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Loans backed by the Federal Housing Administration have grown in popularity over the past year because of the collapse of the subprime mortgage industry. The loans allow people with poor credit to buy houses, which is handy now that lenders are being extremely cautious because of the subprime hangover.

Backers of the FHA loans say the programs offer safeguards that subprime loans didn’t have—for one, you can’t borrow money without giving proof about your income. But other observers aren’t so sure; they note that some of the companies that played a role in making the $700 billion financial bailout necessary have moved into the FHA territory. In some instances, lenders have adopted new company names.

“Subprime loans were regulated by the government, too,” says Gary E. Lacefield, a former federal mortgage investigator who now runs the Arlington, Texas-based consulting firm Risk Mitigation Group. Lacefield told BusinessWeek earlier this month there would be “FHA-insurance Armageddon” in the next 12 to 18 months. “I’m a pretty conservative person, and I think things aren’t as rosy as [the U.S. Department of Housing and Urban Development] would lead you to believe.”

FHA loans trace their roots to the Great Depression. Buyers, some with credit scores as low as 580, are able to borrow up to $280,000 as long as they put down a minimum of 3%. The interest rates are a bit higher than in a standard conforming loan, a difference of about $60 to $70 a month.

Sal Bernadas, president of the Louisiana Mortgage Lenders Association, says the percentage of loans being backed by FHA has gone from 3% nationally less than two years ago, to 15% as a result of the subprime market going belly up. Bernadas says the FHA hasn’t changed its underwriting standards despite the expansion in business. “If there are issues with someone’s credit rating, they really want to understand why,” he says. “Is it because of a divorce or a past bankruptcy?”

But Lacefield says the popularity of FHA loans has led to a surge of former subprime lenders moving into the new territory. He says the number of companies requesting to be approved lenders has increased from about 40 to 50 a month to 400 or 500 a week over the past few months.

“A majority of the new lenders being approved are former subprime brokers,” he says. Lacefield says he can’t understand why regulators are allowing those “bad actors” to go out and lend money, backed by tax dollars.

GMFS, which rose from the ashes of the United Companies, is one local company that moved from subprime loans to FHA-backed deals. Tony Moore, a vice president and senior underwriter, says GMFS made the change early this year in order to survive. “The subprime business had literally died, unless you had your own cash to lend,” he says.

Since then, the company has helped about 500 people get FHA-backed loans to buy houses. Moore says there are “night and day” differences between the subprime and FHA loan business. FHA only gives loans to people who can prove with pay stubs and W-2 forms how much money they make. The vast majority of people who get the loans plan to live in the home, which has virtually eliminated speculation and house flipping. And FHA has ratios, which generally prevent it from giving loans where the house note accounts for more than 31% of gross monthly income.

But despite all the safeguards, and FHA’s low history of loan defaults, some experts see risk on the horizon.

Inside Mortgage Finance in Maryland has estimated future losses on FHA-backed loans could cost taxpayers $100 billion or more over the next five years. Guy Cecala, Insider Mortgage’s CEO and publisher, says that’s because the loans are going to the riskiest buyers. “They’re being exposed to losses down the road,” he says.

But the problem is, FHA loans are one of the things that are keeping the housing market going. Cecala says lenders have become very risk averse. To get a standard conforming loan, buyers need a credit score of 700 to 730 [the U.S. average is about 690] and have to be able to put down a downpayment of 10% to 15%. “How many first-time homebuyers you know have $20,000 kicking around?” he says. “You need to have some lending in a declining housing market.”

Cecala says FHA loans will continue to grow in popularity until investors start to feel comfortable and become less concerned about loaning money for homebuying. After all, home loans are backed by real estate and they’ve been a better investment over the years than commercial or credit card loans.

But Lacefield says the market is still two or three years away from getting over the subprime crisis. The problem is the playing field is still uneven: You’ve got FHA-backed loans going to people with poor credit, but at the same time the FDIC is looking at making it more expensive for community banks to loan money to the people with good credit. “The bad loans are being discovered, and they’re being bailed out left and right,” he says.

REBRANDING EFFORT

Some of the same companies that played a role in making the $700 billion financial bailout necessary have moved into FHA territory:

1. The shift When the subprime market began to collapse in 2006, many lenders and brokers shifted their business to loans guaranteed by the Federal Housing Administration

2. The façade The FHA has granted licenses to some firms with questionable histories; lenders in some instances have adopted new company names

3. The tactics Once approved, some former subprime lenders employ their old tactics, issuing loans to unqualified borrowers and running up high default rates

4. The boom Home loans insured by the FHA—meaning loans that are ultimately backed by taxpayers—account for 26% of all new mortgages, up from 4% in 2007

SOURCE: BusinessWeek