The FHA is a predatory lender

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Article Highlights

  • FHA mortgage insurance pricing grossly overcharges lower-risk borrowers.

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  • Today, the FHA program is all about cross-subsidies; the average low-risk borrower with a $150,000 mortgage is overcharged about $9,000.

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  • Cross-subsidies allow the FHA to offer abusive loan insurance terms to hundreds of thousands of high-risk borrowers.

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According to the FDIC's Inspector General: "Predatory lending typically involves imposing unfair and abusive loan terms on borrowers, often through aggressive sales tactics; taking advantage of borrowers' lack of understanding of complicated transactions; and outright deception."

The Federal Housing Administration's (FHA's) mortgage insurance practices qualify as predatory under this standard.

First, FHA mortgage insurance pricing grossly overcharges lower-risk borrowers. Hundreds of thousands of borrowers have been steered by mortgage lenders and real estate brokers to use FHA mortgage insurance rather than less expensive private alternatives. In FY 2013 alone, nearly 200,000 home purchasers with FHA-insured loans could have saved an estimated $710 million over the life of their loans, or nearly $4,000 in individual savings.

Second, the FHA counts on a borrower's lack of understanding of the complicated nature of FHA insurance as well as the expectation that the FHA would not intentionally permit borrowers to be steered into financially disadvantageous transactions. FHA's premiums add up to about 10 percent of the initial mortgage amount over the average life of a loan. Since FHA does not price for credit risk, it needs to overcharge low-risk borrowers so it may subsidize the rates charged on high-risk borrowers.

When Congress established the FHA in 1934, cross-subsidization between low-and high-risk borrowers was explicitly prohibited. Today, the FHA program is all about cross-subsidies; the average low-risk borrower with a $150,000 mortgage is overcharged about $9,000. This amount is much larger than the pricing difference between FHA and private mortgage insurance, since FHA benefits from many subsidies-not paying taxes, no need to earn a return on capital (if it had any capital), and taxpayers absorbing its administrative costs-which enable the organization to mask monumental losses on their high risk loans.

Third, these cross-subsidies allow the FHA to offer abusive loan insurance terms to hundreds of thousands of high-risk borrowers. For example, FHA's underwriting standards permit borrowers with a 600 FICO credit score, 98 percent loan-to-value, and a 43 percent Debt to Income (DTI) to obtain an FHA insured loan, even though these borrowers have a one in four chance of foreclosure. Abusive terms such as these harm working class families and neighborhoods.

The secretary of HUD should add a number of protections to HUD's consumer bill of rights to prevent such predatory practices. First, he should require the FHA to provide private-government best-execution comparisons to FHA applicants so as to ensure low-risk borrowers do not needlessly overpay thousands of dollars when they obtain an insured mortgage loan. If the private market alternative is a better execution, prospective borrowers should be so informed. If Secretary Donovan fails to do this, Congress should consider adding it to pending FHA reform bills.

Finally, the secretary of HUD should require lenders to disclose to prospective borrowers a clear and conspicuous notice within both 72 hours of application and at closing, which sets forth the applicant's Loan to Value, FICO score, and total debt-to-income ratio, as used in underwriting the applicant's FHA loan. This disclosure shall also include the estimated cumulative foreclosure rate for loans insured by the secretary with similar risk characteristics to the applicant's and the average estimated cumulative foreclosure rate for the most recent fiscal year as determined in the FHA's annual actuarial study. Such a disclosure would provide a prospective borrower the most transparent information regarding their risk of foreclosure. If Secretary Donovan fails to do this, Congress should immediately enact the Protecting American Taxpayers and Homeowners Act (the PATH Act) which provides for this much needed consumer protection.

AEI Resident Fellow Edward Pinto was an executive vice president and chief credit officer for Fannie Mae until the late 1980s. He has done groundbreaking research on the role of government housing policies in the lead-up to the financial crisis.

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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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