so that all of us could learn from our mistakes. If an FHA underwriter had too many defaults against her identifying number, she was put on probation.
This all changed during the subprime days when FHA’s business went down to literally nothing. Today, FHA allows the FHA-approved lenders to appoint and train their own underwriters! Does anyone see the problem with that policy?
Let’s revisit early 2008. Wholesale lenders are dropping like flies, and six figure income mortgage brokers are sweating bullets trying to figure out how to make their next boat, BMW, second home, first home, and condo-in-Hawaii payment month after month. They see the writing on the wall and the future, as far as they could see, was FHA. Thousands of mortgage brokers rushed to become approved to originate FHA loans and hundreds of wholesale lenders and banks had to quick beef up their underwriting departments to handle the onslaught of FHA loans being hurriedly thrown at them.
Many of those underwriters only knew subprime loans and had never seen an FHA file, never read the FHA Single Family Mortgage Insurance Manual for 203b loans and suddenly lenders were making folks FHA underwriters overnight.
And now we’re wondering why default rates are so high.
FHA doesn’t make subprime loans. They will allow loans to people with less than perfect credit but this is definitely not subprime territory.
We have three main problems leading to this dramatic rise in FHA defaults:
- Pressure from government to use FHA for purposes of taking toxic loans off the bank’s balance sheets;
- Lack of education, training, and mentoring of new underwriters during the recent, dramatic rise in FHA originations; and,
- Lack of a large enough down payment from the homeowner to insure against falling home prices.
Negative equity combined with job loss, business failure, or other financial distress means higher FHA defaults are in our future as long as home values continue to drop, we allow banks to put underwriters into service with no training, and we let the politicians use FHA as a toxic waste dump.