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FHA gives those who defaulted on homes another chance

The FHA is a major source of cash for so-called rebound buyers, but the bankrolling of borrowers who contributed to the last housing bubble is raising concerns.

November 14, 2012|By Alejandro Lazo and Walter Hamilton, Los Angeles Times
  • Hermes Maldonado in the Moreno Valley home he bought last summer despite two foreclosures and two bankruptcies. "After everything that happened, thank God I was able to buy another house," he says.
Hermes Maldonado in the Moreno Valley home he bought last summer despite… (Bob Chamberlin, Los Angeles…)

After two foreclosures and two bankruptcies, Hermes Maldonado is as surprised as anyone that he's getting a third shot at homeownership.

The 61-year-old machine operator at a plastics factory bought a $170,000 house in Moreno Valley this summer that boasts laminate-wood floors and squeaky clean appliances. He got the four-bedroom, two-story house despite a pockmarked credit history.

The last time he owned a home, Maldonado refinanced four times and took on a second mortgage. He put a Cadillac and Mercedes-Benz C300W in the driveway and racked up about $45,000 in credit card bills and other debts. His debt-fueled lifestyle ended only when he was forced into bankruptcy.

His reentry into homeownership three years later came courtesy of the Federal Housing Administration. The agency has become a major source of cash for so-called rebound buyers — a burgeoning crop of homeowners with past defaults who otherwise would be shut out of the market.

"After everything that happened, thank God I was able to buy another house," Maldonado said in Spanish. "Now, it's good because the interest rates are low and there are lots of homes."

The FHA, which backs nearly 8 million loans, is helping rebound buyers recapture the American dream, boosting the housing market in the process. But that's touched off a fierce debate about the financial and ethical wisdom of bankrolling borrowers who contributed to the last housing bubble — and the potential cost to taxpayers.

The agency has suffered deepening losses in the last three years that have put it under enormous scrutiny.

Created during the Great Depression to revive the devastated housing market, the FHA doesn't originate loans. It guarantees mortgages made by banks in exchange for insurance premiums. The agency now insures more than $1 trillion worth of homes. This year it has backed roughly 14% of all mortgage originations, according to the trade publication Inside Mortgage Finance.

Critics worry that the FHA is foolishly allowing marginal buyers to get loans just three years after foreclosure with as little as 3.5% down. What's more, the agency doesn't even track how many rebound borrowers it backs.

Exactly how much money is hemorrhaging from the agency could be revealed Thursday, when the agency files a self-evaluation report to Congress. Analysts say the FHA could request a bailout from the U.S. Treasury for the first time in its history.

What's unclear is how much money the agency needs to stay afloat. The Housing and Urban Development Department, however, projects $13 billion might be needed.

"It looks uglier and uglier for the FHA," said Anthony Yezer, a George Washington University economics professor.

At a minimum, the experiences of Maldonado and other rebound borrowers illustrate how fast the financial errors of the boom are being wiped clean by government policy that is eager to give the housing market a boost.

"If somebody goes through foreclosure or bankruptcy, or whatever, you don't allow them to jump back into the housing market as quickly as three years," said Guy Cecala, publisher of Inside Mortgage Finance. "Aren't you setting yourself up for future losses ... if you make those loans to the same high-risk borrowers?"

Proponents say rebound lending is essential to the economy. This group has emerged as an unexpected source of strength for housing this year, particularly in badly scarred areas such as the Inland Empire.

Besides, advocates argue, giving people a second chance — or even a third chance — is as deeply ingrained in American culture as buying a home itself.

"It's happening quite a bit," said Doug Shepherd, owner of Shepherd Realty Group in Riverside. "It is something that is an important part of the coming market."

Home builders and real estate agents are capitalizing on this market.

Some even keep files on former homeowners who will become eligible to apply for new loans once past transgressions are cleared from their credit reports.

Greg McGuff, the Inland Empire division president for home builder Lennar Corp., said roughly 1 in 5 buyers in his region had either a previous short sale or a foreclosure. Many of them are eager to own again and often recognize the opportunity that declining prices and low-interest mortgage rates provide.

"They know to the day when the event clears from their credit history," McGuff said. "Buyers are working diligently to improve their credit scores through the use of credit repair companies, not only to meet the minimum requirements, but also to ensure the best interest rate pricing."

The FHA is trying to straddle the line between financial caution and doing what it can to aid the economic recovery.

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