June 6, 2013 | Issue Brief on Housing
The conventional mortgage market has tightened lending standards in the past few years and, consequently, witnessed a decline in delinquency rates with fairly clear lines in credit quality of borrowers and reasonable requirements on borrower collateral (generally a 20 percent down payment to avoid private mortgage insurance) for loan approval.
The Federal Housing Administration (FHA), however, has maintained a weaker book of loans containing a high proportion of borrowers with poor credit quality and low down payment, resulting in higher delinquency rates. The deteriorating financial health of the FHA has loomed behind the scenes until recently.
The FHA has deviated from its mission of providing support to low- and moderate income and first-time homebuyers with sound underwriting standards. The FHA should eliminate its current practice of supporting homeownership among high-income individuals and setting lending standards that undermine sustainable homeownership for creditworthy low- and moderate-income and first-time homebuyers.
Taxpayers and Homeowners at Risk
The FHA’s core mission of targeted homeownership support encourages individuals to save and create opportunity for responsible working-class homeownership. The FHA does not make the loans itself, but sets lending guidelines and provides 100 percent insurance coverage on mortgage loans made by approved lenders.
While delinquency rates have recently decreased in most of the conventional mortgage market, the delinquency rate in the FHA portfolio remains high. More than 16 percent of FHA loans have been 30 days or more delinquent over the past two years; over 11 percent are 60 days or more delinquent.
The high rate of delinquency and default on loans seriously impacts the financial solvency of the FHA book of loans. The FHA backs a total loan portfolio over $1 trillion—even though it has a little more than $1 billion (or 0.1 percent) in capital, leaving it with a forward capital shortfall—portfolio insolvency—in the range of $20 billion per year.
The losses in the FHA insurance fund are likely to continue and could ultimately necessitate a substantial taxpayer bailout.
FHA Homeownership Support Beyond Creditworthy Working-Class Homebuyers
The FHA has a core mission of providing targeted support to creditworthy low- and moderate-income, minority, and first-time homebuyers. The FHA cannot responsibly achieve these intended objectives when it is expanding its market share and competing with the conventional market for high-cost mortgage loans.
The conforming loan limit in FHA’s book of loans is 16 percent higher than the conforming limit in the conventional mortgage market. The Housing and Economic Recovery Act of 2008 (HERA) increased the maximum conforming loan limit for mortgages in the FHA and other government-sponsored enterprises (GSEs) to $729,750 for loans held in their respective books of business. The conforming loan limit for GSEs has since decreased to $625,500, while the FHA loan limit has remained the same.
The changes in the FHA’s conforming loan limit are important for a number of reasons. First, Congress passed HERA when the housing market was very weak, with home prices about 30 percent lower than current levels. As home prices have increased and the FHA conforming limit remains $100,000 above the conventional market, the FHA’s share of the mortgage market has grown from 5 percent to nearly 30 percent in the past two years.
Second, the FHA continues to set lending guidelines that effectively combine low borrower down payments and low borrower credit profiles. The concentration of loans with low down payments (less than 5 percent) has increased from about 60 percent of total loans in 2007 to over 70 percent in 2012. Moreover, the percentage of FHA loans with low credit quality remains a large share of its overall book of loans.
Third, the FHA’s insurance fund faces an estimated capital shortfall of up to $35 billion yet continues to provide 100 percent coverage to lenders on all loans in its insurance fund.
How to Avoid a Bailout
Small yet prudent actions are necessary and urgent to decrease the credit risk in the FHA book of loans, reduce its share of the mortgage market by lowering its maximum loan limits, and establish proper incentives with lenders.
The FHA’s Proper Role
Addressing these reforms to FHA policy over an appropriate time frame would ensure that its practices do not undermine federal taxpayers and the low- to middle-income homeowners it intends to support. The FHA needs to properly align incentives for borrowers and lenders and return to a smaller, more targeted role in the mortgage market.
—John L. Ligon is a Senior Policy Analyst in the Center for Data Analysis at The Heritage Foundation.
The Veterans Administration insures between 25 and 50 percent of losses, depending on the size of the loans. Private insurance companies provide similar risk sharing with lenders, generally covering between 20 and 30 percent on loan losses. See Mark Calabria, “Fixing Mortgage Finance: What to Do with the Federal Housing Administration?,” Cato Institute, February 6, 2012, p. 11, http://www.cato.org/sites/cato.org/files/pubs/pdf/bp123.pdf (accessed May 14, 2013).
Edward J. Pinto, FHA Watch, Vol. 2, No. 5 (May 2013), American Enterprise Institute, Appendix Table A2, http://www.aei.org/files/2013/05/22/-fha-watch-vol-2-no-5-may-2013_142246828385.pdf#page=3 (accessed June 3, 2013).
AEI scholar Joseph Gyourko notes that unemployment is a strong predictor of default and that the FHA’s default estimation model fails to account for this risk. Consequently, the FHA remains unable to accurately forecast aggregate losses on its insurance fund. See Joseph Gyourko, “Unfounded Optimism: The Danger of FHA’s Mispriced Unemployment Risk,” American Enterprise Institute, April 2013, http://www.aei.org/files/2013/04/24/-unfounded-optimism-the-danger-of-fhas-mispriced-unemployment-risk_122326666163.pdf (accessed May 15, 2013).
Matthew J. Scire, U.S. Government Accountability Office, letter to the Honorable Jeb Hensarling (R–TX) and Randy Neugebauer (R–TX), March 7, 2013, pp. 7–10, http://www.gao.gov/assets/660/652829.pdf (accessed May 15, 2013).
The maximum FHA loan limit on houses is as high as $729,050 in most high-cost areas ($1,094,625 is the limit in “exception” areas) in the U.S. for one-unit properties. It is about 16 percent above the conforming loan limit in the conventional market. U.S. Department of Housing and Urban Development, “Federal Housing Administration Maximum Loan Limits, Effective Period: January 1, 2013, through December 31, 2013,” December 6, 2012, http://portal.hud.gov/hudportal/documents/huddoc?id=12-26ml.pdf (accessed May 14, 2013).
Scire, pp. 5–6.
Integrated Financial Engineering, Inc., “Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012,” prepared for the U.S. Department of Housing and Urban Development, November 5, 2012, pp. 46–48, http://portal.hud.gov/hudportal/documents/huddoc?id=ar2012_forward_loans.pdf (accessed May 16, 2013).
Peter J. Wallison and Edward J. Pinto, “Bet the House: Why the FHA Is Going (for) Broke,” American Enterprise Institute, December 2011/January 2012, http://www.aei.org/files/2012/01/24/-bet-the-house-why-the-fha-is-going-for-broke_144915374900.pdf (accessed May 23, 2013).