The Bush administration has unveiled its first major assault against predatory mortgage lending: A cut-off of Federal Housing Administration (FHA) mortgage insurance for property "flippers." Under a proposed rule published last week, FHA insurance no longer would be available on houses sold within six months of acquisition by the seller.

Flipping involves rapid resales of houses -- usually at artificially-inflated prices -- allowing the seller to pocket substantial profits. For example, say an investor buys a rowhouse in a central city neighborhood for $40,000. Barely a week later, having made a few cosmetic repairs, he turns around and flips the property -- offers the house for sale to unsophisticated first-time buyers at $80,000, with almost no downpayment.

Working through a cooperative lender and appraiser, the seller gets the house appraised fraudulently at the full $80,000 asking price. The buyer puts down less than $1,000 and gets an FHA-insured mortgage.

After the flip, what do we have? For starters, we have a borrower who now "owns" a $40,000 house that he bought for the inflated price of $80,000. We also have an FHA mortgage covering most of that $80,000, the net proceeds of which -- say $38,000 or more in this example -- went into the pockets of the sellers, the appraiser and the loan officer. When the buyers default because their income and credit never really qualified for the mortgage or the house in the first place, who's holding the bag? Why it's the FHA -- the federal government -- which provided 100 percent insurance to the lender against loss in the event of a default.

Flips like these have become an epidemic across the country in recent years. Hundreds of houses have been involved in FHA flipping scams in places like Baltimore, New York, Los Angeles and elsewhere.

As one Baltimore-area mortgage broker put it, "this is not rocket science. It's easy. You need a friendly appraiser, you need somebody to get you through the (FHA) hoops, and you can make very good money."

The new FHA proposal would attempt to close down this mis-use of the federal mortgage insurance program by forcing sellers to hold properties for at least half a year. It would also restrict FHA insurance to properties purchased from the "owner of record" on the title at the county courthouse. This would effectively derail scammers from flipping purchase contracts -- the right to acquire the house -- at inflated prices. In this scenario, the rowhouse investor would sells or assigns his purchase contract to the $40,000 property to a second party -- say for a quick $10,000 or $15,000. The party acquiring the contract to the house then either sells to the first-time homebuyers or flips the contract still again.

Flipping chains like these have been documented repeatedly by the Office of Inspector General at the department of Housing and Urban Development (HUD), parent agency of FHA.

Under the proposed regulation, there would be limited exceptions to the six month rule. These include:

Published: September 10, 2001

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.