FHA: Reform or illusion of reform

Article Highlights

  • The reality is that sustainable loans to borrowers with 580-619 FICOs can't be done without shorter loan terms and higher down payments.

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  • FHA's attempts to reform minimum credit score standards would only impact a tiny percentage of FHA's business.

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  • It will take real reform, not the illusion of reform, to end the nightmare at FHA.

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Recently, FHA Commissioner Carol Galante has been extolling the FHA’s efforts at underwriting reform and to shrink its competition with the private sector.

For example, with respect to loans greater than $625,500:

“The combination of a higher down payment and higher mortgage insurance premiums for these loans will                       continue our efforts to drive this business to the private market.”

And regarding minimum credit score for all new loans:

"This will “reduce claim rates by approximately 20 percent for borrowers with credit scores of 620 or below…        this    policy change will significantly strengthen the extent to which… borrowers are offered loans that are sustainable for them.”

Is this reform or the illusion of reform?

Loans greater than $625,500:

1.    FHA raised the premium 25 bps in June 2012 for loans over $625,500.

a.    In CY 2012 a mere 0.5% of FHA’s volume was greater than $600,000 (note: FHA does not report for greater than $625,500, so this percentage would be even less). This compares to the same 0.5% in CY 2011.

b.    Since the same infinitesimal number of FHA loans exceeded $625,500 in both 2011 or 2012 this claim of reform is illusory.

2.    In November 2012 the FHA announced it would raise the premium for all loans, including loans above $625,500, by another 10 bps.

3.    In January 2013, FHA announced, in an effort to “scale back FHA market share”, that it would lower the maximum LTV on loans greater than $625,500 from 96.5% to 95%. FHA Commissioner Galante said “The combination of a higher down payment and higher mortgage insurance premiums for these loans will continue our efforts to drive this business to the private market.”

Bottom line—these changes make great sound bites but this is merely the illusion of reform.

Minimum credit score for all new loans:

1.    Borrowers with credit scores below 620 have to have a maximum debt-to-income (DTI) ratio no greater than 43% using automated underwriting with any exceptions requiring manual underwriting.

a.    FHA Commissioner Galante said “this requirement would reduce claim rates by approximately 20 percent for borrowers with credit scores of 620 or below… this policy change will significantly stengthen the extent to which… borrowers are offered loans that are sustainable for them.”

2.    In FY Q.3:12, about 3% of FHA’s volume had a FICO score below 620 (down from 45% in 2007). This drop is almost entirely due to lender credit overlays, not actions taken by FHA. Thanks to lenders’ prudent actions, the FHA has avoided billions of dollars in additional losses. As gratitude, HUD has made noises about outlawing the practice of credit overlays.

a.    These changes would only impact a tiny percentage of the FHA’s business, leaving large and risky swaths of its insurance business untouched.

3.    Using a claims rate projection model based on an analysis of 3.4 million loans, FHA loans with a FICO below 620, an LTV of 96.5%, a 30-year term and a DTI range of 41-55% have an expected claim rate of 28.6% (characteristics before the announced change).* Limiting DTI to a max of 41% as proposed by FHA reduces the claim rate to 23.1%. True, this is a reduction of 19.2%, right on par with FHA’s estimate of a 20% decline, but loans with a 23% claim rate are not sustainable.

a.    FHA has once again nibbled around the edges for headline effect.

4.    The reality is that sustainable loans to borrowers with 580-619 FICOs can’t be done without a shorter loan term than 30 years and a higher down payment than 3.5%.

Once again, these changes make great sound bites but clearly this is the illusion of reform.

It will take real reform, not the illusion of reform, to end the nightmare at FHA.

* Based on a book of loans with an overall loan claim rate of 10%, slightly less than FHA’s 37 year average loan claim rate of 10.63%.

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About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

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