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FHA Reform, Past, Present, and Future



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FHA Reform, Past, Present, and Future

  1. 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. |1
  2. 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. |2
  3. 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) |3
  4. 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), and 1979-2012: MBA National Delinquency Survey. All data year-end, except 2012 data, which is Q2:2012. |4
  5. 5. FORECLOSURE CRISIS: CHICAGO Highest foreclosure rates and greatest loan volumes are concentrated in working class zip codes |5
  6. 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 |6
  7. 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 |7
  8. 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 |8
  9. 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% |9
  10. 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 | 10
  11. 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 | 11
  12. 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 | 12
  13. 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. | 13
  14. 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. | 14
  15. 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. | 15
  16. 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. | 16