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The FHA critics I suspect are thinking I told you so with Friday's announcement that the FHA “reserves” have fallen below 2%. But they would be wise to consider the following episode.
The story is legend among the HUD career staff: many, many years ago, an unnamed HUD Secretary upon learning the FHA “reserve” fund had surpassed $20 billion instructed the staff to print a rather large check, imprint it with the dollar amount and make it payable to the White House (whose budget office was looking for revenue). With the check and the photographer in tow, the group proceeded to the White House. With much fanfare, the Secretary presented the check to the White House budget office who was rather surprised at the Secretary’s gesture. Why? What he didn’t know, was that the FHA reserves (technically it is called a “Capital Reserve”) only existed in the ethereal and arcane world of actuarial accounting.
In short, each year a contractor hired by HUD estimates 30 years into the future how FHA loans will perform year-by-year. If you wondering how exact can an opinion of what the economy will be like each year now until 2039 you’re not alone. As a reminder the FHA is a mortgage insurance product plain and simple. It collects premiums from borrowers (revenue) and also pays out claims to lenders when loans go into default and foreclosure (outlays). The contractor estimates whether or not the revenue exceeds the expenditures. The Congress has told HUD that the capital ratio must exceed 2% of the economic value of the loan portfolio which today numbers more than 5 million homes.
What happens to FHA if the value of those homes continues to erode and thus devalues their value within the FHA portfolio? Or if the economy is sluggish and more people lose their jobs and can no longer make their mortgage payments? While FHA did not take part in the housing boom, it is nonetheless feeling its effects through declining house prices which in turn drives down the economic value of their portfolio.
Additionally, one year ago Congress, with much prodding from the FHA, finally banned a form of down payment assistance that utilized so-called “gift” funds. Many of these entities that offered buyers “zero down” loans essentially funneled a donation from the seller through their charity to the borrower. With absolutely no “skin in the game” from the borrower (many of whom had to repay the “gift” when it was added to the sales price) it is no wonder those loans defaulted at a rate 3 times greater than loans without the “gift” down payment. Unfortunately, those loans became 1/3 of FHA’s new loan portfolio by 2007. FHA twice tried to end the practice but was rebuked by the Courts. Congress finally ended the program, but those loans are still in the FHA portfolio and there are hundreds of thousands of them. Coupled with the struggling economy and declining home prices, the FHA loan portfolio must also endure the “gift” down payment loans for many years to come.
On the bright side, the last 18 months has put an exclamation point on why we have an FHA. FHA has saved close to a million sub-prime/Alt-a borrowers from possible financial ruin by allowing them to refinance into a safe and secure 30 year fixed rate mortgage. And I say “allow” since prospective borrowers must verify income and job history as part of a rigorous underwriting process.
Another 2 million qualified borrowers (80% of them first-time homebuyers) have taken advantage of the declining house prices and historically-low interest rates to purchase a home using FHA. And through it all FHA has helped pump more than $400 billion of mortgage activity and liquidity into the market since 2008 and with a higher credit quality borrower whose average FICO score is 700.
One can only imagine how much worse our economy would be right now without the FHA.
But there are areas of concern with FHA. For more than two years I implored Congress to give FHA the funds for more staff and to upgrade their IT systems whose average age was 18 years. It is still a mystery to me why we never got the much-need funds especially when FHA went from 7%-10% of the mortgage market to close to 30% in a matter of weeks. American taxpayers should be grateful to the FHA career staff who endured that massive run-up in volume without any additional staff.
So what happens next? In an effort to increase the capital ratio back above 2% FHA could do some or all of the following:
- Tighten underwriting criteria
- Increase premiums
- Raise the down payment requirements above 3.5%
- Overlay a credit score cut-off
- Utilize other efficiency and risk management measures
And it may be the case that home prices will no longer decrease and thus the economic value of the portfolio could improve on its own.
I would add another fix: FHA should strongly consider lowering its loan limits. While the maximum loan limit of $729,000 is only in 75 high-cost counties, another 600 counties have a loan limit between $275,000 and $729,000. With a nationwide median home price of less than $200,000 I think it is time to consider lowering them. I think most Americans are asking themselves that regardless of the location, why is the federal government helping someone buy a $729,000 home or a $600,000 one for that matter?
One year from now, FHA will again see how the FHA fund endured the withering economy. While that outcome is not known, what is known is this: the FHA which is celebrating its 75th anniversary this year has performed its counter-cyclical role as designed. And in so doing, saved millions of families from possible foreclosure. That is a success story too few people know, unless you are one of the families FHA helped save. Congress needs to do whatever it can to help ensure FHA is around another 75 years – and beyond.