p Nightmare at FHA - How the FHA Hurts Working-Class Families and Communities

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How the FHA Hurts Working-Class Families and Communities
By Edward J. Pinto





Executive Summary

The Federal Housing Administration’s (FHA’s) mission is to be a targeted provider of mortgage credit for low- and moderate-income Americans and first-time home buyers, leading to homeownership success and neighborhood stability. But is the FHA achieving this mission?

This paper reports on a comprehensive study that shows the FHA is engaging in practices resulting in a high proportion of low- and moderate-income families losing their homes. Based on an analysis of the FHA’s FY 2009 and 2010 books of business, the FHA’s lending practices are inconsistent with its mission and represent a disservice to American working-class families and communities.

The findings of this study indicate:

  • An estimated 40 percent of the FHA’s business consists of loans with either one or two subprime attributes—a FICO score below 660 or a debt ratio greater than or equal to 50 percent (based on loans insured during FY 2012). The FHA’s underwriting policies encourage low- and moderate-income families with low credit scores or high debt burdens to make risky financing decisions—combining a low credit score and/or a high debt ratio with a 30-year loan term and a low down payment. A substantial portion of these loans have an expected failure rate exceeding 10 percent.
  • Across the country, 9,000 zip codes with a median family income below the metro area median have projected foreclosure rates equal to or greater than 10 percent.These zips have an average projected foreclosure rate of 15 percent and account for 44 percent of all FHA loans in the low- and moderate-income zips.

The study found the direct and indirect costs associated with a foreclosure rate greater than 10 percent, particularly in working-class communities, are unacceptably high. Risk layering,combined with high FHA loan volumes, has a substantial impact on these communities. The resulting reduced or declining home values impact FHA and non-FHA low- and moderate-income families diligently making their payments. These families may be denied the opportunity to build equity, provide security for their family, and have the down payment for their next home as their family grows. Foreclosures also result in increased blight and crime and the larger community suffers from a reduced tax base and higher costs for providing municipal services.

The study identified specific reforms to focus the FHA on responsible lending and return it to its traditional mission:

Step 1: Do not knowingly insure a loan with a projected claim termination rate greater than 10 percent, assuming no house price appreciation or depreciation.

Step 2: Target an average 5 percent projected claim termination rate, assuming no house price appreciation or depreciation.

Step 3: Stop guaranteeing lower-risk loans and high-dollar-balance borrowers, as this allows for cross-subsidization of those loans with excessive risk. This will also let the FHA step back from markets that can be served by the private sector and allow it to concentrate on home buyers who truly need help.

Step 4: Price for risk, since not doing so deprives the borrower of the price information needed to understand the true risk of the loan. Until this is done, the FHA should disclose to the borrower his or her expected claim rate, assuming no house price appreciation or depreciation.

Step 5: Implement underwriting that results in the extension of responsible mortgage credit, by balancing down payment, loan term, FICO score, and debt-to-income ratio to achieve meaningful equity.