fha reform, past, present, and future

FHA REFORM:

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.

nightmareatfha.com | 1

PAST, PRESENT & FUTURE

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.

FHA CLAIMS

WEIGHTED AVERAGE CLAIM RATE OF 12.54% FOR 1975-2011


AND CLAIM RATE 3.14 MILLION FORECLOSURES AND 1 IN 8 FAMILIES

0%

5%

10%

15%

20%

25%

30%

35%

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000 FHA projected cumulative claim rate-note: annual claim rates do not excludeFHA-toFHA refinances (right axis)

FHA adjusted loan count (excludesstreamline/FHA-FHA refi from 1983 on) leftaxis

Weighted average claim rate:

Over 37 years (1975-2011 ): 10.63%

Over 37 years (1975-2011 ): 12.54%

(net of 4.5 million FHA-to-FHA refinances)

Actual and projected claims (foreclosures)

over 37 book years: 3.14 million families

Sources:

Loan count:

HUD PD &R historical data

Projected annual cumulative claim rate

and FHA-to-FHA refinances:

Annual FHA Actuarial Studies

Number of claims by year:

Loan count (includes FHA-toFHA refinances)

FHA LENDING

VA AND FHA DELINQUENCY RATES


RISKIER THAN EVER

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

19

46

19

49

19

52

19

55

19

58

19

61

19

64

19

67

19

70

19

73

19

76

19

79

19

82

19

85

19

88

19

91

19

94

19

97

20

00

20

03

20

06

20

09

20

12

VA serious delinquency

FHA serious delinquency

the FHA’s rate averaged

197% of the VA’s


96%of the VA’s


118% of the VA’s

Working class families

with FHA loans

deserve better.

1946-1967

1979-2000

2001-2012

Sources: 1946-1967: John P. Herzog and James S. Earley, Home Mortgage

Delinquency and Foreclosure (Cambridge, MA: National Bureau of Economic

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.

http://www.nber.org/books/herz70-1 and 1979-2012







FORECLOSURE

Highest foreclosure rates

and greatest loan volumes

are concentrated in working

class zip codes


CHICAGO CRISIS:

FORECLOSURE CRISIS:

nightmareatfha.com

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

QUADRANT OF DOOM

FHA VERSUS VA

The VA serves a greater percentage of African American families than FHA


6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

2004 2005 2006 2007 2008 2009 2010 2011

FHA African American Percentage

VA African American Percentage

Source: Mortgage Bankers Association,

derived from Home Mortgage Disclosure Act.

FHA AND VA AFRICAN AMERICAN LOAN GUARANTEE PERCENTAGES

PRACTICE COMPARISON


• Covers 25-50% of claim (est. average 25%)

• Uses an appraiser panel

• Vets appraisers

• Assigns appraisers by rotation

Since appraiser is independent of lender

influence, appraisal quality regarding

market value and property condition is

better assured

• Uses a more comprehensive definition of

housing related obligations (includes utilities

and home maintenance) and tests for residual

income to cover ability to pay other remaining

household expenses

• Covers 100% of claim

• Does not use appraiser panel

• Accepts state certification

• Allows lender to choose

appraiser

Appraiser is then dependent

on lender influence

• Uses a less comprehensive

definition of housing related

obligations and does not test

for residual income

VA FHA

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).

FICO Maximum1

Proposed

Maximum

loan term Maximum total DTI

Equity @4

years2

Claim termination rate (CTR)

under current / proposed policies3

660 -

679

Current: 98%

95%

30 years

30 years

15% >50%/Aver=41%

<50%/Aver=37%

7%

10%

CTR=10.7%

CTR-6.8%

620 -

659

Current: 98%

95%

90%

85%

30 years

20 years

25 years

30 years

15% >50%/Aver=41%

<50%/Aver=40%

<45%/Aver=35%

<30%/Aver=25%

7%

16%

15%

20%

CTR=17%

CTR=5.9%

CTR=6.3%

CTR=6.3%

580 -

619

Current: 98%

90%

85%

80%

Current: 80%

30 years

15 years

20 years

25 years

30 years

15% >50%/Aver=41%

<45%/Aver=37%

<45%/Aver=37%

<40%/Aver=32%

<35%/Aver=27%

7%

26%

25%

26%

24%

CTR=25%

CTR=7.0%

CTR=6.9%

CTR=7.5%

CTR=11.8%

FHA REFORM,

nightmareatfha.com

• 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

A BIPARTISAN EFFORT

APPENDIX A

nightmareatfha.com

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

FHA REFORM SUPPORT

APPENDIX A

nightmareatfha.com

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

FHA REFORM SUPPORT

APPENDIX B

nightmareatfha.com

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

VA’S ABILITY TO PAY PRACTICES

APPENDIX C

nightmareatfha.com

• 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

REINSTATE APPRAISER PANELS

APPENDIX D

nightmareatfha.com

• 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

REDUCE FHA’s 100% MAX COVERAGE

APPENDIX E

nightmareatfha.com

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

REDUCE SELLER CONCESSIONS

fha reform, past, present, and future

News & Politics