Why FHA Should Not Increase Borrower Costs

There's a lot of worry in Washington regarding the massive FHA mortgage insurance program. The big issue is that the FHA needs reserves to protect the program against losses and the need for a taxpayer bailout.
Lately, things have not been going so well for the FHA. According to HUD’s annual report to Congress, released in November 2012, the agency could face a $16-billion shortfall in the coming year. Another estimate paints an even gloomier picture – the FHA, declares Forbes, “will cost taxpayers $150 billion.”
Indeed, Michael D. Berman, the past chairman of the Mortgage Bankers Association, told Congress in May that his group was worried because the FHA might be “over-utilized.”
“While FHA should continue to play a critical role in our housing finance system,” said Berman, “MBA firmly believes that it is not in the public interest for a government insurance program like FHA to dominate the market, especially if private capital is available to finance and insure mortgages that exhibit a low risk of borrower default."
One way of reducing the public’s reliance on FHA mortgages is by increasing their costs.

New Legislation

In response to these concerns, legislation passed by the House in September – the “FHA Emergency Fiscal Solvency Act of 2012” – would raise FHA premiums during the first 11 years of an FHA loan’s term, meaning for most new borrowers the entire loan term because few mortgages are held for 30 years. It's possible that similar legislation could be passed in the Senate as well.
But is such legislation necessary? Should borrower premiums increase? The answer on both counts is no. Here's why:
First, the worst of the FHA losses are over. Just look at the “book of business” generated by the FHA – it had losses from 2000 through 2009, but new originations with higher mortgage insurance premiums have been hugely profitable. HUD’s own November 16, 2012 press release claims that its reported loss “does not mean FHA has insufficient cash to pay insurance claims, a current operating deficit, or will need to immediately draw funds from the Treasury.” In addition, “The actuary found that the FHA’s books of business since FY2010 are expected to be very beneficial,” said HUD, “providing billions of dollars in net revenues to offset losses on earlier books.  Under the base-case projection of the independent actuary, FHA’s FY2013 book should add an additional $11 billion in economic value to the Fund.”
Second, the FHA no longer allows “seller-funded” down payments. These were FHA loans in which the seller made a “charitable” contribution to an organization, which then passed the “gift” money to a buyer who did not have down payment cash. Unfortunately, these loans ended up in default three times as often as those in which the buyers came up with their own down payments. With that sort of mortgage out of the picture, the health of FHA’s insurance pool improved without increasing premiums.

Toxic Loans

Third, as home values increase, FHA losses will decline.
Imagine that a home is financed with a $178,000 FHA loan. At some point, the borrower becomes unemployed, faces a medical crisis or a spouse dies. The mortgage cannot be paid and the home is foreclosed. The lender or investor that owns the loan is reimbursed by FHA’s mortgage insurance, so it doesn’t lose money.
The office of Housing and Urban Development (HUD), which oversees FHA lending, now gets title to the foreclosed property and seeks to re-sell it.  If the house is worth $208,000 when it goes into foreclosure, its sale will likely cover the outstanding $178,000 loan and foreclosure fees, and the FHA’s reserves remain intact. But if the home’s value has declined to $158,000, the FHA will take a loss.
In the past, home foreclosures were not a particular drain on reserves, because the FHA had a cushion against loss from the owner's down payment, loan amortization and the equity that had built up with generally rising prices. However, due to the recent mortgage crisis, home values are roughly 15 percent lower than they were in April 2007. That devaluation, a form of financial collateral damage produced by toxic loans the FHA neither originated nor insured, has magnified FHA losses today.
Home values are recovering, however. That crisis has hopefully passed.

If It Isn’t Broken – Don’t Fix It

Raising premiums makes FHA loans less attractive to new borrowers – one way to artificially resolve the alleged problem of “over-utilization.” More importantly, raising insurance premiums for new FHA borrowers misses the point: The FHA is on the path to profitability without congressional interference.
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