Subprime redux? » Are FHA lending standards -- tightened in recent weeks because of increases in problem loans -- still too loose? Has FHA become the new subprime lender of record? Some predict coming loan losses are going to reach alarming levels.

Like many Utahns, Justin and Kristi Lloret would have had several different loan options had they bought their home just a few years ago.

But this year they had only one, FHA.

Although the number of homebuyers taking out mortgages insured by the Federal Housing Administration had been on the decline as recently as 2006, "today, FHA is pretty much the only game in town," said Salt Lake City real estate agent Scott Colemere, who works with first-time buyers such as the Llorets of Taylorsville. "It's the loan most people qualify for."

Critics, though, worry that the FHA program's popularity, with its low down payments and more lenient lending guidelines, has made the federal government the lender of last resort. They fear it is insuring too many loans that the private sector has deemed too risky, setting up the country for a second wave of defaults resembling the subprime meltdown.

Certainly there's cause for concern because FHA loan defaults are climbing and its fund to cover losses on the mortgages it insures is shrinking. But there also is little doubt among many in the housing industry that the loans, along with federal homebuying incentives of as much as $8,000, have helped prop up the battered housing sector and insulate the overall economy from an even more severe downturn.

"Without [them], sales of new and existing homes would have been much lower than they have been over the past year," said James Wood, director of the Utah Bureau of Economic and Business Research. And that's saying a lot because last year was one of the most dismal on record.

Today about a third of buyers nationally are borrowing with help of the FHA, up from 3 percent just four years ago. Certainly, there are scores of buyers in Utah, such as Paul and Jennifer Anaya of West Valley City, who would not have been able to buy without an FHA loan.

The couple, who have three children, wanted to buy a home in 2008. But not until last year had they saved up the minimum 3 percent down payment the FHA required at the time. The $8,000 tax credit for first-time buyers and a low mortgage rate tipped the scales further in the Anaya's favor.

"We wouldn't be in our house if we would have had to put 5 percent or more down," Jennifer Anaya said. "It's hard to save up $10,000 to put down on a house."

The FHA was created in the 1930s with the idea of helping first-time buyers who have only modest down payments. Rather than putting the federal government in the position of providing loans directly to buyers, the agency was designed to boost ownership by offering mortgage insurance that protected lenders against losses should borrowers default. FHA's fund would pay claims to lenders.

With insurance protection, lenders through the years have been willing to loosen their standards by, say, accepting less of a down payment or a lower credit score. Homeowners pay the cost of the FHA mortgage insurance in part as an upfront fee at the time the loan is made; another portion is added into the monthly mortgage payment.

Since its start, the FHA has been a well-used resource but its popularity waned during times of easy loans by the private sector from the early- to mid-2000s because borrowers simply had too many other lower-cost options. Scores of loan products deemed too risky a generation ago were offered by private-sector lenders, packaged and peddled on the secondary market as safe investments.

But they weren't safe, and eventually those easy loans to risky borrowers led to the nation's subprime lending debacle. People ill-equipped to repay their loans began to default in large numbers, with many walking away from their debts and properties. The wave of bad loans eventually swept over the nation's lenders and the economy.

By the summer of 2007, lenders no longer were offering no-down payment and low-down payment loans, and instead were raising credit standards for borrowers. Gone are the days of most of the easiest-to-get loans, and those that remain require such large down payments and high credit scores that even some borrowers with good credit and money for down payments of up to 20 percent have no other option than the FHA.

That helps explain the huge increase in FHA loan volumes. In Utah alone last year, nearly 40,000 FHA-insured loans were granted, up from less than 8,700 in 2006.

But the reliance on federally insured home loans has raised concerns. Are FHA lending standards -- tightened in recent weeks because of increases in problem loans -- still too loose? Has FHA become the new subprime lender of record? Are coming loan losses going to reach unacceptable -- even alarming - --- levels?

"Homeownership is a noble goal, however, the benefits of promoting [that] using government subsidies must be balanced against the potential risk of insuring less creditworthy borrowers and exposing the taxpayer to that risk," U.S. Rep. Scott Garrett, R-N.J., said in a recent statement announcing his support of a larger minimum down payment of 5 percent on FHA loans.

At the base of concerns by Garrett and others is the strong correlation between down payment and loan performance. Many factors influence whether a borrower will fall behind on a loan or even default, but generally the lower the borrower's credit score or down payment, the higher the risk the borrower will default.

Conversely, the more wealth a person has tied up in his or her property, the harder they'll generally work to keep their home if they encounter financial difficulty.

Loans with small down payments are especially risky in housing markets where prices are falling because it doesn't take much for a homeowner to be "underwater," owing more on their mortgage than they can get by selling their home. Generally, the more underwater a borrower, the more likely a default.

Home values in the Salt Lake area have fallen about 13 percent from a peak about three years ago and are expected to decline another 3 to 5 percent in the next year or so. That could effectively wipe out the down payment of those who bought homes in the past year and put down only 3 to 5 percent, raising the risk of more defaults.

Foreclosures have been a plague on the economy the past couple of years, but FHA defaults would add another burdensome layer. Since the FHA was created in 1934, taxpayers haven't had to add any money to cover loan losses because there's been enough collected in FHA premiums to pay claims. But today, amid challenging economic conditions, FHA defaults and foreclosures are rising, and the agency's reserves are dwindling, raising the possibility of a taxpayer-funded bailout.

In most areas of the country, FHA defaults and foreclosures have jumped, and Utah is no exception. The agency said it paid out claims on more than 600 loans in the state last year, up from just under 200 in 2007.

Other reports show the same trend. Nearly 10.7 percent of 82,800 outstanding FHA loans in Utah were at least 30 days or more overdue in the fourth quarter of last year, according to data from the Mortgage Bankers Association. That's up from 8.2 percent for the same quarter in 2008.

About 2.4 percent of FHA loans in Utah were in foreclosure at the end of the fourth quarter of last year, up from 0.7 percent in 2008. Rising defaults nationally prompted the federal government to increase the mortgage insurance premium required on FHA loans to 2.25 percent of the loan amount, up from the 1.75 percent. Most borrowers don't pay these fees in cash but roll them into the loan amount.

FHA loan standards also have been tightened. Years ago, there was no set minimum credit score, and borrowers often could buy a home without coming up with a down payment because the government allowed sellers to provide it (a questionable practice that no longer is allowed).

Now, standards among individual lenders vary, but in today's marketplace FHA buyers generally need a credit score of at least 620 to be able to qualify for the minimum down payment of 3.5 percent. The FHA actually accepts lower credit scores but most lenders won't go that low even with FHA insurance. Most conventional loans require a credit score of 660 or higher and a bigger down payment. Other qualifying criteria are tougher without FHA insurance.

But others want to see the FHA tighten up even more. In addition to Congressman Garrett's call for larger minimum down payments, former Fannie Mae executive Edward Pinto, a mortgage industry consultant, has floated the idea of a 10 percent minimum.

Certainly, fewer loans would be made under those scenarios. And although no one can say with certainty whether that might be a disastrous move for the already fragile economy, some in the industry are fearful.

"If we go even to a 5 percent down payment, it will really hurt, the effect on our economy and jobs would be tremendous," said mortgage lender Julia Borst, president of the Utah Mortgage Lenders Association. Utah would be especially hurt because "we have a large first-time homebuyer population that is younger and doesn't have as much of a down payment."

Utah homebuilder Clark Ivory agrees, arguing that raising the required down payment "would slow down the time frame for purchasing, which is something you don't want to do when you're trying to stimulate the economy."

lesey@sltrib.com