Study concludes FHA lending practices in Baltimore area could lead to high foreclosure rates

Homes with federally insured mortgages — afforded to mostly lower-income borrowers — are expected to see a spike in foreclosures because of dicey lending practices, according to a recent study.

More than a dozen ZIP codes in the Baltimore metropolitan area could see foreclosure rates above 15 percent and as high as 43 percent for Federal Housing Administration-backed loans, according to the American Enterprise Institute for Public Policy Research, a conservative think tank.


Historically, such loans have put homeownership within reach for Americans who otherwise wouldn't be able to afford it. The minimum down payment on an FHA loan is 3.5 percent, while private lenders typically require as much as 20 percent.

But Edward J. Pinto, who conducted the study of 2.4 million FHA-insured loans, contends the FHA's underwriting practices make it too easy for borrowers with poor credit scores or high debt-to-income ratios to get loans. Eventually, many fall behind on payments, creating clusters of foreclosures that drive down property values and undermine FHA's mission to get low- and middle-income people into homes.


"The FHA, because it's national, never looks at what it's doing at the local level," said Pinto, a resident fellow at the American Enterprise Institute and former chief credit officer at Fannie Mae.

Pinto studied data from 2009 and 2010 after abuses in the subprime mortgage market came to light. In the two years reviewed, about 40 percent of the loans FHA insured went to buyers with "subprime attributes" — a credit score below 660 or a debt-to-income ratio of 50 percent or larger, Pinto said.

Pinto used FHA data to illustrate the effects on the ZIP code level.

Many of the troubled borrowers are concentrated in certain neighborhoods, including many in and around Baltimore, which amplifies the adverse effects of foreclosures stemming from the FHA's liberal lending practices, he said.

These areas with high foreclosure potential have lower-than-average median incomes and home values, according to the report.

For instance, in ZIP code 21223, a large section of West Baltimore, 132 FHA-insured loans were made in the two-year period, and more than half of the borrowers had credit scores Pinto considered subprime. Pinto projects that 43 percent of the homes financed by those FHA-backed loans will go into foreclosure.

That section of town, which stretches from Mill Hill in the south to Midtown-Edmondson in the north and from the western edge of downtown to Gwynns Falls Park, has Pinto's highest predicted foreclosure rate in metro Baltimore.

But several other West Baltimore ZIPs — 21215, 21216 and 21217 among them — and a large swath of East Baltimore with the ZIP code 21213 are projected to have foreclosure rates on FHA-insured loans around 20 percent, according to the study. Those ZIP codes include more than 1,000 FHA mortgages from the two-year period, so 200 or more homes backed by the federal insurance fund could go into foreclosure if Pinto's analysis pans out.


Areas outside Baltimore City also fall into this trend. More than 2,000 FHA-insured loans were made in the Baltimore County communities of Essex, Dundalk and Gwynn Oak in the two-year study period, and Pinto projects a foreclosure rate on those loans of about 15 percent.

The FHA has the lowest allowable credit score among its peer lenders, said Fern Dannis, director of housing programs for the Maryland Association of Realtors. But that does not mean the FHA is becoming a servicer for the subprime market, she said. The recent implementation of more rigorous application reviews demonstrates that the FHA does not want to be a subprime servicer, she said.

"I see a lot of young people, I see a lot of people who don't have traditional documentation of credit" seeking FHA support, Dannis said. "But that doesn't mean they're not credit-worthy."

Pinto contends that the FHA, a division of the U.S. Department of Housing and Urban Development, has for decades employed practices that lead to unacceptably high foreclosure rates among the mortgages it insures.

Attempts at reforming those practices have been blocked in part by lobbying from the housing industry, which prefers FHA's underwriting policies because they lead to more homes sold, Pinto said.

The FHA was created in the mid-1930s and integrated with HUD in the mid-1960s. It operates only on income it generates, but in a 2012 annual report released last month, the FHA acknowledged it is paying out on more policies than it can afford. That has led some observers to speculate that Treasury funds will be required to keep the agency afloat.


The FHA's level premium distribution — in which high-risk borrowers incur the same premium as low-risk borrowers — contributes to the agency's financial instability, Pinto said.

But the FHA has defended its practices. HUD Secretary Shaun Donovan stated in the annual report that FHA's efforts to insure more mortgages at the height of the lending crisis, although costly, prevented the housing downturn from getting worse.

In a Senate hearing this month, Donovan cautioned Republican lawmakers — who have expressed a desire to tighten the FHA's underwriting policies — that restricting government-backed lending could prove detrimental to the housing market recovery.

Agency officials also point out that while delinquency rates, a strong indicator of foreclosure, are high among loans made at the height of the recession, those rates are declining as time passes and the economy improves. According to the FHA, loans issued from 2009 to 2011 are performing about four times better than those from 2007 and 2008.

After three years, 23 percent of FHA loans issued in 2007 were delinquent. That figure dropped to 17.6 percent for 2008 loans and 7.5 percent for 2009 loans.

In a statement released with the annual report, acting FHA Commissioner Carol Galante said that loans made during President Barack Obama's administration have been the strongest in the agency's history. Still, she said, the worrisome financial situation is being taken seriously. The FHA has outlined a half-dozen steps to bolster the insurance fund, including an increase on premiums paid by new borrowers.


"We will continue to take aggressive steps to protect FHA's financial health while ensuring that FHA continues to perform its historic role of providing access to homeownership for underserved communities and supporting the housing market during tough economic times," Galante said.