1. FHA REFORM:
PAST, PRESENT & FUTURE
Edward Pinto, Resident Fellow
American Enterprise Institute
March 11, 2013
The views expressed here are those of the author
alone and do not necessarily represent those
of the American Enterprise Institute.
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2. FHA REFORM SUPPORT
COMMON CRITIQUES OF FHA OVER THE YEARS INCLUDE:*
• Raised loan limits are counter to FHA mission
• Imprudent appraisal practices
• 100% guarantee causes problems
• Poor underwriting practices impact first time and working class borrowers
• Reform requires structural change
“Mr. Chairman and Committee members, I would like to close by reminding you
that this is far from the first time I have been before you to talk about the
problems at the FHA. It’s time we finally got the FHA straightened out.”
Gale Cincotta, 1998 FHA hearing
“[H]ousing is the American dream, but there is nothing worse than a dashed
dream. So if someone gets involved in a housing circumstance for which it is
over their head and they have some of their real savings lost, and then they lose
the house, you have a real issue of social cohesion.”
Rep. Waters, 2000 Predatory Lending hearing
*Additional quotes may be found in Appendix A.
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3. FHA CLAIMS
AND CLAIM RATE
WEIGHTED AVERAGE CLAIM RATE OF 12.54% FOR 1975-2011
3.14 MILLION FORECLOSURES AND 1 IN 8 FAMILIES
1,800,000 35% FHA projected cumulative claim rate-
note: annual claim rates do not exclude
1,600,000 FHA-toFHA refinances (right axis)
30% FHA adjusted loan count (excludes
streamline/FHA-FHA refi from 1983 on) left
1,400,000 axis
25%
1,200,000 Weighted average claim rate:
Over 37 years (1975-2011 ): 10.63%
1,000,000 20%
Over 37 years (1975-2011 ): 12.54%
(net of 4.5 million FHA-to-FHA refinances)
800,000 15%
Actual and projected claims (foreclosures)
600,000
over 37 book years: 3.14 million families
10%
Sources:
400,000 Loan count:
HUD PD &R historical data
5%
200,000 Projected annual cumulative claim rate
and FHA-to-FHA refinances:
Annual FHA Actuarial Studies
0 0%
Number of claims by year:
Loan count (includes FHA-toFHA refinances)
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4. FHA LENDING
RISKIER THAN EVER
VA AND FHA DELINQUENCY RATES
10%
the FHA’s rate averaged 9%
1946-1967 96%of the VA’s VA serious delinquency
FHA serious delinquency
8%
the FHA’s rate averaged
1979-2000 118% of the VA’s 7%
the FHA’s rate averaged 6%
2001-2012 197% of the VA’s 5%
4%
Working class families 3%
with FHA loans 2%
deserve better. 1%
Sources: 1946-1967: John P. Herzog and James S. Earley, Home Mortgage
Delinquency and Foreclosure (Cambridge, MA: National Bureau of Economic
0%
1946
1949
1952
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
Research, 1970), www.nber.org/books/herz70-1 and 1979-2012: MBA National
Delinquency Survey. All data year-end, except 2012 data, which is Q2:2012.
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5. FORECLOSURE
CRISIS:
CHICAGO
Highest foreclosure rates
and greatest loan volumes
are concentrated in working
class zip codes
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6. FORECLOSURE CRISIS:
QUADRANT OF DOOM
In Chicago, the highest foreclosure rates and percentage of loans
with FICOS greater than 660 are concentrated in working-class zips
where incomes and home prices are below area median
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7. FHA VERSUS VA
FHA AND VA AFRICAN AMERICAN LOAN GUARANTEE PERCENTAGES
The VA serves a greater percentage of African American families than FHA
15%
FHA African American Percentage
VA African American Percentage
14%
Source: Mortgage Bankers Association,
derived from Home Mortgage Disclosure Act.
13%
12%
11%
10%
9%
8%
7%
6%
2004 2005 2006 2007 2008 2009 2010 2011
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8. PRACTICE COMPARISON
VA FHA
• Covers 25-50% of claim (est. average 25%) • Covers 100% of claim
• Uses an appraiser panel • Does not use appraiser panel
• Vets appraisers • Accepts state certification
• Assigns appraisers by rotation • Allows lender to choose
Since appraiser is independent of lender appraiser
influence, appraisal quality regarding Appraiser is then dependent
market value and property condition is on lender influence
better assured
• Uses a more comprehensive definition of • Uses a less comprehensive
housing related obligations (includes utilities definition of housing related
and home maintenance) and tests for residual obligations and does not test
income to cover ability to pay other remaining for residual income
household expenses
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9. STOP FINANCING FAILURE
580-679 FICO BORROWERS HAVE ENOUGH CHALLENGES,
HERE’S HOW TO BREAK THE CYCLE OF FAILURE
Balance down payment, loan term, FICO, and debt-to-income (DTI) to achieve meaningful
equity and a Claim Termination Rate of 6.5% (includes an estimated 25-30% favorable
reduction in CTRs due to impact of process improvements outlined in Appendices B-E).
Maximum1 Maximum Equity @4 Claim termination rate (CTR)
FICO Maximum total DTI
Proposed loan term years2 under current / proposed policies3
660 - Current: 98% 30 years 15% >50%/Aver=41% 7% CTR=10.7%
679 95% 30 years <50%/Aver=37% 10% CTR-6.8%
Current: 98% 30 years 15% >50%/Aver=41% 7% CTR=17%
620 - 95% 20 years <50%/Aver=40% 16% CTR=5.9%
659 90% 25 years <45%/Aver=35% 15% CTR=6.3%
85% 30 years <30%/Aver=25% 20% CTR=6.3%
Current: 98% 30 years 15% >50%/Aver=41% 7% CTR=25%
90% 15 years <45%/Aver=37% 26% CTR=7.0%
580 -
85% 20 years <45%/Aver=37% 25% CTR=6.9%
619
80% 25 years <40%/Aver=32% 26% CTR=7.5%
Current: 80% 30 years <35%/Aver=27% 24% CTR=11.8%
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10. FHA REFORM,
A BIPARTISAN EFFORT
• Sensible risk mitigation steps and time tested process reforms
allow a return to core mission of supporting home purchases
by first-time homebuyers and working class families
• Insuring 580-679 FICO households at a 6% FHA claim rate
is both desirable and feasible
• Targets the substantial Ginnie/FHA subsidy to those who
need it most — first-time homebuyers and working class families
• 25% of all households (not homeowners)
have a FICO of 580-679
• Reduces competition with the private sector
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11. APPENDIX A
FHA REFORM SUPPORT
Loan limits and FHA’s mission: “The first such ‘reform’ is a proposal to raise the FHA program’s loan
limits. Despite the fact that it is absurd to expand a program already in such a deep crisis, raising the
limits would move the FHA away from its mission of helping low and moderate income families achieve
homeownership.” Gale Cincotta-1998 hearing
Appraisal practices: “Since December 1994, private mortgage [lenders] who make FHA insured loans
have been able to select any licensed or certified appraiser listed on FHA's roster. Before that time,
appraisals for FHA insured loans were conducted almost exclusively by a panel of fee appraisers which
FHA assigned to the lenders on a rotational basis….some appraisals did not reflect conditions we
observed that could adversely affect the structural soundness and continued marketability of the houses
and the health and safety of their occupants.” GAO-1998 hearing
Lack of Appraiser independence: “Everybody knows the appraiser works for the lender and goes out
there—many times they just stay in their car. It's a three-room flat, vinyl roof; it's got a garage, and it's in
this neighborhood, and they check against other things.” Rep. Gutierrez-1998 hearing
Problem with 100% guarantee: “The FHA is liberals’ nightmare of corporate welfare and profiteering
that preys on minority and working-class people—since mortgage bankers can’t lose with the FHA’s
100% guaranteed loan program.” Gale Cincotta-1998 hearing
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12. APPENDIX A
FHA REFORM SUPPORT
Impact on first-time homebuyers and problem with 100% guarantee: “Because of the quandary
FHA's foreclosures present, the people who truly lose the most are the first-time homeowners. At the
end of this process, they have nothing to show except a seven-year negative credit report with a
foreclosed property. Mortgage bankers and brokers collect their fees, and lenders' loan losses are
covered by the guarantee insurance they purchased from the FHA.” Rep. J. Jackson, Jr.-1998 hearing
Excessive debt load: “Now the economists also say…if you're buying a house, it shouldn't cost more
than twice your income….say it's a family with an income of ten thousand dollars, the house shouldn't
cost much more than twenty thousand. Well, I've seen folk making ten thousand dollars, living in a forty-
and fifty-thousand-dollar house. And you know they just barely make it….Never have anything to put
away for rainy days.” Martin Luther King, Jr. 1968
Decades of FHA fraud, abuse, and neglect: “We have been fighting abuse, fraud, and neglect of the
FHA program that has destroyed too many neighborhoods and too many families’ dreams of
homeownership for more than 25 years.” Gale Cincotta-1998 hearing
FHA finances failure: “They [HUD] point with pride to the thousands of families who get FHA
mortgages every year. It’s a meaningless statistic if last month’s homeowners become next month’s
home losers because of FHA-related foreclosures..” Gale Cincotta-1998 hearing
Need for structural change: “[S]ome structural changes must be made in the program or more low to
moderate first-time homebuyers may suffer…. Many opponents of FHA raise a valid point. The FHA
needs to be preventative instead of reactive.” Rep. J. Jackson, Jr.-1998 hearing
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13. APPENDIX B
VA’S ABILITY TO PAY PRACTICES
The VA requires underwriters to identify and verify income available to meet:
• The mortgage payment
• Other shelter expenses (includes utilities and maintenance)
• Debts and obligations (includes job related expenses such as child care)
• Family living expenses
If utilities, maintenance and job related expenses were added, the FHA’s average total debt
ratio would be increase from 41 percent to approximately 50 percent.
In addition, the VA deducts federal, state and social security taxes from income and then
applies a residual income test. Using a table derived from regional Census data (adjusted for
family size and loan amount), an estimate of a family’s remaining living expenses is calculated.
This sum is compared to the amount of the borrower’s residual income. VA’s minimum
residual income (balance available for family support) is used as an underwriting factor.
Use of the VA’s ability to pay practices would protect working class home buyers
and neighborhoods as well as reduce FHA’s default incidence and severity rates.
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14. APPENDIX C
REINSTATE APPRAISER PANELS
• Panel members based on experience and geographical competence (VA) vs. state certified
appraiser (FHA)
• # of appraisers: 4500 (VA) vs. 55,000 (FHA). VA did 30 per cent of the FHA’s volume (2012)
- Reopening of local panel based on need and as need arises additions based on competence (VA)
• Assignment based on rotation (VA) vs. lender selection (FHA)
• Quality control (VA)
- By VA staff appraisers or designated lenders vs. minimal oversight (FHA)
• Minimum of 10% of work is field reviewed (VA)
• Tidewater initiative (VA): protocol to objectively address potential of a low valuation without
compromising appraiser integrity and independence vs. FHA-not addressed.
• While the benefits of appraiser panels are many, two merit special mention:
- Appraiser independence takes away a tool of unscrupulous lenders who provide assignments based
on “made as instructed”.
• This would help FHA’s efforts in policing its mortgagees--a challenging task for FHA.
- Appraiser independence results in greater identification of needed property repairs and shortcomings.
• Example: repairs—VA standard is to identify obvious deficiencies and repair root cause of deficiency vs. with
FHA, risk is if appraiser points out too many problems, won’t get future assignments
Use of appraiser panels would protect working class home buyers and neighborhoods
as well as reduce FHA’s default incidence and severity rates.
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15. APPENDIX D
REDUCE FHA’s 100% MAX COVERAGE
• FHA has experienced substantially higher serious delinquency rates than the VA for decades and
are currently double the VA rate (2001-2012).
• LTV comparison: VA loans have higher risk based on effective LTV at closing.
• FHA = 97.5% (96% LTV + 1.5% upfront MIP fee)
• VA= 103% (100% LTV + 2.25% upfront average funding or guarantee fee)
• FHA pays 100% of the claim amount, while the VA pays 25-50%.
• The average claim paid by FHA is $78,000 (63% of gross claim-estimate) while VA pays an
average of $38,000 (25% of gross claim).
• The average claim paid by the Ginnie/FHA MBS issuer is $9,000 (7% of gross claim-estimate)
while the Ginnie/VA MBS issuer pays an average of $45,000 (30% of gross claim-estimate).
• Both FHA and VA issuers are paid the same fees, however the FHA issuer absorbs a 7% loss (but on twice
an many claims) while the VA issuer absorbs a 30% loss (but on half an many claims) .
• Because of this difference, Ginnie underwrites its VA issuers more stringently than FHA issuers
since the former pose a much higher counter-party solvency risk.
FHA’s loss rate is an estimated 5 times the VA’s (2 times the incidence and 2.5 times the severity).
The VA charges 1/3 the premium of FHA (on a present value basis).
VA issuers absorb two times the loss percentage compared to FHA issuers for the same fee.*
* 30%/7%=4x loss %, but ½ the loss incidence.
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16. APPENDIX E
REDUCE SELLER CONCESSIONS
In July 2010, FHA Commissioner Stevens proposed
eliminating seller concessions >3%.*
• FHA allows up to a 6% seller concession vs. 3% for conventional market:
• 82 percent of FHA-insured homebuyers make the minimum down payment of 3.5%.
• Median concession is 4%.
• The incidence of concessions and the average concession is highest for loans <$180,000
(lowest loan size for which FHA provided data).
• 33% of loans below $180,000: seller concession of >3% (nearly 50% of loans >4%).
• When concession is >3%, default rate 1.9 times that of loans where 0%
(1/3 of FHA loans below $180,000 have a 0% concession.
• When concession is >3%, default rate 1.3 times that of loans where >0% and <=3%.
• In February 2012, Commissioner Galante proposed a limit of 3% or $6,000,
whichever is greater.
Concessions of >3% subject working class families
and neighborhoods to needless foreclosure risk.
* These are not the same as seller assisted downpayments, which Congress banned. The above statistics are from the
February 2012 proposal and are for FY 2009 and 2010, after the ban on seller assisted downpayments took effect.
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