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Report to the Chairman, Subcommittee on Housing and Community 
Opportunity, Committee on Financial Services, House of Representatives: 

February 2005: 

Mortgage Financing: 

Actions Needed to Help FHA Manage Risks from New Mortgage Loan 
Products: 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-194]: 

GAO Highlights: 

Highlights of GAO-05-194, a report to the Chairman, Subcommittee on 
Housing and Community Opportunity, Committee on Financial Services, 
House of Representatives

Why GAO Did This Study: 

The U.S. Department of Housing and Urban Development (HUD), through its 
Federal Housing Administration (FHA), insures billions of dollars in 
home mortgage loans made by private lenders. FHA insures low down 
payment loans and a number of parties have made proposals to either 
eliminate or otherwise change FHA’s borrower contribution requirements. 
GAO was asked to (1) identify the key characteristics of existing low 
and no down payment products, (2) review relevant literature on the 
importance of loan-to-value (LTV) ratios and credit scores to loan 
performance, (3) report on the performance of low and no down payment 
mortgages supported by FHA and others, and (4) identify lessons for FHA 
from others in terms of designing and implementing low and no down 
payment products.

What GAO Found: 

FHA and many other mortgage institutions provide many low and no down 
payment products with requirements that vary in terms of eligibility, 
borrower investment, underwriting, and risk mitigation. While these 
products are similar, there are some important differences, including 
that FHA has lower loan limits, allows closing costs and the up-front 
insurance premium to be financed in the mortgage, and permits the down 
payment funds to come from nonprofits that receive funds from sellers. 
FHA also differs in that it does not require prepurchase counseling. 

A substantial amount of research GAO reviewed indicates that LTV ratio 
and credit score are among the most important factors when estimating 
the risk level associated with individual mortgages. GAO’s analysis of 
the performance of low and no down payment mortgages supported by FHA 
and others corroborates key findings in the literature. Generally, 
mortgages with higher LTV ratios (smaller down payments) and lower 
credit scores are riskier than mortgages with lower LTV ratios and 
higher credit scores. 

Some practices of other mortgage institutions offer a framework that 
could help FHA manage the risks associated with introducing new 
products or making significant changes to existing products. Mortgage 
institutions may impose limits on the volume of the new products they 
will permit and on who can sell and service these products. FHA 
officials question the circumstances in which they can limit volumes 
for their products and believe they do not have sufficient resources to 
manage a product with limited volumes. Mortgage institutions sometimes 
require additional credit enhancements, such as higher insurance 
coverage; and sometimes require stricter underwriting, such as credit 
score thresholds, when introducing a new low or no down payment 
product. FHA is authorized to require an additional credit enhancement 
by sharing risk through co-insurance but does not currently use this 
authority. FHA has used stricter underwriting criteria but this has not 
included credit score thresholds. 
Average Four-Year Default Rates for FHA Insured Loans Originated in 
1998, 1999, and 2000 (by LTV): 

[See PDF for image]

[End of figure]

What GAO Recommends: 

GAO suggests that Congress consider limiting any new no down payment 
product it may authorize. GAO recommends that HUD, among other things, 
consider piloting new or changed products and that HUD establish a 
framework for when and how to pilot products. In written comments, HUD 
stated that it had considered these actions, including piloting, but 
instead adopted an alternative solution. However, it is not clear under 
which circumstances HUD would consider piloting. 

www.gao.gov/cgi-bin/getrpt?GAO-05-194.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact William B. Shear at (202) 
512-8678 or shearw@gao.gov.

[End of section]

Contents: 

Letter: 

Results in Brief: 

Background: 

Characteristics and Standards of Low and No Down Payment Products Vary 
by Mortgage Institution: 

Research Shows LTV Ratio and Credit Score Are Important When Estimating 
Risk of Individual Mortgages: 

Our Analysis Indicated That Mortgages with Higher LTV Ratios and Lower 
Credit Scores Pose Greater Risks: 

Several Practices Mortgage Institutions Use in Designing and 
Implementing Low and No Down Payment Products Could Be Instructive for 
FHA: 

Conclusions: 

Matters for Congressional Consideration: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendixes: 

Appendix I: Scope and Methodology: 

Appendix II: Papers Identified in Literature Search and Included in 
Analysis: 

Appendix III: Comments from the Department of Housing and Urban 
Development: 

Appendix IV: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Staff Acknowledgments: 

Tables: 

Table 1: Eligibility Limitations of FHA Compared with RHS, VA, and 
Selected Products of Fannie Mae and Freddie Mac: 

Table 2: LTV Calculations for FHA, RHS, VA, Fannie Mae, and Freddie 
Mac: 

Figures: 

Figure 1: Evolution of Low and No Down Payment Products: 

Figure 2: Percentage of Home Purchase Mortgages with a LTV Ratio Higher 
Than 95 Percent for HUD (FHA), VA, Fannie Mae, and Freddie Mac for 
Loans Originated in 2000: 

Figure 3: Percentage of Loans with LTV Ratios of 95 Percent or Higher 
That Fannie Mae and Freddie Mac Purchased, 1997-2000: 

Figure 4: Four-year Relative Default Rates by LTV Ratio for FHA-Insured 
Mortgages (1992, 1994, and 1996): 

Figure 5: Four-year Relative Default Rates by Credit Score for FHA- 
Insured Mortgages (1992, 1994, and 1996): 

Figure 6: Four-year Relative Default Rates by LTV Ratio and Credit 
Score for FHA-insured Mortgages (1992, 1994, and 1996): 

Figure 7: Four-Year Relative Default Rates by LTV Ratio for 
Conventional Mortgages (1997, 1998, and 1999): 

Figure 8: Four-Year Relative Default Rates by Credit Score for 
Conventional Mortgages (1997, 1998, and 1999): 

Figure 9: Four-Year Relative Default Rates by LTV Ratio and Credit 
Score for Conventional Mortgages (1997, 1998, and 1999): 

Abbreviations: 

ARM: adjustable rate mortgage: 

FASAB: Federal Accounting Standards Advisory Board: 

FHA: Federal Housing Administration: 

GSE: government-sponsored enterprise: 

HECM: Home Equity Conversion Mortgage: 

HUD: U.S. Department of Housing and Urban Development: 

LTV: loan-to-value: 

MMI: Mutual Mortgage Insurance: 

OFHEO: Office of Federal Housing Enterprise Oversight: 

RHS: Rural Housing Service: 

USDA: U.S. Department of Agriculture: 

VA: U.S. Department of Veterans Affairs: 

Letter February 11, 2005: 

The Honorable Bob Ney: 
Chairman: 
Subcommittee on Housing and Community Opportunity: 
Committee on Financial Services: 
House of Representatives: 

Dear Mr. Chairman: 

Every year, the U.S. Department of Housing and Urban Development (HUD), 
through its Federal Housing Administration (FHA), insures billions of 
dollars in home mortgage loans made by private lenders, very often with 
low down payments. FHA mortgage insurance helps homebuyers with limited 
funds to obtain a home mortgage. Homebuyers with FHA-insured loans need 
to make a 3 percent contribution toward the purchase of the property 
and may finance some of the closing costs associated with the loan. As 
a result, an FHA-insured loan could equal nearly 100 percent of the 
property's value or sales price--commonly called loan-to-value (or LTV) 
ratio.[Footnote 1] In recent years, various mortgage industry 
participants, such as lenders, private mortgage insurers, and 
government-sponsored enterprises (the Federal National Mortgage 
Association [Fannie Mae] and the Federal Home Loan Mortgage Corporation 
[Freddie Mac]) have begun to support mortgage products that require 
very little or no down payment. Among these products, some allow third- 
party provision of gift down payment assistance. Recently, in a HUD 
contractor study of a national sample of FHA loans, of those loans that 
received down payment assistance, 29 percent received assistance from a 
nonprofit down payment assistance provider. In addition, the FHA and 
others have proposed eliminating the borrower contribution requirement 
for FHA-insured loans. At the same time, the mortgage industry has 
moved toward greater use of automated systems assessing the risk level 
of mortgages. These automated underwriting systems rely, in part, on 
individuals' credit scores or credit history, and these systems have 
played an integral role in the provision of low and no down payment 
mortgage products.[Footnote 2]

In light of recent changes in the composition of FHA-insured mortgage 
products and the proposal to eliminate the borrower contribution 
requirement for FHA-insured mortgages, you asked us to evaluate low and 
no down payment lending. Specifically, this report examines (1) the key 
characteristics and standards of mortgage products--supported by FHA 
and others--that require low or no down payments; (2) what published 
research indicates about the importance of variables such as LTV ratios 
and credit scores in estimating the risk level associated with 
individual mortgages; (3) the performance of low and no down payment 
mortgages supported by FHA and others; and (4) what lessons FHA might 
learn from others that support low and no down payment lending in terms 
of designing and implementing such products.

To address the objectives we interviewed officials at FHA, the U.S. 
Department of Agriculture (USDA), and U.S. Department of Veterans 
Affairs (VA); and staff at selected conventional mortgage 
providers[Footnote 3]; private mortgage insurers; two government- 
sponsored enterprises (GSE); the Office of Federal Housing Enterprise 
Oversight (OFHEO); selected state housing finance agencies; and 
nonprofit down payment assistance providers. We reviewed descriptions 
of low and no down payment mortgage products supported by selected 
mortgage industry participants and compared the standards used by these 
entities. To determine what published research indicates about the 
variables that are most important when estimating the risk level 
associated with individual mortgages, we reviewed recent and relevant 
papers that we identified through a systematic search of economic 
literature. To describe the low and no down payment performance of 
loans supported by FHA and others, we examined the relationship among 
mortgage performance, LTV ratio, and credit score using 4-year default 
rates for a special research sample of over 400,000 mortgages insured 
by FHA during 1992, 1994, and 1996 and for all conventional loans 
originated in 1997, 1998, and 1999 and purchased by Fannie Mae or 
Freddie Mac. We chose these years because, for FHA, these data are the 
only significant data set of FHA-insured loans that includes credit 
scores and that had at least 4 years of loan performance activity. For 
Fannie Mae and Freddie Mac, in 1997, these institutions began 
purchasing an increasing number of loans with the highest LTV ratios; 
loans originated after 1999 would have less than 4 years of experience 
to analyze. The GSEs provided us data that they considered to be 
proprietary. We did not disclose information that could be considered 
proprietary, but this did not limit our overall findings. We assessed 
the reliability of the FHA, Fannie Mae, and Freddie Mac data by 
discussing the data with knowledgeable FHA officials and Fannie Mae and 
Freddie Mac officials; reviewing recent audit reports that evaluated 
the information systems at each entity; and comparing the data with 
similar publicly available data. We determined that the data are 
sufficiently reliable to use in our analysis of the performance of low 
and no down payment mortgages. To determine what lessons FHA might 
learn from others that support low and no down payment lending, we 
obtained testimonial information from mortgage industry participants 
about the steps they take to design and implement low and no down 
payment lending products. We did not verify that these institutions, in 
fact, used these practices.

We performed our audit work from January 2004 to December 2004 in 
accordance with generally accepted government auditing standards. 
Appendix I provides a full description of our scope and methodology.

Results in Brief: 

FHA and other mortgage institutions provide products that enable 
homebuyers to purchase homes using little of their own funds. While 
similar, the products offered by FHA and others have important 
differences in terms of eligibility, borrower investment, underwriting, 
and risk mitigation. With respect to eligibility, for example, FHA loan 
limits are lower than those in the conventional market. In terms of 
borrower investment, FHA's product differs from others in that it 
allows some of the closing costs and the up-front insurance premium to 
be financed in the mortgage. Although FHA requires a 3 percent borrower 
contribution, it can come from sources other than the borrower. Many 
conventional low and no down payment products also permit down payment 
funds to come from others but generally stipulate that down payment 
funds, either directly or indirectly, cannot come from an interested or 
seller-related party. FHA also does not permit down payment funds to 
come directly or indirectly from sellers but does permit nonprofits 
that receive contributions from sellers to provide down payment 
assistance to homebuyers. With respect to underwriting, many mortgage 
institutions use automated systems to some extent. These systems allow 
lenders to quickly assess the riskiness of mortgages by simultaneously 
considering multiple factors including the credit score and credit 
history of borrowers. With respect to risk mitigation, FHA differs from 
conventional mortgage institutions that provide low and no down payment 
products. For example, while FHA does not require prepurchase 
counseling, some institutions require borrowers to receive counseling 
for their no down payment products. Additionally, some mortgage 
institutions require higher private mortgage insurance coverage on 
their no down payment products. While FHA already provides nearly 100 
percent insurance, it does have the authority to share risk but does 
not currently use this authority.

A substantial body of economic research indicates that LTV ratio and 
credit score are among the most important factors when estimating the 
risk level associated with individual mortgages. We reviewed 45 
economic research papers that examined multiple factors that could be 
important; of these, 37 examined if LTV ratio was important. Almost all 
of these papers (35) found the LTV ratio of a mortgage important when 
estimating the risk level associated with individual mortgages. For 
example, one study found that the default rates for mortgages with an 
LTV ratio above 95 percent are three to four times higher than default 
rates for mortgages with an LTV ratio of 90 to 95 percent. Of the 45 
papers we reviewed, 19 examined whether credit score was important. All 
but one of these papers found the borrower's credit score important 
when estimating the risk level associated with individual mortgages. 
For example, one study found that a mortgage with a credit score of 728 
(indicating an applicant with excellent credit) had a default 
probability of 1.26 percent, while the default probability of a 
mortgage with a credit score of 642 was more than two times higher-- 
3.41 percent. The research also indicated that additional factors--such 
as characteristics of the borrower, mortgage, and property--may help in 
estimating the risk level associated with individual mortgages.

Our analysis of FHA and conventional mortgage data indicated that, 
generally, mortgages with higher LTV ratios (smaller down payments) and 
lower credit scores are riskier than mortgages with lower LTV ratios 
and higher credit scores.[Footnote 4]For example, FHA-insured mortgages 
with LTV ratios greater than 80 percent and low credit scores (below 
660), had a default rate above the FHA average default rate.[Footnote 
5] There is a similar relationship for conventional mortgages. For 
example, conventional mortgages with LTV ratios greater than 80 percent 
and credit scores below 700 had a default rate above the conventional 
average default rate.

FHA and other mortgage institution officials report using a number of 
similar practices in designing and implementing low and no down payment 
products but FHA does not typically follow some practices that could 
help it to manage the risks associated with introducing new products or 
making significant changes to existing products. Mortgage institutions 
we spoke with, such as Fannie Mae, Freddie Mac, and the private 
mortgage insurers, told us they often initially analyze the risk of 
products that are similar to those they are considering by both using 
internal data and data they acquire externally. For example, Freddie 
Mac officials said that Freddie Mac obtained external loan data when 
they purchased loans through a structured transaction to provide 
insight into low and no down payment lending when designing its low and 
no down payment products.[Footnote 6] These loans had characteristics 
of loans they were considering purchasing on a routine basis. FHA 
officials also said they have purchased loan performance and other data 
when designing a new product or studying changes to an existing product 
but rely more heavily on internal data. Mortgage institutions also 
sometimes require additional credit enhancements or stricter 
underwriting when introducing a new low or no down payment 
product.[Footnote 7] FHA has the authority, but does not currently 
require an additional credit enhancement, and has made adjustments to 
mortgage underwriting features but this has not included credit score 
thresholds such as those used by other mortgage institutions.[Footnote 
8] FHA does adjust premiums. In implementing new products, mortgage 
institutions may impose limits on the volume of the new products they 
will permit and on who can sell and service these products. Fannie Mae 
and Freddie Mac officials described new low and no down payment 
products that they first introduced as part of a pilot or with certain 
limits on how many of the new products they would commit to purchase. 
However, limits on the availability of new or revised FHA mortgage 
insurance are sometimes set: 

through legislation and focus on the volume of loans that FHA may 
insure.[Footnote 9] FHA officials questioned the circumstances in which 
they can use pilots or limit volumes when it is not required by 
Congress and told us that they lack the resources to effectively manage 
a program with limited volumes. Finally, mortgage institutions, 
including FHA, establish enhanced monitoring and oversight for new low 
and no down payment products and revise new products as they improve 
their understanding of these products. In addition to reviewing routine 
data on the characteristics and performance of all loans, some 
institutions may regularly review the underwriting of all loans within 
a new product line as compared with a sample of loans for their 
established products (for which they better understand performance). 
FHA typically reviews a sample of loans for a new product and says that 
they make changes to products based on their acquired understanding.

This report includes matters for congressional consideration and 
recommendations to HUD. We suggest that Congress consider limiting the 
initial availability of any new single-family insurance product it may 
authorize. We recommend that FHA consider using pilots for new products 
and for making significant changes to its existing products and that, 
when doing so, FHA develop a framework for when to use pilots and how 
they should be implemented. We also recommend that FHA explore various 
techniques for mitigating risks when implementing new products that 
have greater risk or for which risk is not well understood.

We provided a draft of this report to HUD, Fannie Mae, Freddie Mac, 
USDA, and VA. We received written comments from HUD, which are 
discussed later in this report and reprinted in appendix III. We also 
received technical comments from HUD, Fannie Mae, and USDA which have 
been incorporated where appropriate. VA did not have comments on the 
draft. HUD stated that in developing its proposed zero down payment 
product, it considered all of the items that we recommended they 
consider including piloting. However, it is not clear under what 
circumstances HUD believes piloting or limiting the availability of a 
changed or new product would be appropriate or possible. During the 
course of our work, HUD officials told us that they face challenges in 
administering a pilot program because of the difficulty of selecting 
only a limited number of lenders and borrowers. HUD officials also held 
that they may not have the authority to limit products and that they 
lacked sufficient resources to adequately manage products as part of a 
pilot or with limited volumes. We believe that HUD needs to further 
consider piloting or limiting volume of new or changed products. There 
are several available techniques for limiting an initial product, 
including limiting the time period in which it is available. Further we 
believe that in some circumstances the potential costs of making widely 
available a product with risk that is not well understood could exceed 
the cost of initially implementing such a product on a limited basis. 
We therefore recommend that HUD consider a wide range of options for 
mitigating risk, including piloting or limiting the volume of new or 
changed products. To the extent HUD believes it does not have the 
authority for exercising the options we describe, it should seek the 
authority from Congress.

Background: 

Mortgage insurance, a commonly used credit enhancement, protects 
lenders against losses in the event of default. Lenders usually require 
mortgage insurance when a homebuyer has a down payment of less than 20 
percent of the value of the home. FHA, VA, the USDA's Rural Housing 
Service (RHS), and private mortgage insurers provide this insurance. In 
2003, lenders originated $3.8 trillion of single-family mortgage loans, 
of which more than 60 percent were for refinancing. Of all the insured 
loans including refinancings originated in 2003, private companies 
insured about 64 percent, FHA insured about 26 percent, VA insured 
about 10 percent, and RHS insured a very small number. Private mortgage 
insurers generally offer first loss coverage--that is, they will pay 
all the losses from a foreclosure up to a stated percentage of the 
claim amount.[Footnote 10] Generally, these insurers limit the coverage 
that they offer to between 25 percent and 35 percent of the claim 
amount. The insurance offered by the government varies in the amount of 
lender incurred losses it will cover. For example, VA guarantees losses 
up to 25 percent to 50 percent of the loan, while FHA's principal 
single-family insurance program insures almost 100 percent.[Footnote 
11] FHA plays a particularly large role in certain market segments, 
including low-income and first-time homebuyers. During fiscal years 
2001 to 2003, FHA insured a total of about 3.7 million mortgages with a 
total value of about $425 billion. FHA insures most of its mortgages 
for single-family housing under its Mutual Mortgage Insurance Fund. To 
cover lenders' losses, FHA collects insurance premiums from borrowers. 
These premiums, along with proceeds from the sale of foreclosed 
properties, pay for claims that FHA pays lenders as a result of 
foreclosures.

Fannie Mae and Freddie Mac are government-sponsored private 
corporations with stated public missions chartered by Congress to 
provide a continuous flow of funds to mortgage lenders and borrowers. 
Fannie Mae and Freddie Mac purchase mortgages from lenders across the 
country and finance their mortgage purchases through borrowing or 
issuing mortgage-backed securities that are sold to investors. They 
purchase single-family mortgages up to the "conforming loan limit," 
which for 2005 was set at $359,650.[Footnote 12] Their purchase 
guidelines and underwriting standards have a dominant role in 
determining the types of loans that primary lenders will originate in 
the conventional conforming market.

Members of the conventional mortgage market (such as private mortgage 
insurers, Fannie Mae, Freddie Mac, and large private lenders) have been 
increasingly active in supporting low and no down payment mortgage 
products. Many private mortgage insurers will now insure a mortgage up 
to 100 percent of the value of the housing being purchased. Fannie Mae 
and Freddie Mac, working together with the private mortgage insurers, 
have become more aggressive in developing high LTV products that target 
low-and moderate-income or first-time homebuyers while also developing 
high LTV products designed for use by borrowers across the income 
spectrum. Figure 1 shows the history of the introduction of low and no 
down payment mortgage products at three LTV levels. FHA and VA have 
been backing low and no down payment mortgages for many years, and 
Fannie Mae and Freddie Mac permitted conventional lenders to sell them 
mortgages with an LTV of 97 percent in 1994 and 1998, respectively. 
Freddie Mac and Fannie Mae's no down payment mortgage products were 
introduced in 2000.

Figure 1: Evolution of Low and No Down Payment Products: 

[See PDF for image] 

[End of figure] 

As shown in figure 2, a greater proportion of the FHA-insured and VA- 
guaranteed mortgage loans had low down payments than was the case for 
loans purchased by Fannie Mae and Freddie Mac. Further, the number of 
loans FHA insured in 2000 that had LTVs greater than 95 percent 
exceeded the total number of loans with such LTVs that were guaranteed 
by VA and purchased by Fannie Mae and Freddie Mac combined.

Figure 2: Percentage of Home Purchase Mortgages with a LTV Ratio Higher 
Than 95 Percent for HUD (FHA), VA, Fannie Mae, and Freddie Mac for 
Loans Originated in 2000: 

[See PDF for image] 

[End of figure] 

While relatively few loans purchased by Fannie Mae or Freddie Mac had 
low or no down payments, in recent years the GSEs have purchased 
relatively more of these loans than in the past. As shown in figure 3, 
both Fannie Mae and Freddie Mac, during the years 1997-2000, acquired a 
higher proportion of mortgages with a high LTV than in previous years. 
To do this, they increased the number of product options available to 
borrowers with limited down payment funds.

Figure 3: Percentage of Loans with LTV Ratios of 95 Percent or Higher 
That Fannie Mae and Freddie Mac Purchased, 1997-2000: 

[See PDF for image] 

[End of figure] 

The mortgage industry is increasingly using mortgage scoring and 
automated underwriting. During the 1990s, private mortgage insurers, 
the GSEs, and larger financial institutions developed automated 
underwriting systems. Mortgage scoring is a technology-based tool that 
relies on the statistical analysis of millions of previously originated 
mortgage loans to determine how key attributes such as the borrower's 
credit history, the property characteristics, and the terms of the 
mortgage note affect future loan performance. Automated underwriting 
refers to the process of collecting and processing the data used in the 
underwriting process. FHA has developed and recently implemented a 
mortgage scoring tool, called the FHA TOTAL Scorecard, to be used in 
conjunction with existing automated underwriting systems. More than 60 
percent of all mortgages were being underwritten by an automated 
underwriting system, as of 2002, and this percentage continues to 
rise.[Footnote 13] The mortgage industry also uses credit scoring 
models for estimating the credit risk of individuals--these 
methodologies are based on information such as payment patterns. 
Statistical analyses identifying the characteristics of borrowers who 
were most likely to make loan payments have been used to create a 
weight or score associated with each of the characteristics. According 
to Fair, Isaac and Company sources, credit scores are often called 
"FICO scores" because most credit scores are produced from software 
developed by Fair, Isaac and Company.[Footnote 14] FICO scores 
generally range from 300 to 850 with higher scores indicating better 
credit history. The lower the credit score, the more compensating 
factors lenders might require to approve a loan. These factors can 
include a higher down payment and greater borrower reserves.

Characteristics and Standards of Low and No Down Payment Products Vary 
by Mortgage Institution: 

The characteristics and standards for low and no down payment mortgage 
products vary among mortgage institutions. Standards to determine a 
borrower's eligibility differ from lender to lender. For example, one 
mortgage institution might have a limit on household income where 
another might not. Each of these mortgage products requires some form 
of borrower investment. Most mortgage institutions use automated 
systems to underwrite loans but differ on how they consider factors 
such as the borrower's credit score and credit history. Finally, 
mortgage institutions also try to mitigate the increased risk 
associated with these products by employing tools like prepurchase 
counseling and greater insurance coverage.

Eligibility Standards Are Not Uniform throughout the Mortgage Industry: 

Each mortgage institution we studied limits in some way the mortgages 
or the borrowers that may be eligible for their low and no down payment 
products, but the specific limits and criteria differ among 
institutions. Fannie Mae and Freddie Mac are constrained in the size of 
the mortgages they may purchase. Specifically, the Housing and 
Community Development Act of 1980 requires a limit (conforming loan 
limit) on the size of mortgages that can be purchased by either Fannie 
Mae or Freddie Mac. In 2005, the conforming mortgage limit for Fannie 
Mae and Freddie Mac is $359,650 for most of the nation.[Footnote 15] 
FHA is also limited in the size of mortgages it may insure. The FHA 
loan limit varies by location and property type, depending on the cost 
of homes in an area and the number of units in a property. Thus, FHA's 
loan limit may be as high as 87 percent of the conforming loan limit, 
or $312,895 in 2005; or as low as 48 percent of the conforming loan 
limit, or $172,632 in 2005. In addition, FHA also has higher limits in 
Alaska, Hawaii, Guam, and the U.S. Virgin Islands because these are 
considered to be high cost areas. Although VA does not have a mortgage 
limit, lenders generally limit VA mortgages to four times the VA 
guaranty amount, which is now set at 25 percent of the conforming loan 
limit. Since the maximum guaranty currently is legislatively set at 
$89,913, VA-guaranteed mortgages will rarely exceed $359,650.

Moreover, while FHA does not restrict eligibility to borrowers with 
certain income, other mortgage institutions may limit eligibility by 
borrower income and other measures. Most state housing finance agencies 
target their low and no down payment products to first-time 
homebuyers.[Footnote 16] Some mortgage institutions providing 
affordable low and no down payment products also limit the loans to 
households with income at or below area median levels. For example, 
USDA's RHS, in its section 502 Guaranteed Loan program, does not 
guarantee loans to individuals with incomes exceeding 115 percent of 
the area median income or 115 percent of the median family income of 
the United States. We also found that Web sites of many state housing 
finance agencies show that their mortgage products include income 
limits as well as sales price limits and in some cases designated 
"targeted areas" within a state.[Footnote 17] Table 1 illustrates some 
of the major similarities and differences in the eligibility criteria 
of FHA and other mortgage institutions.

Table 1: Eligibility Limitations of FHA Compared with RHS, VA, and 
Selected Products of Fannie Mae and Freddie Mac: 

Eligibility criteria: Borrower type; 
FHA: N/A[A]; 
RHS: Resident in rural-designated area; 
VA: Veteran or active duty; 
Fannie Mae MyCommunity-Mortgage program™: N/A; 
Freddie Mac Affordable Gold programs: N/A.

Eligibility criteria: Income; 
FHA: N/A; 
RHS: Cannot exceed 115 percent of area median income or the median 
family income of the U.S; 
VA: N/A; 
Fannie Mae MyCommunity-Mortgage program™: Cannot exceed 100 percent of 
area median income[B,C]; 
Freddie Mac Affordable Gold programs: Cannot exceed 100 percent of area 
median income[B,C].

Eligibility criteria: Property type; 
FHA: 1-4 unit, owner-occupied; 
principal residence[D]; 
RHS: 1-unit, owner-occupied principal residence; 
VA: 1-4 unit, owner-occupied principal residence; 
Fannie Mae MyCommunity-Mortgage program™: 1-4 unit, owner-occupied 
principal residence; 
Freddie Mac Affordable Gold programs: 1-unit, owner-occupied principal 
residence.

Eligibility criteria: Mortgage type; 
FHA: Up to 30-year fixed rate or adjustable rate mortgages (ARM); 
RHS: 30-year fixed rate; 
VA: Up to 30- year fixed rate or ARMs; 
Fannie Mae MyCommunity-Mortgage program™: Up to 30 years fixed rate or 
ARMs; 
Freddie Mac Affordable Gold programs: Up to 30-year fixed rate.

Legend: 

N/A = not applicable: 

Sources: HUD, VA, USDA, Fannie Mae, and Freddie Mac.

[A] While FHA does not set specific requirements for the type of 
borrower, it tends to serve low-income and first-time homebuyers.

[B] Can be higher in high cost areas.

[C] Waiver of income limit may apply in targeted areas.

[D] Under certain circumstances FHA may insure loans on second 
residences, investment properties, and properties owned by nonprofits 
and state and local governments.

[End of table]

Fannie Mae and Freddie Mac affordable mortgage products primarily 
target low-to-moderate income and first-time homebuyers. Freddie Mac 
and RHS allow a borrower to purchase a home containing one unit, while 
FHA, VA, and Fannie Mae allow a borrower to purchase properties that 
have up to four units with one mortgage. VA stipulates that if the 
veteran must depend on rental income from the property to qualify for 
the mortgage, the borrower must show proof that he or she has the 
background or qualifications to be successful as a landlord and have 
enough cash reserves to make the mortgage payments for at least 6 
months without help from the rental income. With regard to mortgage 
type, many mortgage institutions permit 30-year fixed-rate mortgages. 
Some also permit adjustable rate mortgages (ARM).

Most Low and No Down Payment Products Require Some Form of Borrower 
Investment: 

Most low and no down payment mortgage products require some form of 
borrower investment, either a borrower contribution or cash reserve, as 
a way of reducing risk and assuring that the borrower has a stake in 
the property. Low down payment products offered by FHA, Fannie Mae, 
Freddie Mac and private insurers require a cash investment of at least 
3 percent from the borrower. No down payment mortgage products offered 
by VA, RHS, Fannie Mae, Freddie Mac, and some private insurers require 
either no down payment or a minimum amount (such as $500 in Fannie 
Mae's MyCommunityMortgage program).

Many institutions permit down payment assistance. FHA stipulates that 
the gift donor may not be a person or entity with an interest in the 
sale of the property, such as the seller, real estate agent or broker, 
builder, or entity associated with them. FHA mortgagee letters state 
that "gifts from these sources (seller, builder, etc.) are considered 
inducements to purchase and must be subtracted from the sales price." 
However, FHA allows nonprofit agencies that may receive contributions 
from the seller to provide down payment assistance to the borrower. In 
contrast, Fannie Mae, Freddie Mac, and some of the private insurers 
generally do not allow down payment funds, either directly or 
indirectly, from an interested or seller-related party to the 
transaction. Fannie Mae and Freddie Mac officials told us that such 
seller-related contributions could contribute to an overvaluation of 
the price of the property.

Even where borrowers pay no down payment they very often must pay a 
minimum percentage of closing costs from their own funds.[Footnote 18] 
FHA requires that borrowers pay 3 percent of the total loan amount 
toward the purchase of the home. This contribution may be used for down 
payment or closing costs. Thus, FHA borrowers may finance closing 
costs, within limits. FHA borrowers may also finance their insurance 
premium. Unlike FHA, some mortgage institutions do not allow financing 
of the closing costs and the insurance premiums in the first mortgage. 
VA generally allows payment of all closing costs to be negotiated while 
restricting those that may be charged to the borrower. VA allows 
borrowers to finance their insurance premium, called the funding fee. 
In the section 502 Guaranteed Loan program for RHS, borrowers may pay 
closing costs but they are not required to do so and may be allowed to 
finance the closing costs and their insurance premium, called the 
Guarantee Fee.[Footnote 19] Freddie Mac in its no down payment product 
requires a 3 percent borrower contribution to be used for closing 
costs, financing costs, or prepaids and escrows, all of which can come 
from gifts or property seller contributions.

FHA, RHS, VA, Fannie Mae, and Freddie Mac differ somewhat in terms of 
their maximum allowable LTV ratios and how they calculate this ratio. 
LTV ratios are important because of the direct relationship that exists 
between the amount of equity borrowers have in their homes and the 
likelihood of risk of default. The higher the LTV ratio, the less cash 
borrowers will have invested in their homes and the more likely it is 
that they may default on mortgage obligations, especially during times 
of economic hardship.

The Omnibus Budget Reconciliation Act of 1990 (Pub. L. No. 101-508), 
established LTV limits for FHA-insured mortgages of 98.75 percent if 
the home value is $50,000 or less, or 97.75 percent if the home value 
is in excess of that. However, because FHA allows financing of the up- 
front insurance premium, borrowers can receive a mortgage with an 
effective LTV ratio of close to 100 percent.

In table 2, we calculate the effective LTV ratio for selected low and 
no down payment products. The example assumes a $100,000 purchase price 
(appraisal value) and a 30-year fixed-rate mortgage. It also assumes 
average closing costs of about 2.1 percent of sales price. FHA has a 
formula to calculate the maximum loan amount based on a percentage of 
the purchase price of the home. FHA does not have a down payment 
requirement but instead has what FHA calls a minimum cash investment 
requirement. This investment requirement can be used to pay either the 
down payment and in some cases the closing costs. Not shown are the 
actual out-of-pocket expenses to the borrower which could vary based on 
the individual transaction and whether the investment requirement was 
split among the closing costs and down payment, as well as whether the 
borrower opted to finance their up-front premium.[Footnote 20]

Table 2: LTV Calculations for FHA, RHS, VA, Fannie Mae, and Freddie 
Mac: 

Mortgage elements: Purchase price; 
Government: FHA[A] 203b: $100,000; 
Government: USDA 502 guaranteed program: $100,000; 
Government: VA zero down: $100,000; 
Conventional: Fannie Mae and Freddie Mac 100 LTV products: $100,000.

Mortgage elements: Loan amount before up-front insurance; 
Plus up-front insurance premium/fee; 
Government: FHA[A] 203b: Loan amount before up-front insurance: 
$97,750[B]; Plus up-front insurance premium/fee: +$1,466[C] (1.5%); 
Government: USDA 502 guaranteed program: Loan amount before up-front 
insurance: $100,000; Plus up-front insurance premium/fee: +$2,000[D] 
(2%); 
Government: VA zero down: Loan amount before up-front insurance: 
$100,000; Plus up-front insurance premium/fee: +$2,150[E] (2.15%); 
Conventional: Fannie Mae and Freddie Mac 100 LTV products: N/A.

Mortgage elements: Total mortgage; 
Government: FHA[A] 203b: $99,216[F]; 
Government: USDA 502 guaranteed program: $102,000; 
Government: VA zero down: $102,150; 
Conventional: Fannie Mae and Freddie Mac 100 LTV products: $100,000.

Mortgage elements: Effective LTV ratio[G]; 
Government: FHA[A] 203b: 99.2%; 
Government: USDA 502 guaranteed program: 102%; 
Government: VA zero down: 102%; 
Conventional: Fannie Mae and Freddie Mac 100 LTV products: 100%.

Sources: HUD, VA, USDA, Fannie Mae, and Freddie Mac.

[A] This is the existing FHA mortgage insurance product that requires 
the least amount of a down payment. This product is not a "no down" 
mortgage product.

[B] We are assuming, for this example, that the mortgage is in a state 
with average closing costs of above 2.1 percent of sales price. In this 
case, the maximum mortgage (not including a financed up-front insurance 
premium) would be $100,000 x 97.75 percent.

[C] Up-front insurance premium = $97,750 x 1.5 percent = $1,466.

[D] Guarantee fee = $100,000 x 2 percent = $2,000. Loans can be 
guaranteed up to 102 percent LTV if doing so is necessary to allow the 
2 percent guarantee fee to be financed by the borrower. A 100 percent 
LTV threshold may only be exceeded to allow the guarantee fee to be 
financed. If a borrower chooses not to finance the guarantee fee, loans 
are limited to 100 percent LTV. Closing costs are allowed but closing 
costs may not be financed if the borrower is already financing the 
guarantee fee such that they have reached the maximum allowed LTV of 
102 percent, not including closing costs.

[E] Funding fee = $100,000 x 2.15 percent = $2,150.

[F] The borrower is required to pay 3 percent (of the contract sales 
price--called a minimum cash investment requirement) toward closing 
costs and down payment.

[G] Calculation = total mortgage / purchase price.

[End of table]

In addition, some of the affordable conventional mortgage products 
allow for subordinate financing in the form of secondary mortgages to 
pay for a down payment and/or closing costs. These secondary mortgages 
allow for a total effective LTV of up to 105 percent.

Some Underwriting Standards Differ between FHA and Other Mortgage 
Institutions: 

When underwriting mortgages, FHA and other mortgage institutions 
require that lenders examine a borrower's ability and willingness to 
repay the mortgage debt. Lenders for low and no down payment mortgages 
may use automated underwriting systems examining the borrower's credit 
score or creditworthiness, qualifying ratios, and cash reserves. In 
some cases, they use manual underwriting to accommodate nontraditional 
credit histories. By screening the majority of applications with 
automated systems, underwriters have more time to review special cases 
with manual underwriting.

Many mortgage institutions use credit scores in assessing mortgage 
applicants through their automated underwriting systems. For standard 
products, institutions tend to rely on automated underwriting, which 
develops a mortgage score based on various factors including credit 
score and, based on this, they make a decision on the loan. However, in 
some instances, mortgage institutions set credit score minimums for 
some low and no down payment products. In some instances, these credit 
score minimums exist within the automated underwriting system. In other 
instances, the credit score minimums exist only in products that are 
underwritten using manual underwriting. FHA does not require a credit 
score minimum, nor do VA and RHS. These three governmental agencies 
examine the overall pattern of credit behavior rather than rely on one 
particular credit score. All three agencies allow a good deal of 
judgment and interpretation on the part of the underwriters in 
determining the creditworthiness of the prospective borrower. Fannie 
Mae does not use externally derived credit scores for its loan products 
that use automated underwriting but instead relies on the credit 
history of the borrower. Based on a review of Web sites of private 
mortgage insurers, products with no down payment that are insured by 
these private mortgage insurers have minimum credit score requirements 
ranging from 660 to 700. Individual low and no down payment products 
that use credit score minimums use a variety of cutoff scores. Many 
mortgage industry sources consider borrowers with credit scores of 720 
or higher as having excellent credit. One study that focused on issues 
related to homeownership and cited extensive interviews with leading 
experts in government and industry found that mortgage applicants with 
scores above 660 are likely to have acceptable credit.[Footnote 21] On 
the other hand, for applicants with FICO scores between 620 and 660, 
mortgage institutions typically perform more careful underwriting, 
scrutinizing many factors. FICO scores under 620 indicate higher risk 
and are unlikely to be approved by conventional lenders unless 
accompanied by compensating factors.

Some of these mortgage institutions may, under some circumstances, 
accept a lower credit score, if the borrower provides additional 
compensating factors (such as 2 months cash reserve) that would 
indicate a lower risk on the part of the borrower. Mortgage 
institutions might also accept a lower credit score if they were 
receiving additional compensation for the risk, such as a mortgage 
originator receiving a higher interest rate or a mortgage insurer 
getting a higher insurance premium. Some mortgage institutions state in 
their underwriting guidance that FICO scores together with the LTV 
determine in part the borrower's minimum contribution. For example, one 
private mortgage insurer allows borrowers with credit scores equal or 
greater than 700 to have a minimum borrower contribution of 0 percent 
on a 100 LTV loan. For this same insurer, a borrower with a credit 
score between 660 and 699 would have a minimum borrower contribution of 
3 percent on a 100 LTV loan.

Many mortgage institutions use two qualifying ratios as factors in 
determining whether a borrower will be able to meet the expenses 
involved in homeownership. The "housing-expense-to-income ratio" 
examines a borrower's expected monthly housing expenses as a percentage 
of the borrower's monthly income, and the "total-debt-to-income ratio" 
looks at a borrower's expected monthly housing expenses plus long-term 
debt as a percent of the borrower's monthly income. Lenders who do 
business with Fannie Mae or Freddie Mac place more emphasis on the 
total-debt-to-income ratio. Total debt includes monthly housing 
expenses and the total of other monthly obligations, such as auto 
loans, credit cards, alimony, or child support. The guidelines for 
manual underwriting are discussed below; automated underwriting systems 
weight the qualifying ratios, as well as numerous other factors, in 
assessing the borrower's ability to meet the expenses involved in 
homeownership.

Unless there are compensating factors, FHA monthly housing-expense-to- 
income ratio is set at a maximum of 29 percent, while the monthly 
"total-debt-to-income ratio" is, at most, 41 percent of the borrower's 
stable monthly income. The requirements set by Fannie Mae, Freddie Mac, 
and the private insurers on the monthly housing expense-to-income ratio 
vary greatly. Some have set lower thresholds, such as Freddie Mac, 
which uses as a guideline that the monthly housing expense-to-income 
ratio should not be greater than 25 percent to 28 percent, with 
exceptions for some products. Others, such as some private insurers, 
have set higher thresholds than FHA has set, such as 33 percent.

Some mortgage institutions set thresholds on the "total-debt-to-income" 
ratio that are lower than FHA's threshold. Conventional mortgages that 
are manually underwritten to Fannie Mae or Freddie Mac standards are 
set at a benchmark total-debt-to-income ratio of 36 percent of the 
borrower's stable monthly income, compared with FHA's 41 percent. 
However, Fannie Mae and Freddie Mac state that they occasionally 
specify a higher allowable debt-to-income ratio for a particular 
mortgage loan if compensating factors are present.[Footnote 22]

Cash reserves represent the amount of funds a borrower has after 
closing on the loan. Generally the reserves required of borrowers are 
expressed in terms of the numbers of monthly mortgage payments they may 
comprise. Conceptually they represent the ability of the borrower to 
repay the mortgage out of accumulated funds. Many mortgage institutions 
including FHA consider it a compensating factor that reduces the risk 
of delinquency. FHA, unlike conventional lenders who do business with 
the GSEs and the private insurers, does not require cash reserves for 
its low down payment product. VA and RHS also do not require cash 
reserves. Generally the GSEs and the private insurers with whom we 
spoke required cash reserves of either 1 or 2 months of monthly 
mortgage payments for low and no down payment products.

Mortgage Institutions Use Various Risk Mitigation Tools: 

Some of the mortgage institutions we spoke with used various tools to 
mitigate risk. For example, most mortgage institutions offering 
affordable low and no down payment mortgages to first-time homebuyers 
require prepurchase counseling, and some require postpurchase 
counseling. These include lenders working with Fannie Mae, Freddie Mac, 
private insurers, and state housing finance agencies. Homeownership 
counseling for first-time homebuyers takes a variety of forms. There 
are counseling programs administered by government agencies, lenders, 
nonprofit organizations, and the private insurers, among others. These 
programs are delivered through many different avenues including 
classroom, home study, individual counseling, and telephone. The 
content of the counseling programs also varies significantly across 
each of these administrative and delivery mechanisms, as does the 
timing of the counseling--which can be either prior to closing or 
postpurchase (when the borrower becomes delinquent on a payment).

More specifically, Freddie Mac in each of its Affordable Gold products 
(intended for first-time homebuyers who generally earn 100 percent or 
less of area median income) requires that at least one qualifying 
borrower in the transaction must receive prepurchase counseling. 
Lenders must document the organization that administered the counseling 
and how the counseling was delivered. Freddie Mac exempts those 
borrowers who have cash reserves after closing equal to at least two 
monthly mortgage payments from the counseling requirement. Similarly, 
Fannie Mae in its MyCommunityMortgage, requires prepurchase counseling 
for first-time homebuyers when they are purchasing a one-unit property. 
If they are purchasing a two to four unit property, landlord counseling 
is required. Fannie Mae also requires postpurchase counseling for 
borrowers under certain low down payment programs who become delinquent 
on their payments early in the mortgage.

Some private insurers require pre-and postpurchase counseling, but some 
only recommend it. For example, two private insurers require pre-and 
postpurchase counseling with all of its affordable low and no down 
payment products, and they provide most of this counseling themselves. 
On the other hand, another private insurer recommends, but does not 
require, prepurchase counseling for first-time homebuyers in its low 
and no down payment products. However, this insurer's underwriting 
guidance states that prepurchase counseling is considered a positive 
underwriting factor. It also recommends postpurchase counseling, 
particularly for borrowers who are experiencing financial difficulties 
but have a good chance of overcoming their financial problems and 
maintaining homeownership.

FHA, unlike most low and no down payment mortgage institutions serving 
affordable first-time homebuyers, does not require prepurchase 
counseling. VA also does not require prepurchase counseling, but 
considers it to be a compensating factor in improving creditworthiness. 
RHS encourages lenders to offer or provide for homeownership counseling 
and lenders may require first-time homebuyers to undergo such 
counseling if it is reasonably available in the local area.

FHA, VA, RHS, and the private insurers also differ in the amount of 
insurance or guaranty they provide to protect lenders against the 
losses associated with mortgages that go to foreclosure. While FHA 
essentially protects against almost 100 percent of the losses 
associated with a foreclosed mortgage, VA, RHS and the private insurers 
protect against a portion of the loss.[Footnote 23] Private insurers 
generally provide protection to lenders for only a portion of losses. 
This protection is usually expressed as a percentage of the claim 
amount. For example, an insurer may provide insurance coverage of 30 
percent. This means that the insurer will cover losses up to 30 percent 
of the claim amount. In exchange for offering this insurance, the 
insurer charges borrowers a premium.

Some of the insurers with whom we spoke, as well as the GSEs, noted 
that they require higher insurance coverage for mortgages with lower 
down payments. For example, one insurer said that the amount of 
insurance coverage tends to be 35 percent for no down payment 
mortgages, in contrast to 30 percent for low down payment mortgages. 
Private insurers noted that they charge higher premiums or require more 
stringent underwriting when they provide higher insurance coverage. For 
example, one private insurer stated that its monthly premium rates to a 
borrower increase about 15 percent for every 5 percentage point 
increase in insurance coverage between 20 and 35 percent.

Research Shows LTV Ratio and Credit Score Are Important When Estimating 
Risk of Individual Mortgages: 

Economic research we reviewed indicated that LTV ratios and credit 
scores are among the most important factors when estimating the risk 
level associated with individual mortgages.[Footnote 24] We identified 
and reviewed 45 papers that examined factors that could be 
informative.[Footnote 25] Of these, 37 examined if the LTV ratio was 
important and almost all of these papers (35) found the LTV ratio of a 
mortgage important and useful. Nineteen research papers evaluated how 
effective a borrower's credit score was in predicting loan performance, 
and all but one reported that the credit score was important and 
useful.[Footnote 26] In addition, a number of the papers reported that 
other factors were useful when estimating the risk level. For example, 
characteristics of the borrower--such as qualifying ratios--were cited 
in several of the papers we reviewed. Finally, other research evaluated 
additional factors; however, we identified very few papers that 
investigated the same variables or corroborated these findings. 
Collectively, the research we reviewed appeared to concur that 
considering multiple factors was important and useful in estimating the 
risk level of individual mortgages. For example, some of the papers (7) 
reported that considering LTV ratio and credit score concurrently was 
important and useful when estimating the risk level of individual 
mortgages.[Footnote 27]

LTV Ratio Helps Estimate Risk of Individual Mortgages: 

Many studies found that a mortgage's LTV ratio was an important factor 
when estimating the risk level associated with individual mortgages. In 
theory, LTV ratios are important because of the direct relationship 
that exists between the amount of equity borrowers have in their homes 
and the likelihood of risk of default. The higher the LTV ratio, the 
less cash borrowers will have invested in their homes and the more 
likely it is that they may default on mortgage obligations, especially 
during times of economic hardship (e.g., unemployment, divorce, home 
price depreciation). And, according to one study, "most models of 
mortgage loan performance emphasize the role of the borrower's equity 
in the home in the decision to default."[Footnote 28] We identified 45 
papers that examined the relationship between default and one or more 
predictive variables; of these, 37 examined if LTV ratio was important 
and useful. Almost all of these papers (35) determined that LTV ratio 
was effective in predicting loan performance--specifically, when 
predicting delinquency, default, and foreclosure. Several papers 
reported that there was a strong positive relationship between LTV 
ratio and default. Specifically, one paper reported that the default 
rates for mortgages with an LTV ratio above 95 percent were three to 
four times higher than default rates for mortgages with an LTV ratio 
between 90 to 95 percent.[Footnote 29] Another paper found that, at the 
end of 5 years, the cumulative probability of default risks for 
mortgages with an LTV ratio less than 95 percent was 2.48 percent; 
however, the cumulative probability of default for mortgages with an 
LTV ratio greater than or equal to 95 percent was 3.53 
percent.[Footnote 30] While the majority of the empirical research 
found that LTV ratio mattered, 4 of the research efforts did not find 
that LTV ratio is important when estimating the risk level associated 
with individual mortgages.[Footnote 31] For example, one paper found 
that, for subprime loans, delinquency rates were relatively unaffected 
by the LTV ratio.[Footnote 32] Generally, subprime loans are loans made 
to borrowers with past credit problems at a higher cost than 
conventional mortgage loans. Additionally, some (7) research efforts 
examined the relationship between the LTV ratio and severity (losses), 
and all found that there was a positive relationship between the LTV 
ratio and severity. For a detailed list of the economic research that 
addresses the relationship between LTV ratio and mortgage performance, 
see appendix II.

Credit Score Helps Estimate Risk of Individual Mortgages: 

Despite the relatively recent use of credit score information in the 
mortgage industry, several studies found that credit score was an 
important and useful factor when estimating the risk level associated 
with individual mortgages.[Footnote 33] In general, credit scores 
represent a borrower's credit history. Credit histories consist of many 
items, including the number and age of credit accounts of different 
types, the incidence and severity of payment problems, and the length 
of time since any payment problems occurred. The credit score reflects 
a borrower's historic performance and is an indication of the 
borrower's ability and willingness to manage debt payments. Of the 45 
papers we reviewed, 19 evaluated how effective a borrower's credit 
score was in predicting loan performance. Eighteen research efforts 
evaluated how effective a borrower's credit score was in predicting 
delinquency, default, and foreclosure; all of these efforts found that 
a borrower's credit score was important. Generally, the papers reported 
that higher credit scores were associated with lower levels of 
defaults. Specifically, one study found that a mortgage with a credit 
score of 728 (indicating an applicant with excellent credit) had a 
default probability of 1.26 percent, while a mortgage with a credit 
score of 642 had a default probability of 3.41 percent--or more than 
two times higher.[Footnote 34] Additionally, four research efforts 
examined the relationship between credit score and severity (losses), 
and three reported that there was a negative relationship between 
credit score and severity. For example, one study found that credit 
scores were also helpful in predicting the amount of losses resulting 
from foreclosed mortgages. In particular, the paper reported the loss 
rate for defaulted mortgages with high credit scores was lower than 
foreclosed mortgages with low credit scores.[Footnote 35] For a list of 
the economic research, that we reviewed, that addresses the 
relationship between credit score and mortgage performance, see 
appendix II.

Other Factors May Help in Estimating the Risk of Individual Mortgages: 

Many of the papers we reviewed identified factors that, in addition to 
LTV ratios and credit scores, were important and useful determinants of 
credit risk for home mortgages. Of these, the most widely analyzed 
factor--accumulation of equity in the home--was a subject of 26 studies 
we reviewed. Some factors were the subject of far fewer papers. Yet 
other factors were the subject of a single paper only. The most widely 
assessed factors included borrower characteristics such as accumulation 
of equity in the home, qualifying ratios, and income.[Footnote 36] 
Additionally, characteristics of the area in which the property was 
located included variables such as unemployment rates and income 
levels. Finally, characteristics of the mortgage included variables 
such as mortgage age and term of the mortgage (e.g., 15 year vs. 30 
year). The extent to which the authors agreed on the importance of the 
other factors varied. For example, nearly all of the papers that looked 
at equity accumulation (a factor which is not known at the time of loan 
origination), the unemployment rate of the area in which the property 
is located, and mortgage age, found that these factors were important. 
However, the research was less certain as to the importance of 
qualifying ratios and income. That is, several of the papers found that 
the qualifying ratios and income were important in estimating risk; 
however, some found that qualifying ratios and income were not an 
important factor.

The economic research we reviewed also indicated that considering 
factors in combination was helpful in estimating the risk level of 
individual mortgages. Of all 45 papers we reviewed, more than half 
conducted multivariate analyses. For example, seven studies found that 
using credit score information in combination with the LTV ratio was 
helpful in estimating the risk level of individual mortgages. 
Specifically, one study found that the "foreclosure rate is 
particularly high for borrowers with both low credit scores and high 
LTV ratios--almost 50 times higher than that for borrowers with both 
high credit scores and low LTV ratios."[Footnote 37] Other studies 
examined several aspects of a mortgage concurrently. For example, in 
one study, the authors controlled for certain loan characteristics, 
such as credit history and LTV, and they found that borrower income is 
useful in estimating risk levels of mortgages.[Footnote 38] In another 
study, the authors controlled for house price appreciation (10 percent) 
and unemployment rates (8 percent) and examined loan performance--after 
15 years--in terms of LTV ratio and a borrower's relative income. 
Regardless of income, default was higher for zero down payment 
mortgages. Specifically, under these conditions, the authors reported 
that zero down payment mortgages of borrowers with incomes below 60 
percent of the metropolitan statistical area's (MSA) median level would 
have cumulative default rates about twice as high as mortgages that 
required a 10 percent down payment made to borrowers with similar 
incomes. Similarly, the zero down payment mortgages of borrowers with 
incomes greater than one-and-a-half times the MSA's median level would 
have cumulative default rates about 50 percent greater than mortgages 
that required a 10 percent down payment made to borrowers with similar 
incomes.[Footnote 39]

Our Analysis Indicated That Mortgages with Higher LTV Ratios and Lower 
Credit Scores Pose Greater Risks: 

Consistent with studies we reviewed, our analysis of FHA and 
conventional mortgage data indicated that mortgages with high LTV 
ratios (smaller down payments) and low credit scores generally are 
riskier than mortgages with low LTV ratios and high credit 
scores.[Footnote 40] For example, FHA-insured mortgages with LTV ratios 
greater than 80 percent and low credit scores (below 660) had a default 
rate above the FHA average default rate. Similarly, conventional 
mortgages with LTV ratios greater than 80 percent and somewhat low 
credit scores (below 700) had a default rate above the conventional 
average default rate. While this analysis is useful in determining the 
extent to which LTV ratios and credit scores can help predict the risk 
level associated with individual mortgages, care should be taken when 
comparing the FHA with the conventional relative default. In 
particular, the relative default rates are derived from different 
calendar years (that is, a sample of FHA mortgages insured in 1992, 
1994, and 1996 and conventional mortgages originated in 1997, 1998, and 
1999 and purchased by Fannie Mae or Freddie Mac). Also the average 
default rate for FHA-insured mortgages is higher than the average 
default rate for conventional mortgages.

FHA-Insured Mortgages with Higher LTV Ratios and Lower Credit Scores 
Are Riskier Than Other FHA-Insured Mortgages: 

When considering LTV alone, FHA-insured mortgages with higher LTV 
ratios (smaller down payments) generally perform worse than FHA-insured 
mortgages with lower LTV ratios. As figure 4 illustrates, our analysis 
indicates that the incidence of default increases as LTV ratios 
increase. When considering the LTV ratio alone, the default rate for 
sampled FHA-insured mortgages, with an LTV of 70 percent or less, is no 
more than half the average FHA default rate. In contrast, the default 
rate for mortgages with LTV ratios greater than 90 percent, as a group, 
surpasses the average FHA default rate. For the highest LTV ratio 
group--greater than 97 to 100 percent--the default rate for these 
mortgages is about 1.75 times the average FHA default rate.

Figure 4: Four-year Relative Default Rates by LTV Ratio for FHA-Insured 
Mortgages (1992, 1994, and 1996): 

[See PDF for image] 

Note: Because of the sensitive nature of the data, we have chosen to 
illustrate relative 4-year default rates for each LTV ratio and credit 
score category. These relative 4-year default rates are defined as 
follows: the 4-year default rate for each category, divided by the 
average 4-year default rate for a sample of mortgages insured by FHA in 
1992, 1994, and 1996. For example, if the 4-year default rate for a 
particular LTV ratio and credit score category was 3 percent, and the 4-
year default rate for all FHA mortgages sampled was 2 percent, the 
relative 4-year default rate for this category would be 3 divided by 2, 
or 1.5 times the average 4-year default rate. To generate the average 4-
year default rate, we merged mortgage volume and performance data for 
the sample of FHA mortgages insured in 1992, 1994, and 1996. Loan data 
are measured in dollars.

[End of figure] 

FHA-insured mortgages with lower credit scores generally perform worse 
than FHA-insured mortgages with higher credit scores, regardless of LTV 
ratio. As figure 5 illustrates, our analysis indicated that the 
incidence of default increases as credit scores decrease. Considering 
the credit score, the default rate for sampled FHA-insured mortgages 
with credit scores 700 and above is no more than half the average FHA 
default rate for all sampled mortgages. The default rate for mortgages 
with a credit score below 660, as a group, surpasses the average FHA 
default rate. For the lowest credit score group--less than 620--the 
default rate for these mortgages is almost twice the average FHA 
default rate.

Figure 5: Four-year Relative Default Rates by Credit Score for FHA- 
Insured Mortgages (1992, 1994, and 1996): 

[See PDF for image] 

Note: For description of relative default rates, please see note with 
figure 4.

[End of figure] 

As expected, FHA-insured mortgages with both high LTV ratios (smaller 
down payments) and low credit scores generally perform worse than 
mortgages with both low LTV ratios and high credit scores. Our analysis 
indicates that the incidence of default increases as LTV ratios 
increase and credit scores decrease. As figure 6 illustrates, mortgages 
with lower LTV ratios and higher credit scores (those at the bottom of 
the figure) have lower default rates than mortgages with higher LTV 
ratios and lower credit scores (at the top of the figure). FHA-insured 
mortgages with LTV ratios greater than 80 percent and low credit scores 
(below 660) had a default rate above the FHA average default rate. FHA- 
insured mortgages, with LTV ratios greater than 90 percent and credit 
scores below 620, had a default rate more than double the FHA average.

Figure 6: Four-year Relative Default Rates by LTV Ratio and Credit 
Score for FHA-insured Mortgages (1992, 1994, and 1996): 

[See PDF for image] 

Notes: For description of relative default rates, please see note with 
figure 4.

We do not present relative default rates for categories with fewer than 
1,000 observations as the performance information may not be reliable 
when there are too few observations. In the figure, these instances are 
noted as "N/A." For a more detailed description of our analysis, see 
appendix I.

[End of figure] 

Conventional Mortgages with Higher LTV Ratios and Lower Credit Scores 
Are Riskier Than Other Conventional Mortgages: 

Generally, the performance relationships that exist for FHA-insured 
mortgages also exist for conventional mortgages originated in the late 
1990s. As figure 7 illustrates, our analysis indicates that 
conventional mortgages with higher LTV ratios (smaller down payments) 
generally perform worse than conventional mortgages with lower LTV 
ratios. When considering LTV ratio alone, the default rate for the 
group of conventional mortgages with LTV ratios below 80 percent was no 
more than half the average conventional default rate. Generally, the 
default rates then increase with higher categories of the LTV ratio. In 
fact, the default rate for conventional mortgages with an LTV ratio 
greater than 90, but less than 97 percent, as a group, is more than 
twice the average conventional default rate. One notable exception to 
this general pattern is that conventional mortgages in the highest LTV 
ratio category (that is, greater than 97 to 100 percent) appear to have 
a lower risk of default than do conventional mortgages in some of the 
lower LTV ratio categories. According to GSE officials, this may be 
explained by a number of possible factors. The GSEs had just begun to 
purchase an increasing number of mortgages with very high LTV ratios 
during the late 1990s and the GSEs took steps to limit the risks 
associated with these mortgages. For example, some of these loans were 
part of negotiated deals with individual lenders. These negotiated 
transactions may have required the use of manual underwriting and 
minimum credit scores, and the GSEs may have used specific servicers 
for these loans. GSE officials told us that lenders and servicers 
operating as part of negotiated deals with them tend to be more 
conservative in their approach to these loans. GSE officials also told 
us that the borrowers during this time period would have been the very 
best segment of the applicant pool. Agency officials indicate that, for 
more recent loans where volumes are higher and lenders are reaching 
deeper into the applicant pool, default rates on loans in these 
categories are higher than they were in the 1997-1999 period and are 
now consistent with the relationship we would expect between LTV and 
default rates. We discuss these practices in greater depth later in the 
report.

Figure 7: Four-Year Relative Default Rates by LTV Ratio for 
Conventional Mortgages (1997, 1998, and 1999): 

[See PDF for image] 

Note: Because of the sensitive nature of the data, we have chosen to 
illustrate relative 4-year default rates for each LTV ratio category. 
These relative 4-year default rates are defined as follows: the 4-year 
default rate for each category, divided by the average 4-year default 
rate for all conventional mortgages originated in 1997, 1998, and 1999 
and purchased by Fannie Mae or Freddie Mac. For example, if the 4-year 
default rate for a particular LTV ratio category was 3 percent, and the 
4-year default rate for all conventional mortgages sampled was 2 
percent, the relative 4-year default rate for this category would be 3 
divided by 2, or 1.5 times the average 4-year default rate. To generate 
the average conventional 4-year default rate, we combined Fannie Mae 
and Freddie Mac mortgage volume and mortgage performance data; we also 
combined the sample data for mortgages originated in 1997, 1998, and 
1999. Loan data are measured in dollars.

[End of figure] 

When considering credit score alone, conventional mortgages with lower 
credit scores generally perform worse than conventional mortgages with 
higher credit scores. As figure 8 illustrates, our analysis indicates 
that the incidence of default generally increases as credit scores 
decrease. The average default rate for mortgages with credit scores of 
740 and higher is no more than 20 percent that of the average default 
rate for conventional loans and loan performance declines for each 
lower category of credit score. In fact, the default rate for mortgages 
with a credit score below 700, as a group, surpasses the average 
default rate. Ultimately, the average default rate for the lowest 
credit score category (below 620) is more than 4 times the average 
conventional default rate.

Figure 8: Four-Year Relative Default Rates by Credit Score for 
Conventional Mortgages (1997, 1998, and 1999): 

[See PDF for image] 

Note: For description of relative default rates, please see note with 
figure 7.

[End of figure] 

As expected, conventional mortgages with both high LTV ratios (smaller 
down payments) and low credit scores generally perform worse than 
mortgages with both lower LTV ratios (larger down payments) and higher 
credit scores. Our analysis indicates that the incidence of default 
generally increases as LTV ratios increase and credit scores decrease. 
As figure 9 illustrates, mortgages with lower LTV ratios and higher 
credit scores (those at the bottom of the figure) have much smaller 
default rates than mortgages with higher LTV ratios and lower credit 
scores (at the top of the figure). Specifically, as a group, mortgages 
with LTV ratios greater than 80 percent and credit scores below 700 
have default rates greater than the average conventional default rate. 
Further, conventional mortgages with LTV ratios greater than 80 percent 
and credit scores below 660 had a default rate more than twice the 
conventional average.

Figure 9: Four-Year Relative Default Rates by LTV Ratio and Credit 
Score for Conventional Mortgages (1997, 1998, and 1999): 

[See PDF for image] 

Notes: For description of what we mean by relative default rates, 
please see note with figure 7.

We do not present relative default rates for categories with fewer than 
3,000 mortgages as the performance information may not be reliable when 
there are too few observations. In the figure, these instances are 
noted as "N/A." For a more detailed description of our analysis, see 
appendix I.

[End of figure] 

One notable exception to this general pattern is that the group of 
conventional mortgages with the highest LTV ratios (that is, greater 
than 97 to 100 percent) appears to have a lower risk of default than do 
the group of conventional mortgages with lower LTV ratios for loans 
originated during these years. For example, of conventional loans with 
credit scores of 740 and higher, those that had LTV ratios greater than 
97 percent, as a group, performed better than those with LTV ratios 
greater than 90 to 97 percent. Similarly, of conventional loans with 
credit scores below 620, those with the highest LTV ratio performed 
better than those with LTV ratios greater than 90 to 97 percent. This 
anomaly, where the highest LTV mortgages appear to perform better than 
the lower LTV loans, may reflect that the GSEs had just begun to 
purchase an increasing number of mortgages with very high LTV ratios in 
the years we analyzed and that the GSEs took steps to limit the risks 
associated with these mortgages. Likewise, lenders may perform more 
rigorous underwriting when first originating a new loan product.

While this analysis is useful in determining the extent to which LTV 
ratios and credit scores are helpful in predicting the risk level 
associated with individual mortgages insured by FHA and for mortgages 
purchased by the GSEs during specific years, there are several reasons 
why care should be taken when comparing the FHA with the conventional 
relative default rates. The relative default rates are derived from 
different years (that is, FHA mortgages insured in 1992, 1994, and 
1996; and conventional mortgages originated in 1997, 1998, and 1999 and 
purchased by Fannie Mae or Freddie Mac). Also, the actual average 
default rate for FHA-insured mortgages is higher than the actual 
average default rate for conventional mortgages. Finally, the 
distribution among LTV categories for FHA-insured loans and 
conventional loans differs. Generally, over half of the loans that the 
GSEs purchase have LTV ratios at or below 80 percent. In comparison, 
loans insured by FHA generally have LTV ratios greater than 95 percent.

Several Practices Mortgage Institutions Use in Designing and 
Implementing Low and No Down Payment Products Could Be Instructive for 
FHA: 

Mortgage institutions we spoke with used a number of similar practices 
in designing and implementing new products, including low and no down 
payment products. Some of these practices could be helpful to FHA in 
its design and implementation of new products. When considering new 
products, mortgage institutions focused their initial efforts on 
identifying other products with similar enough characteristics to their 
new product so that data on these products could be used to understand 
the potential issues and performance for the proposed product. Some 
mortgage institutions, including FHA, said they may acquire external 
loan performance data and other data when designing new products. 
Moreover, mortgage institutions often establish additional requirements 
for new products such as additional credit enhancements or underwriting 
requirements. FHA has less flexibility in imposing additional credit 
enhancements but it does have the authority to seek co-insurance, which 
it is not currently using. FHA makes adjustments to underwriting 
criteria and to its premiums, but is not currently using any credit 
score thresholds. Mortgage institutions also use different means to 
limit how widely they make available a new product, particularly during 
its early years. FHA does sometimes use practices for limiting a new 
product but usually does not pilot products on its own initiative, and 
FHA officials question the circumstances in which they can limit the 
availability of a program and told us they do not have the resources to 
manage programs with limited availability. According to officials of 
mortgage institutions, including FHA, they also often put in place more 
substantial monitoring and oversight mechanisms for their new products 
including lender oversight, but we have previously reported that FHA 
could improve oversight of its lenders.

Mortgage Institutions Initially Analyze the Risk of Products Similar to 
the Product They Are Seeking to Develop: 

Mortgage institutions, such as Fannie Mae, Freddie Mac, the private 
mortgage insurers, and FHA first identify what information, including 
data, they already have that would allow them to understand the 
performance of a potential product. When these institutions do not have 
sufficient data, they may purchase external data that allows them to 
conduct their own analysis of loans that are related to a type of loan 
product that they are considering. For example, Freddie Mac purchased 
structured transactions of Alt A and subprime loans in order to learn 
more about the underwriting characteristics and performance of high LTV 
and low credit score loans.[Footnote 41] Freddie Mac officials reported 
that these data were very helpful to them in considering how to best 
structure some of their high LTV products. Moreover, the accounting 
standards related to the Federal Credit Reform Act of 1990, which 
requires federal agencies to estimate the budget cost of federal credit 
programs, suggest that federal agencies making changes to programs 
should consider external sources of data. FHA officials told us that 
FHA has purchased such loan performance data. According to FHA 
officials, FHA relies more heavily on data that it has collected 
internally from the approximately 1 million loans it endorses each year 
and its single-family data warehouse, which contains data on 
approximately 30 million loans. FHA officials stated that, when 
possible, they use these internal data to create a proxy for how a loan 
product with certain characteristics might perform. FHA officials said 
they used these data to create a "virtual zero down loan" when FHA was 
considering how it might implement a proposed no down payment product.

The mortgage institutions with whom we spoke noted that any loan 
performance data they develop or produce when implementing new products 
are also used to enhance their automated underwriting systems. The data 
improve the statistical models used in their automated underwriting 
systems. In May 2004, FHA implemented a statistical model for 
evaluating mortgage risk that may be used in lenders' automated 
underwriting systems, called the FHA TOTAL Scorecard. In developing the 
TOTAL Scorecard, FHA purchased external data (credit score data), which 
they merged with their existing FHA data to try to better understand 
the loan performance of FHA-insured loans.

Mortgage Institutions Require Additional Credit Enhancements or 
Stricter Underwriting for New Low and No Down Payment Products: 

Some mortgage institutions require additional credit enhancements-- 
mechanisms for transferring risk from one party to another--on low and 
no down payment products and set stricter underwriting requirements for 
these products. Mortgage institutions such as Fannie Mae and Freddie 
Mac mitigate the risk of low and no down payment products by requiring 
additional credit enhancements such as higher mortgage insurance 
coverage. Fannie Mae and Freddie Mac require credit enhancements on all 
loans they purchase that have LTVs above 80 percent. Typically, this 
takes the form of private mortgage insurance. Fannie Mae and Freddie 
Mac also require higher levels of private mortgage insurance coverage 
for loans that have higher LTV ratios. For example, Fannie Mae and 
Freddie Mac require insurance coverage of 35 percent for loans that 
have an LTV greater than 95 percent. This means that, for any 
individual loan that forecloses, the mortgage insurer will pay the 
losses on the loan up to 35 percent of the claim amount. Fannie Mae and 
Freddie Mac require lower insurance coverage for loans with LTVs below 
95 percent. Fannie Mae and Freddie Mac believe that the higher-LTV 
loans represent a greater risk to them and they seek to partially 
mitigate this risk by requiring higher mortgage insurance coverage.

Although FHA is required to provide up to 100 percent coverage of the 
loans it insures, FHA may engage in co-insurance of its single-family 
loans. Under co-insurance, FHA could require lenders to share in the 
risks of insuring mortgages by assuming some percentage of the losses 
on the loans that they originated (lenders may use private mortgage 
insurance). FHA has used co-insurance before, primarily in its 
multifamily programs, but does not currently use co-insurance at 
all.[Footnote 42] FHA officials told us they tried to put together a co-
insurance agreement with Fannie Mae and Freddie Mac and, while they 
were able to come to agreement on the sharing of premiums, they could 
not reach agreement on the sharing of losses and it was never 
implemented.

FHA could also benefit from other means of mitigating risk such as 
stricter underwriting or increasing fees. Fannie Mae officials also 
stated that they would charge higher guarantee fees on low and no down 
payment loans if they were not able to require the higher insurance 
coverage. Fannie Mae and Freddie Mac charge guarantee fees to lenders 
in exchange for converting whole loans into mortgage-backed securities, 
which transfer the credit risk from the lender to Fannie Mae or Freddie 
Mac. Within statutory limits, the HUD Secretary has the authority to 
set up-front and annual premiums that are charged to borrowers who have 
FHA-insured loans. In fact, in the administration's 2005 budget 
proposal for a zero down payment product, it included higher premiums 
for these loans. The Secretary has the authority to establish an up- 
front premium, which may be up to 2.25 percent of the amount of the 
original insured principal obligation of the mortgage. Within statutory 
limits, the Secretary may also require payment of an annual premium. 
Under the Administrative Procedures Act, the Secretary would generally 
follow a process in which the change to premiums would include issuing 
a proposed rule, receiving public comments, and then issuing a final 
rule.

Additionally, mortgage institutions such as Fannie Mae and Freddie Mac 
sometimes introduce stricter underwriting standards as part of the 
development of new low and no down payment products (or products about 
which they do not fully understand the risks). Institutions can do this 
in a number of ways, including requiring a higher credit score 
threshold for certain products, or requiring greater borrower reserves 
or more documentation of income or assets from the borrower. Freddie 
Mac officials stated that they believed limits on allowing ARMs or 
multiple-unit properties were also reasonable, at least initially. Once 
the mortgage institution has learned enough about the risks that were 
previously not understood, it can change the underwriting requirements 
for these new products to align with its standard products. Although 
FHA sometimes has certain standards set for it through legislation, 
there exists some flexibility in how it implements a newly authorized 
product or changes to an existing product. The HUD Secretary has 
latitude within statutory limitations in changing underwriting 
requirements for new and existing products and has done this many 
times. Examples included the decrease in what is included as borrower's 
debts and an expansion of the definition of what can be included as 
borrower's effective income when lenders calculate qualifying ratios. 
In the context of the new zero down product, the Federal Housing 
Commissioner at HUD has stated that all loans being considered for a 
zero down loan would go through FHA's TOTAL Scorecard, and borrowers 
would be required to receive prepurchase counseling.

Before Fully Implementing New Products, Some Mortgage Institutions May 
Limit Their Availability: 

Fannie Mae and Freddie Mac sometimes use pilots, or limited offerings 
of new products, to build experience with a new product type or to 
learn about particular variables that can help them better understand 
the factors that contribute to risk for these products. Freddie Mac and 
Fannie Mae also sometimes set volume limits for the percentage of their 
business that could be low and no down payment lending. Fannie Mae and 
Freddie Mac officials provided numerous examples of products that they 
now offer as standard products but which began as part of underwriting 
experiments.[Footnote 43] These include the Fannie Mae Flexible 97® 
product, as well as the Freddie Mac 100 product. FHA has utilized 
pilots or demonstrations as well when making changes to its single- 
family mortgage insurance but generally does this in response to 
legislation that requires a pilot and not on its own initiative. One 
example in which FHA might have opted to do a pilot, or otherwise 
limited volumes, for a product is with allowing nonprofit down payment 
assistance. Concerns have been raised about the performance of FHA 
loans that have down payment assistance. FHA might have benefited from 
setting some limits on this type of assistance such that they could 
study its implications before allowing its broader use.

FHA's Home Equity Conversion Mortgage (HECM) insurance program is an 
example of an FHA program that started out as a pilot. HECM was 
initiated by Congress in 1987 and is designed to provide elderly 
homeowners a financial vehicle to tap the equity in their homes without 
selling or moving from their homes. Homeowners borrow against equity in 
their home and receive payments from their lenders (sometimes called a 
"reverse mortgage"). Through statute, HECM started out as a 
demonstration program that authorized FHA to insure 2,500 reverse 
mortgages. Through subsequent legislation, FHA was authorized to insure 
25,000 reverse mortgages, then 50,000, and then finally 150,000 when 
Congress made the program permanent in 1998. Under the National Housing 
Act, the HECM program was required to undergo a series of evaluations 
and it has been evaluated four times since its inception. FHA officials 
told us that administering this demonstration for only 2,500 loans was 
difficult because of the challenges of selecting only a limited number 
of lenders and borrowers. FHA ultimately had to limit loans to lenders 
drawn through a lottery.

The appropriate size for a pilot program depends on several factors. 
For example, the precise number of loans needed to detect a difference 
in performance between standard loans and loans of a new product type 
depends in part on how great the differences are in loan performance. 
If delinquencies early in the life of a mortgage were about 10 percent 
for FHA's standard high LTV loans, and FHA wished to determine whether 
loans in the pilot had delinquency rates no more than 20 percent 
greater that the standard loans (delinquency no more than 12 percent), 
a sample size of about 1,000 loans would be a sufficient size to detect 
this difference with 95 percent confidence. If delinquency rates are 
different, or FHA's desired degree of precision were different, a 
different sample size would be appropriate. FHA officials with whom we 
spoke told us they could use pilots or otherwise limit availability 
when implementing a new product or making changes to an existing 
product, but they also questioned their authority and the circumstances 
under which they would do so. FHA officials also said that they lacked 
sufficient resources to be able to appropriately manage a pilot.

Some mortgage institutions may also limit the initial implementation of 
a new product by limiting the origination and servicing of the product 
to their better lenders and servicers, respectively. Mortgage 
institutions may also limit servicing on the loans to servicers with 
particular product expertise, regardless of who originates the loans. 
Fannie Mae and Freddie Mac both reported that these were important 
steps in introducing a new product and noted that lenders tend to take 
a more conservative approach when first implementing a new product. FHA 
officials agreed that they could, under certain circumstances, envision 
piloting or limiting the ways in which a new or changed product would 
be available but pointed to the practical limitations in doing so. FHA 
approves the sellers and services that are authorized to support FHA's 
single-family product. FHA officials told us they face challenges in 
offering any of their programs only in certain regions of the country 
or in limiting programs to certain approved lenders or servicers. They 
generally offer their products on a national basis and, when they do 
not, specific regions of the county or lenders may question why they 
are not able to receive the same benefit (even on a demonstration or 
pilot basis). These officials did, though, provide examples in which 
their products had been initially limited to particular regions of the 
country or to particular lenders, including the rollout of the HECMs 
and their TOTAL Scorecard.

Mortgage Institutions Establish Enhanced Monitoring and Oversight for 
New Low and No Down Payment Products and Make Changes Based on What 
They Learn: 

Mortgage institutions, including FHA, may take several steps related to 
increased monitoring of new products and then make changes based on 
what they learn. Fannie Mae and Freddie Mac officials described 
processes in which they monitor actual versus expected loan performance 
for new products, sometimes including enhanced monitoring of early loan 
performance. FHA officials told us they also monitor more closely loans 
underwritten under revised guidelines. Specifically, FHA officials told 
us that FHA routinely conducts a review of underwriting for 
approximately 6 to 7 percent of loans it insures. FHA officials told us 
that, as part of the review, it may place greater emphasis on reviewing 
those aspects of the insurance product that are the subject of a recent 
change. Some mortgage institutions, such as Fannie Mae, told us that 
they may conduct rigorous quality control sampling of new acquisitions, 
early payment defaults, and nonperforming loans. Depending on the scale 
of a new initiative, and its perceived risk, these quality control 
reviews could include a review of up to 100 percent of the loans that 
are part of the new product.

Fannie Mae and Freddie Mac also reported that they conduct more regular 
reviews at seller/servicer sites for new products. In some cases, 
Fannie Mae and Freddie Mac have staff who conduct on-site audits at the 
sellers and servicers to provide this extra layer of oversight. FHA 
officials also reported that they have staff that conduct reviews of 
lenders that they have identified as representing higher risk to FHA 
programs. However, we recently reported that HUD's oversight of lenders 
could be improved and identified a number of recommendations for 
improving this oversight.[Footnote 44] Mortgage institutions may issue 
a lender bulletin, announcement, or seller/servicer guidelines to 
clarify instructions for new products or changes to existing products. 
FHA does this through the mortgagee letters it issues to all of its 
approved lenders. Mortgage institutions may also issue a lender 
bulletin, announcement, or seller/servicer guidelines to communicate 
required additional controls, practices, procedures, reporting, and 
remitting. Importantly, changes can be made to the structure of a 
product, including the automated underwriting systems used to approve 
individual loans, based on information learned from monitoring of new 
products or from other sources.

FHA officials told us that they routinely analyze the changing 
performance of loans they insure as part of the annual process for 
estimating and re-estimating subsidy costs. The Federal Credit Reform 
Act of 1990 requires that federal government programs that make direct 
loans or loan guarantees (including insuring loans) account for the 
full cost of their programs on an annual budgetary basis. Specifically, 
federal agencies must develop subsidy estimates of the net cost of 
their programs that include estimates of the net costs and revenues 
over the projected lives of the loans made in each fiscal year. FHA's 
Mutual Mortgage Insurance Fund has historically been self-sufficient 
(not requiring subsidy). When preparing cost estimates for loan 
guarantee programs, agencies are expected to develop a plan to 
establish the appropriate information, models, and documentation to 
better understand the new product and to be able to make changes based 
on what they learn.[Footnote 45] FHA officials state that they have a 
process in which changes to their model are made to reflect the 
incorporation of new programs and policies and that they review the 
performance of a new program in the context of their annual development 
of subsidy estimates, as well as their annual actuarial study.[Footnote 
46]

Conclusions: 

While credit score is an effective predictor of default, LTV remains an 
effective predictor of default. Loans with lower or no down payments 
carry greater risk. Without any compensating measures such as 
offsetting credit enhancements and increased risk monitoring and 
oversight of lenders, introducing a new FHA no down payment product 
would expose FHA to greater credit risk. The administration's proposal 
for a zero down product included increased premiums to help compensate 
for an increase in the cost of the FHA program, and the Federal Housing 
Commissioner stated that borrowers would be required to go through 
prepurchase counseling. The extent to which increased cost for one 
program could effect the overall performance of FHA's Mutual Mortgage 
Insurance (MMI) fund depends, in part, on the scale of any new product, 
its relative cost, and how the new product affects demand for FHA's 
existing products.

Although FHA appears to follow many key practices used by mortgage 
institutions in designing and implementing new products, several 
practices not currently or consistently followed by FHA stand out as 
appropriate means to manage the risks associated with introducing new 
products or significantly changing existing products. Moreover, these 
practices can be viewed as part of a framework used by some mortgage 
institutions for managing the risks associated with new or changed 
products. The framework includes techniques such as limiting the 
availability of a new product until it is better understood and 
establishing stricter underwriting standards--all of which would help 
FHA to manage risk associated with any new product it may introduce. 
For example, FHA could set volume limits or limit the initial number of 
lenders participating in the product. Further, changes in FHA's 
premiums, an important practice used by FHA, within statutory limits, 
permits FHA to potentially offset additional costs stemming from a new 
product that entails greater risk or not well understood risk.

FHA officials believe that the agency does not have sufficient 
resources to implement products with limited volumes, such as through a 
pilot program. However, when FHA introduces new products or makes 
significant changes to existing products with risks that are not well 
understood, such actions could introduce significant risks when 
implemented broadly. Products that would introduce significant risks 
can impose significant costs. We believe that FHA could mitigate these 
costs by using techniques such as piloting.

Matters for Congressional Consideration: 

If Congress authorizes FHA to insure no down payment products or any 
other new single-family insurance products, Congress may want to 
consider a number of means to mitigate the additional risks that these 
loans may pose. Such means may include limiting the initial 
availability of such a new product, requiring higher premiums, 
requiring stricter underwriting standards, or requiring enhanced 
monitoring. Such risk mitigation techniques would serve to help protect 
the Mutual Mortgage Insurance Fund while allowing FHA the time to learn 
more about the performance of loans using this new product. Limits on 
the initial availability of the new product would be consistent with 
the approach Congress took in implementing the HECM program. The limits 
could also come in the form of an FHA requirement to limit the new 
product to better performing lenders and servicers as part of a 
demonstration program or to limit the time period during which the 
product is first offered.

Recommendations for Executive Action: 

If Congress provides the authority for FHA to implement a no down 
payment mortgage product or other products about which the risks are 
not well understood, we recommend that the Secretary of HUD direct the 
Assistant Secretary for HUD-Federal Housing Commissioner to consider 
the following three actions: 

* incorporating stricter underwriting criteria such as appropriate 
credit score thresholds or borrower reserve requirements,

* piloting the initial product or limiting its initial availability and 
asking Congress for the authority if HUD officials determine they 
currently do not have this authority, and: 

* utilizing other techniques for mitigating risks including use of 
credit enhancements and prepurchase counseling.

Regardless of any new products Congress may authorize, when making 
significant changes to its existing products or establishing new 
products, we recommend that the Secretary of HUD direct the Assistant 
Secretary for HUD-Federal Housing Commissioner to consider the 
following two actions: 

* limiting the initial availability of the product and when doing so, 
the Commissioner should establish the conditions under which piloting 
should be used, the techniques for limiting the initial availability of 
a product, and the methods of enhanced monitoring that would be 
connected to predetermined measures of success or failure for the 
product; and: 

* asking Congress for the authority to offer its new products or 
significant changes to existing products on a limited basis, such as 
through pilots, if HUD officials determine they currently lack 
sufficient authority.

Agency Comments and Our Evaluation: 

We provided a draft of this report to HUD, Fannie Mae, Freddie Mac, 
USDA, and VA. We received written comments from HUD, which are 
reprinted in appendix III. We also received technical comments from 
HUD, Fannie Mae, Freddie Mac, and USDA, which have been incorporated 
where appropriate. VA did not have comments on the draft.

HUD stated that it is in basic agreement with GAO that all policy 
options, implications, and implementation methods should be evaluated 
when considering or proposing a new FHA product. HUD also stated that 
in designing its zero down payment program it considered the items that 
we recommended it consider, including piloting. HUD stated that it 
adopted the prepurchase counseling requirement as a component of a 
proposed zero down program and that it determined that structuring the 
mortgage insurance premium in such a way as to minimize risk represents 
the most appropriate tool for managing the risk of this proposed 
program.

However, it is not clear under what circumstances HUD believes that 
piloting or limiting the availability of a changed or new product would 
be appropriate or possible. As we noted in our draft report, HUD 
officials told us that they face challenges in administering a pilot 
program because of the difficulty of selecting only a limited number of 
lenders and borrowers. HUD officials also held that they may not have 
the authority to limit products and that they lacked sufficient 
resources to adequately manage products as part of a pilot or with 
limited volumes.

We believe that HUD needs to further consider piloting or limiting 
volume of new or changed products because, as we state in the report, 
it is a practice followed by others in the mortgage industry and could 
assist HUD in mitigating the risks and costs associated with new or 
changed products, while still allowing HUD to meet its goal of 
providing homeownership opportunities. Difficulties in selecting a 
limited number of lenders and questions about a lack of authority could 
both be addressed by seeking clear authority from Congress on these 
matters, if HUD officials determine they currently lack sufficient 
authority. As we note in our report, when considering the resources 
necessary to implement products with limited volumes, if FHA does not 
use pilots or limit the availability of certain new or changed 
products, FHA may face costs due to the significant risks that can be 
associated with products that are implemented broadly and about which 
the risks are not well understood. We do not believe that implementing 
products with initial limits is appropriate or necessary in all cases. 
To ensure that piloting or limiting the initial availability is given 
sufficient consideration, we continue to recommend that HUD consider 
establishing the conditions under which piloting should be used and the 
techniques for limiting the initial availability of a product, as well 
as the methods of enhanced monitoring that would be connected to 
predetermined measures of success or failure for the product.

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, we will send copies of this report 
to the appropriate Congressional Committees and the Secretaries of 
Housing and Urban Development, Agriculture, and Veterans Affairs. We 
also will make copies available to others upon request. In addition, 
the report will be available at no charge on the GAO Web site at 
[Hyperlink, http://www.gao.gov]v.

If you or your staff have any questions concerning this report, please 
contact me at (202) 512-8678 or [Hyperlink, shearw@gao.gov] or Mathew 
Scirč, Assistant Director, at (202) 512-6794 or [Hyperlink, 
sciremj@gao.gov]. Key contributors to this report are listed in 
appendix IV.

Sincerely yours,

Signed by: 

William B. Shear: 
Director, Financial Markets and Community Investment: 

[End of section]

Appendixes: 

Appendix I: Scope and Methodology: 

To describe key characteristics and standards of mortgage products, we 
interviewed officials at the Federal Housing Administration (FHA), U.S. 
Department of Agriculture (USDA), and U.S. Department of Veterans 
Affairs (VA); as well as staff at a conventional mortgage providers 
(Bank of America); private mortgage insurers (for example, The PMI 
Group, Inc; Mortgage Guarantee Insurance Corporation); government- 
sponsored enterprises (GSE) (such as Fannie Mae and Freddie Mac); 
Office of Federal Housing Enterprise Oversight (OFHEO); various state 
housing finance agencies; and nonprofit down payment assistance 
providers (for example, Nehemiah Corporation of America and Ameridream, 
Inc.). We reviewed descriptions of various mortgage products and 
compared the standards used across entities including FHA, USDA, and VA 
regulations and program guidance and the GSEs seller/servicer guides. 
We reviewed Web sites of state housing finance agencies and if we 
identified zero down payment programs, we corroborated some of the Web 
site information through interviews of agency officials. To report on 
the volume of mortgage products, we reviewed relevant reports including 
reports from the U.S. Department of Housing and Urban Development 
(HUD). 

To determine what economic research indicates about the variables that 
are most important when estimating the risk level associated with 
individual mortgages, we conducted a literature search. To identify 
recent and relevant papers, we used various Internet search engines 
(such as Online Computer Library Center, FirstSearch: EconLit; HUD 
USER) and inquired with various mortgage industry participants (for 
instance, FHA, Fannie Mae, Freddie Mac, and Nehemiah). Research we 
reviewed includes articles, reports, and papers that were made 
available to us from economic journals, the Internet, libraries, or 
were provided to us by various entities (e.g., HUD, Fannie Mae, Freddie 
Mac). For the purposes of this report, we refer to these documents as 
"papers."

To facilitate the search we developed several criteria. For example, we 
used the following search terms: mortgage, performance, default, LTV 
ratio, credit score, and down payment assistance. We excluded the 
following terms from our search: multifamily and commercial. We limited 
our search to papers published or issued from 1999 to 2004; however, we 
did include some papers relevant to our inquiry that were published or 
issued prior to 1999 that we determined were significant to our 
research objectives. We identified 151 papers. There may be some 
relevant research that our search did not identify.

For the papers we identified, we conducted a multistep review. 
Initially, we determined which papers to include in our analysis. 
Papers included in the analysis were those that (1) were relevant to 
our inquiry, (2) included empirical analysis, and (3) utilized 
satisfactory methodologies. Papers that were not relevant were excluded 
from our analysis (for example, subject of paper was off-point--car 
loans; or analysis of loans in foreign country). Additionally, we 
determined if the paper included empirical analysis. If the paper did 
not include empirical analysis, we did not include it. However, we did 
review the paper to determine if it talked about papers that we had not 
yet identified that appeared to have empirical analysis. If the paper 
did identify an additional paper that appeared to be relevant to our 
inquiry, we attempted to obtain it. Finally, we excluded papers with 
weak methodologies. GAO economists conducted the evaluations of 
economic models. During this review, we excluded 106 papers leaving 45 
for the second-stage review. Many of the papers we excluded were 
excluded for lack of relevance or because they did not include 
empirical analysis. The second review consisted of documenting the 
findings of the papers that were relevant, had empirical analysis, and 
used satisfactory methodologies. To facilitate this analysis, we 
developed and maintained an Access database to document our analysis-- 
cataloging the specific factors these papers identified as being 
important to estimating the risk level associated with individual 
mortgages. Finally, for these papers, we synthesized the literature by 
determining how many papers found each variable to be important. For a 
bibliography of the 45 papers included in our analysis, see appendix 
II. 

To examine the relationship between mortgage performance and two key 
underwriting variables, loan-to-value (LTV) ratio and credit score, we 
calculated 4-year default rates for several categories of mortgages 
with various LTV ratios and credit scores. We selected 4-year default 
rates because it best balanced the competing goals of having recent 
loans and the greatest number of years of default experience. To 
perform this analysis, we first obtained mortgage volume and 
performance data from three mortgage institutions: FHA (government 
mortgages) and Fannie Mae and Freddie Mac (conventional 
mortgages).[Footnote 47] The FHA mortgage data consist of a stratified 
random sample of over 400,000 FHA-insured mortgages originated in 
calendar years 1992, 1994, and 1996.[Footnote 48] We used these data 
because they are the only significant data set of FHA loans that 
includes credit scores and that had at least 4 years of loan 
performance activity. The data come from a sample built by FHA for 
research purposes. The Fannie Mae and Freddie Mac data consist of all 
purchase-money mortgages originated in calendar years 1997, 1998, and 
1999 and purchased by Fannie Mae or Freddie Mac. The data provided by 
Fannie Mae and Freddie Mac exclude government-insured mortgages. We 
selected these loan years because they include loans that aged at least 
4 years and because, during these years, the GSEs began to purchase an 
increasing number of loans with higher LTVs. The GSEs provided us data 
that they considered to be proprietary. Although we limited the 
reporting of our analysis to that which was considered nonproprietary, 
this did not limit our overall findings for this objective. A 
comparison of results from the FHA and the conventional mortgage 
performance analysis should be done with care, for a number of reasons 
because the data are from different years, FHA and the GSEs calculated 
LTVs differently, and FHA's average 4-year default rate is higher than 
for the GSEs.

For this analysis, we used the LTV ratio contained in the data system 
for each mortgage institution. FHA defines the LTV ratio as the 
original mortgage balance, excluding the financed mortgage insurance 
premium, divided by the appraised value of the house. For the GSEs, LTV 
ratio is defined as the original mortgage balance divided by the lesser 
of the sale price of the house or the appraised value of the house.

For this analysis, the credit score is the Fair Isaac score contained 
in each institution's data system. The mortgage institutions obtain 
credit scores in various ways. FHA has only recently begun to collect 
credit scores in its single-family data warehouse. However, for 
research purposes, FHA purchased historic credit score information for 
the sample of mortgages originated in 1992, 1994, and 1996. On the 
other hand, Fannie Mae obtains credit score information in two ways. 
For some mortgages, the lender obtained the borrower's credit score 
information when it originated the mortgage, and upon Fannie Mae's 
purchase of the mortgage, the lender provides this credit score 
information to Fannie Mae. In some cases, however, lenders do not 
obtain borrower's credit scores; when Fannie Mae purchases the 
mortgage, it obtains a credit score for the borrower. For some 
mortgages, the institutions indicated that a credit score for a 
particular mortgage was unknown. Within the FHA data, about 8 percent 
of the mortgages had unknown scores; within the GSE data, about 3 
percent of the mortgages had unknown scores. We included mortgages with 
unknown credit scores in our analysis and presented the loan 
performance results.

We carried out several actions to ensure that data provided by FHA, 
Fannie Mae, and Freddie Mac were sufficiently reliable for use in our 
analysis. For the FHA sample data, we met with FHA staff involved in 
generating the sample data set. We also discussed data quality 
procedures with appropriate FHA staff. Based on these discussions in 
which FHA officials described their policies and procedures and the 
results of external audits of their data systems, we determined that 
the FHA data were sufficiently reliable to use in our analysis. FHA 
officials indicated that their data systems contain data entry edit 
checks and that data submitted by lenders was reviewed by FHA. FHA's 
data system was audited by external auditors, and no major issues 
concerning data quality were raised. We also discussed data quality 
procedures with appropriate Fannie Mae and Freddie Mac staff. These 
procedures included data entry edit checks, exception reports, and 
checks for reasonableness. Additionally, we reviewed reports from 
audits of Fannie Mae and Freddie Mac. These audits included an 
assessment of the Fannie Mae information systems that generated the 
data used in this report. The audits also assessed Freddie Mac 
information systems that generated the data used in this report. We 
also compared the data with similar publicly available data. Based on 
these discussions and reviews of audit reports, we determined that the 
data Fannie Mae and Freddie Mac provided were sufficiently reliable to 
use in our analysis.

With these data, we generated FHA and conventional 4-year default rates 
for several combinations of LTV ratios and credit scores. To do this, 
we: 

* defined default as a credit event that includes foreclosed mortgages, 
as well as mortgages that did not experience foreclosure, but that 
would typically lead to a credit loss, such as a "short sale" or a 
"deed-in-lieu of foreclosure" termination of the mortgage;

* selected six LTV ratio categories;

* selected six credit score categories;

* combined Fannie Mae and Freddie Mac mortgage volume and performance 
data;

* combined mortgage volume and performance data for the sample (of 
mortgages insured by FHA in 1992, 1994, and 1996; and conventional 
mortgages originated in 1997, 1998, and 1999 and purchased by Fannie 
Mae or Freddie Mac);

* calculated the average 4-year default rate for FHA (weighted average) 
and for all conventional loans separately by dividing the total dollar 
amount of mortgages experiencing a credit event by the total dollar 
amount of mortgages originated (for FHA) or purchased (for 
conventional);

* calculated the average 4-year default rates for sampled FHA loans and 
for conventional loans that fell within each LTV ratio and credit score 
category; and: 

* calculated the relative 4-year default rates for each LTV ratio and 
credit score categories for FHA loans and for conventional loans by 
dividing the average 4-year default rate for each specific LTV and 
credit score category by the average 4-year default rate for sampled 
FHA loans and all conventional loans, respectively.

For example, if the merged average 4-year default rate for FHA loans 
within a particular LTV ratio and credit score category was 3 percent, 
and the average 4-year default rate for all FHA loans was 2 percent, 
the relative 4-year default rate for FHA loans within this particular 
category would be 3 divided by 2, or 1.5 times the average FHA default 
rate.

We do not present relative default rates for categories with small 
numbers of mortgages because the performance information may not be 
reliable when there are too few observations. In the figures, these 
instances are noted as "N/A." For the FHA analysis, we used a cutoff of 
about 1,000 mortgages to determine whether there were sufficient 
observations to reliably measure the relative default rate. For the 
conventional analysis, we used a cutoff of about 3,000 mortgages to 
determine whether the relative default rate was reliable. We chose a 
higher cutoff for the GSE analysis because the GSEs have a lower 
default rate, and analysis of less frequent events requires a larger 
sample size.

To determine what lessons FHA might learn from others that support low 
and no down payment lending we obtained testimonial information from 
the mortgage industry (for example, FHA, GSEs, private mortgage 
insurers, and a private lender) about the steps they take to design and 
implement low and no down payment lending. We selected these entities 
based on the parallels to FHA, as well as their significance in the 
mortgage industry. Where available, we reviewed industry and academic 
information relevant to these steps in carrying out low and no down 
payment lending.

We performed our audit work from January 2004 to December 2004 in 
accordance with generally accepted government auditing standards.

[End of section]

Appendix II: Papers Identified in Literature Search and Included in 
Analysis: 

Paper: Brent W. Ambrose and Charles A. Capone. "The Hazard Rates of 
First and Second Defaults," Journal of Real Estate Finance and 
Economics, vol. 20 no. 3 (May 2000); 
LTV: Yes; 
Credit score: [Empty]; 
Other factor(s): Yes.

Paper: Brent W. Ambrose and Charles A. Capone. "Modeling the 
Conditional Probability of Foreclosure in the Context of Single-Family 
Mortgage Default Resolutions," Real Estate Economics, vol. 26 no. 3 
(1998); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Richard Anderson and James VanderHoff. "Mortgage Default Rates 
and Borrower Race," The Journal of Real Estate Research, vol. 18 no. 2 
(Sep/Oct 1999); 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: Robert B. Avery, Raphael W. Bostic, Paul S. Calem, and Glenn B. 
Canner. "Credit Risk, Credit Scoring, and the Performance of Home 
Mortgages," Federal Reserve Bulletin (July 1996); 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: James A. Berkovec, Glenn B. Canner, Stuart A. Gabriel and 
Timothy H. Hannan. "Race, Redlining, and Residential Mortgage Loan 
Performance," Journal of Real Estate Finance and Economics, vol. 9 no. 
1 (July 1994); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Paul S. Calem and Susan M. Wachter. "Community Reinvestment and 
Credit Risk: Evidence from an Affordable-Home-Loan Program," Real 
Estate Economics, vol. 27 no. 1 (1999); 
LTV: No; 
Credit score: Yes; 
Other factor(s): No.

Paper: Paul S. Calem and James Follain. The Asset-Correlation Parameter 
in Basel II for Mortgages on Single-Family Residences, a report 
prepared as background for public comment on the Advance Notice of 
Proposed Rulemaking on the Proposed New Basel Capital Accord, November 
6, 2003; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Paul S. Calem and Michael LaCour-Little. Risk-based Capital 
Requirements for Mortgage Loans, November 2001; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): No.

Paper: Charles A. Calhoun and Yongheng Deng. "A Dynamic Analysis of 
Fixed-and Adjustable-Rate Mortgage Terminations," Journal of Real 
Estate Finance and Economics, vol. 24 no. 1/2 (Jan 2002); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Dennis R. Capozza, Dick Kazarian, and Thomas A. Thomson. 
"Mortgage Default in Local Markets," Real Estate Economics, vol. 25 no. 
4 (Winter 1997); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Richard L. Cooperstein, F. Stevens Redburn, and Harry G. Meyers. 
"Modelling Mortgage Terminations in Turbulent Times," AREUEA Journal, 
vol. 19 no. 4 (1991); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Robert F. Cotterman. Analysis of FHA Single-Family Default and 
Loss Rates, a report prepared for the Office of Policy Development and 
Research, U.S. Department of Housing and Urban Development, March 25, 
2004; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Robert F. Cotterman. New Evidence on the Relationship Between 
Race and Mortgage Default: The Importance of Credit History Data, a 
report prepared for the Office of Policy Development and Research, U.S. 
Department of Housing and Urban Development, May 23, 2002; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Robert F. Cotterman. Neighborhood Effects in Mortgage Default 
Risk, a report prepared for the Office of Policy Development and 
Research, U.S. Department of Housing and Urban Development, March 2001; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Robert F. Cotterman. Assessing Problems of Default in Local 
Mortgage Markets, a report prepared for the Office of Policy 
Development and Research, U.S. Department of Housing and Urban 
Development, March 2001; 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Amy Crews Cutts and Robert Van Order. "On the Economics of 
Subprime Lending." Freddie Mac Working Paper Series # 04-01(January 
2004) (http://freddiemac.com/corporate/reports/); 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Ralph DeFranco. "Modeling Residential Mortgage Termination and 
Severity Using Loan Level Data." (Ph.D diss., University of California, 
Berkeley, 2002); 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Yongheng Deng, John M. Quigley. Woodhead Behavior and the 
Pricing of Residential Mortgages, (December 2002); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Yongheng Deng and Stuart Gabriel. Enhancing Mortgage Credit 
Availability Among Underserved and Higher Credit-Risk Populations: An 
Assessment of Default and Prepayment Option Exercise Among FHA-Insured 
Borrowers, a report prepared for the U.S. Department of Housing and 
Urban Development, August 2002; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Yongheng Deng and Stuart Gabriel. Modeling the Performance of 
FHA-Insured Loans: Borrowers Heterogeneity and the Exercise of Mortgage 
Default and Prepayment Options, a report submitted to the Office of 
Policy Development and Research, U.S. Department of Housing and Urban 
Development, May 2002; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Yongheng Deng, John M. Quigley, and Robert Van Order. "Mortgage 
Terminations, Heterogeneity and the Exercise of Mortgage Options," 
Econometrica, vol. 68 no. 2 (March 2000); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Yongheng Deng, John M. Quigley, and Robert Van Order, Mortgage 
Default and Low Downpayment Loans: The Costs of Public Subsidy, 
National Bureau of Economic Research: Working Paper No. 5184 
(Cambridge, Mass.: July 1995); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Peter J. Elmer and Steven A Seelig. "Insolvency, Trigger Events, 
and Consumer Risk Posture in the Theory of Single-Family Mortgage 
Default," Journal of Housing Research, vol. 10 no. 1 (1999); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Robert M. Feinberg and David Nickerson. "Crime and Residential 
Mortgage Default: An Empirical Analysis." Applied Economics Letters, 
vol. 9 (2002); 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: Dan Feshbach and Michael Simpson. "Tools for Boosting Portfolio 
Performance," Mortgage Banking, October 1999; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Dan Feshbach and Pat Schwinn. "A Tactical Approach to Credit 
Scores," Mortgage Banking, February 1999; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Gerson M. Goldberg and John P. Harding. "Investment 
Characteristics of Low-and Moderate-Income Mortgage Loans," Journal of 
Housing Economics, vol. 12 (2003); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Government Accountability Office. Mortgage Financing: Changes in 
the Performance of FHA-Insured Loans, GAO-02-773. Washington, D.C. July 
10, 2002; 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Government Accountability Office. Mortgage Financing: FHA's Fund 
Has Grown, but Options for Drawing on the Fund Have Uncertain Outcomes, 
GAO-01-460. Washington, D.C. February 28, 2001; 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Valentina Hartarska, Claudio Gonzalez-Vega, and David Dobos. 
Credit Counseling and the Incidence of Default on Housing Loans by Low- 
Income Households, a paper prepared as part of a collaborative research 
program between Ohio State University and Paul Taylor and Associates, 
of Columbus, Ohio. (February 2002); 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: Abdighani Hirad and Peter M. Zorn (corresponding author). A 
Little Knowledge Is a Good Thing: Empirical Evidence of the 
Effectiveness of Pre-Purchase Homeownership Counseling, May 22, 2001; 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: The Department of Housing and Urban Development, Office of 
Inspector General. Follow-up of Down Payment Assistance Programs 
Operated by Private Nonprofit Entities. 2002-SE-0001, Seattle, 
Washington, September 25, 2002; 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: The Department of Housing and Urban Development, Office of 
Inspector General. Final Report of Nationwide Audit: Down Payment 
Assistance Programs (Office of Insured Single Family Housing), 2000-SE- 
121-0001, Seattle, Washington, March 31, 2000; 
LTV: No; 
Credit score: No; 
Other factor(s): Yes.

Paper: Michael Lacour-Little and Stephen Malpezzi. "Appraisal Quality 
and Residential Mortgage Default: Evidence From Alaska," Journal of 
Real Estate Finance and Economics, vol. 27 no. 2 (2003); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Andrey D. Pavlov. "Competing Risks of Mortgage Termination: Who 
Refinances, Who Moves, and Who Defaults," Journal of Real Estate 
Finance and Economics, vol. 23 no. 2 (September 2001); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Anthony Pennington-Cross. "Credit History and the Performance of 
Prime and Nonprime Mortgages," Journal of Real Estate Finance and 
Economics, vol. 27 no. 3 (2003); 
LTV: No; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Anthony Pennington-Cross. "Subprime and Prime Mortgages: Loss 
Distributions." Office of Federal Housing Enterprise Oversight Working 
Paper Series 03-01 (May 27, 2003); 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Anthony Pennington-Cross. "Patterns of Default and Prepayment 
for Prime and Nonprime Mortgages." Office of Federal Housing Enterprise 
Oversight Working Paper 02-1 (March 2002); 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Roberto G. Quercia, Michael A. Stegman, Walter R. Davis, and 
Eric Stein. Community Reinvestment Lending: A Description and Contrast 
of Loan Products and Their Performance, a report prepared for the Joint 
Center for Housing Studies' Symposium on Low-Income Homeownership as an 
Asset-Building Strategy, September 2000; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Roberto G. Quercia, George W. McCarthy, and Michael A. Stegman. 
"Mortgage Default Among Rural, Low-Income Borrowers," Journal of 
Housing Research vol. 6 no. 2 (1995); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Stephen L. Ross. "Mortgage Lending, Sample Selection and 
Default," Real Estate Economics, vol. 28 no. 4 (Winter 2000); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Robert A. Van Order and Peter M. Zorn. The Performance of Low 
Income and Minority Mortgages: A Tale of Two Options, August 2001; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Robert Van Order and Peter Zorn. Performance of Low-Income and 
Minority Mortgages, a report prepared for the Joint Center for Housing 
Studies' Symposium on Low-Income Homeownership as an Asset-Building 
Strategy, September 2001; 
LTV: Yes; 
Credit score: Yes; 
Other factor(s): Yes.

Paper: Robert Van Order and Peter Zorn. "Income, Location, and Default: 
Some Implications for Community Lending," Real Estate Economics, vol. 
28 no. 3 (2000); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Paper: Economic Systems Inc., ORC Macro, and The Hay Group. Evaluation 
of VA's Home Loan Guaranty Program: Final Report. A report prepared for 
the Department of Veterans Affairs. (July 2004); 
LTV: Yes; 
Credit score: No; 
Other factor(s): Yes.

Source: GAO.

[End of table]

[End of section]

Appendix III: Comments from the Department of Housing and Urban 
Development: 

U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT: 
WASHINGTON, DC 20410-8000:

ASSISTANT SECRETARY FOR HOUSING-
FEDERAL HOUSING COMMISSIONER:

JAN 14 2005:

Mr. William B. Shear: 
Director:
Financial Markets and Community Investments: 
United States Government Accountability Office: 
Washington, DC 20548:

Dear Mr. Shear:

Thank you for the opportunity to comment on the GAO Draft Report 
entitled Actions Needed to Help FHA Manage Risks From New Mortgage Loan 
Products.

The Department is in basic agreement with the GAO in that all policy 
options, implications, and implementation methods should be evaluated 
when considering or proposing a new FHA product. In fact, the 
Department conducts such evaluations routinely. New products are 
proposed only after a thorough and complete analysis of all aspects of 
implementation and risk management. Appropriate measures that balance 
financial risk with the intended social purpose of a program, most 
often to provide homeownership opportunities, are always proposed and 
evaluated as part of the process in developing new mortgage insurance 
products.

The Report identifies three specific actions which GAO recommends be 
considered for inclusion in the Department's proposed zero down payment 
program: imposing stricter underwriting criteria (higher credit scores 
or reserve requirements), artificially limiting program participation 
through the use of a pilot program, and credit enhancements and pre- 
purchase counseling. As we discussed with the GAO, these actions, along 
with others, were each considered during the Department's development 
of the zero down program and while most were not adopted, alternative 
solutions to achieve the objectives were incorporated into the program 
design.

The items the GAO recommended for consideration are all designed to 
mitigate risk and limit financial exposure to the FHA Insurance Fund 
consistent with the FHA's mission of providing homeownership 
opportunities to populations unserved or underserved by the private 
market. While FHA considered the recommended solutions proposed by GAO 
and adopted the pre-purchase counseling requirement as a component of 
the proposed zero down program, FHA determined, through the use of the 
same tools explored by GAO such as risk modeling, market comparison, 
portfolio performance, and consultation, that the most appropriate tool 
for balancing the expected performance of these loans against the goal 
of providing homeownership opportunities to this population was to 
structure the mortgage insurance premium in such a way as to minimize 
the financial risk.

Again, we appreciate the opportunity to comment on the Draft Report and 
will continue, as recommended by the GAO, to consider all possible 
elements of program design when developing new program proposals and 
adopt the combination that best fits the objectives of the proposed 
program.

Sincerely,

Signed by: 

Margaret A. Young: 
Deputy Assistant Secretary For Finance and Budget: 

[End of section]

Appendix IV: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

William B. Shear, (202) 512-8678; 
Matthew Scirč, (202) 512-6794: 

Staff Acknowledgments: 

In addition to those individuals named above, Anne Cangi, Rudy 
Chatloss, Bert Japikse, Austin Kelly, Marc Molino, Andy Pauline, 
Roberto Pińero, and Mitch Rachlis made key contributions to this 
report. 

(250169): 

FOOTNOTES

[1] For purposes of this report, we define loans with LTV ratios of 
greater than 97 percent as having a high LTV ratio. 

[2] Credit scores are a single numerical score, based on an 
individual's credit history, that measures that individual's 
creditworthiness.

[3] Conventional lenders provide mortgages that do not carry government 
insurance or guarantees. 

[4] While this analysis is useful in determining the extent to which 
LTV ratios and credit scores are helpful in predicting the risk level 
associated with individual mortgages, the FHA and conventional relative 
default rates are not strictly comparable because they are for 
different time periods and because FHA has a higher overall default 
rate.

[5] For this analysis, we define default as a credit event that 
includes foreclosed mortgages, as well as mortgages that did not 
experience a foreclosure, but that would typically lead to a credit 
loss, such as a "short sale" or a "third party sale" termination of the 
mortgage. Delinquency was not considered to be default. 

[6] Structured transaction is a broad term that covers any of several 
methods of dividing cash flows among several investors in a pool of 
mortgages.

[7] A credit enhancement is provided when a party agrees to assume 
risks associated with a loan. For example, mortgage insurance is a type 
of credit enhancement.

[8] FHA also has the authority to obtain credit enhancements through 
the use of co-insurance. Co-insurance requires lenders to share in the 
risks of insuring mortgages by assuming some percentage of the losses 
on the loans that they originated.

[9] For example, Congress established volume limits with the 
introduction of FHA's Home Equity Conversion Mortgage program. 

[10] Claim amount includes outstanding loan amount plus other costs 
including legal fees.

[11] Single-family loans insured by FHA may be used to finance the 
purchase of new or existing one-to-four-family properties. 12 U.S.C. 
§1709(b).

[12] Referred to as the conforming loan limit because the mortgages 
conform to underwriting standards established by Fannie Mae and Freddie 
Mac. The limit is higher for single-family mortgages secured by two-, 
three-, and four-unit dwellings. 

[13] Susan Wharton Gates, Vanessa Gail Perry, and Peter Zorn, 
"Automated Underwriting in Mortgage Lending: Good News for the 
Underserved," Housing Policy Debate, 13, no. 2, 2002.

[14] Fair, Isaac and Company, "Understanding your Credit Score," July 
2002.

[15] The conforming loan limit is 50 percent higher for Alaska, Hawaii, 
Guam, and the U.S. Virgin Islands.

[16] Often state housing finance agencies define first-time homebuyers 
as individuals who, during the past three consecutive years have not 
had ownership in a primary residence.

[17] State housing finance agencies have also been actively involved in 
low and no down payment mortgage lending. Using primarily mortgage 
revenue bonds that are sold to investors, they are able to originate, 
fund, or self-insure below-market interest rate mortgages. 

[18] Closing costs could include a loan origination fee, a mortgage 
recordation fee, a title transfer tax, appraisal fees, attorney fees, 
and title insurance. 

[19] According to USDA officials, a borrower may finance closing costs 
and the Guarantee Fee as long as they do not exceed the property's 
appraised value.

[20] Out-of-pocket expenses can include expenses such as funds required 
to establish an escrow account. 

[21] Michael Collins, "Pursuing the American Dream: Homeownership and 
the Role of Federal Housing Policy," January 2002.

[22] Fannie Mae officials noted that Fannie Mae's automated 
underwriting system allows for a higher total-debt-to-income ratio and 
factors the ratio in its evaluation of the loan. 

[23] FHA covers 100 percent of the mortgage balance but does not cover 
all of the costs of the foreclosure. 

[24] Research we reviewed includes articles, reports, and papers that 
were made available to us from economic journals, the internet, 
libraries, or were provided to us by various entities (e.g., HUD, 
Fannie Mae, Freddie Mac). For the purposes of this report, we refer to 
these documents as "papers."

[25] Many papers employ multiple models to analyze the importance of 
variables; as a result, summing the number of papers that found a 
variable important and the number of papers that found a variable not 
important will not equal the total number of papers that analyzed the 
importance of a specific variable. For example, two of the papers that 
assessed the importance of LTV found it important in some circumstances 
but not in others. 

[26] Of the 45 papers identified, 13 identified both LTV ratio and 
credit score as important and useful when estimating the risk level 
associated with individual mortgages.

[27] Of the papers we reviewed, researchers used several measures of 
loan performance (e.g., default, delinquency, severity). Please see 
each paper for the particular loan performance measure it used.

[28] Robert B. Avery, Raphael W. Bostic, Paul S. Calem, and Glenn B. 
Canner. "Credit Risk, Credit Scoring, and the Performance of Home 
Mortgages," Federal Reserve Bulletin (July 1996).

[29] Yongheng Deng, John M. Quigley, and Robert Van Order, Mortgage 
Default and Low Downpayment Loans: The Costs of Public Subsidy, 
National Bureau of Economic Research: Working Paper No. 5184 
(Cambridge, Mass.: July 1995).

[30] Yongheng Deng and Stuart Gabriel, Modeling the Performance of FHA- 
Insured Loans: Borrower Heterogeneity and the Exercise of Mortgage 
Default and Prepayment Options, a report submitted to the Office of 
Policy Development and Research, U.S. Department of Housing and Urban 
Development, May 2002.

[31] Generally, the studies that found the LTV ratio to be important 
had sample sizes greater than 6,000 (and in some cases in the 
millions). In comparison, three of the four studies that did not find 
LTV to be important had smaller sample sizes and the fourth study found 
LTV to be important for the prime market, but not for the subprime 
market. Additionally, one study used national aggregate data rather 
than loan level data. This study found LTV important in some 
specifications, but not in others. 

[32] Amy Crews Cutts and Robert Van Order, "On the Economics of 
Subprime Lending." Freddie Mac Working Paper Series #04-01(January 
2004) (http://freddiemac.com/corporate/reports/).

[33] Generally, the mortgage industry began widely using credit score 
information in the late 1990s; therefore, considering credit score in 
empirical loan performance analysis is very recent. Further, there was 
a particularly strong housing market during this period. 

[34] Robert F. Cotterman. Analysis of FHA Single-family Default and 
Loss Rates, a report submitted to the Office of Policy Development and 
Research, U.S. Department of Housing and Urban Development, March 25, 
2004.

[35] Cotterman. Analysis of FHA Single-family Default and Loss Rates.

[36] Qualifying ratios evaluated in the studies we identified include 
ratios such as payment-to-income, debt-to income, personal savings as 
percentage of disposable income, and household liabilities divided by 
household assets. 

[37] Avery, Bostic, Calem, and Canner. "Credit Risk, Credit Scoring, 
and the Performance of Home Mortgages."

[38] Robert Van Order and Peter Zorn. "Performance of Low-Income and 
Minority Mortgages," A paper prepared for the Joint Center for Housing 
Studies' Symposium on Low-Income Homeownership as an Asset-Building 
Strategy, Working Paper: LIHO-01.10 (September 2001). 

[39] Deng, Quigley, and Van Order, Mortgage Default and Low Downpayment 
Loans: The Costs of Public Subsidy.

[40] The data used in the analysis include a sample of FHA-insured 
mortgages originated in calendar years 1992, 1994, and 1996 and 
conventional mortgages originated in calendar years 1997, 1998, and 
1999. These data represent the most recently available data for each 
entity that includes variables necessary to conduct the analysis (such 
as LTV ratio and credit score). We did not include mortgages guaranteed 
by the USDA and VA in our analysis because credit score information for 
these mortgages was not readily available. Fannie Mae and Freddie Mac 
provided the conventional data. 

In our analysis, we specified six LTV ratio categories and six credit 
score categories. We defined default as a credit event that includes 
foreclosed mortgages, as well as mortgages that did not experience 
foreclosure, but that would typically lead to a credit loss, such as a 
"short sale" or a "third party sale" termination of the mortgage. 

We calculated average 4-year default rates (by dollar amount) for FHA- 
insured and conventional mortgages within specified LTV ratio and 
credit score categories. The average 4-year default rates for each LTV 
ratio and credit score categories were calculated as follows: the total 
dollar amount of mortgages originated (in all three cohorts) and 
defaulted within 4 years of origination, divided by the total dollar 
amount of mortgages originated (in all three cohorts). We then 
classified the default rates for each LTV ratio and credit score 
category relative to the average default rate for the FHA-insured and 
conventional mortgages, respectively. The relative default rates for 
each LTV ratio and credit score category were calculated as follows: 
the average default rate for each category, divided by the average 
default rate for all FHA-insured or conventional mortgages as 
appropriate. For a more detailed description of our analysis, see 
appendix I: Scope and Methodology.

[41] Structured transaction is a broad term that covers any of several 
methods of dividing cash flows among several investors in a pool of 
mortgages. Alt A is a broad term that describes mortgages that fall 
just outside of the underwriting guidelines that govern the regular 
mortgage purchase business of the GSEs. Alt A mortgages are loans to 
borrowers with relatively minor credit problems. 

[42] According to FHA, FHA discontinued the multifamily co-insurance 
program after experiencing significant losses. Since then, Congress 
provided FHA authority to enter into risk sharing agreements with GSEs 
and housing finance agencies on certain multifamily loans. 

[43] The GSE officials did not tell us the numeric extent to which they 
limited products' issuance during its pilot phase. 

[44] GAO, Single-Family Housing: Progress Made, but Opportunities Exist 
to Improve HUD's Oversight of FHA Lenders, GAO-05-13 (Washington, D.C.: 
Nov. 12, 2004).

[45] The Federal Accounting Standards Advisory Board (FASAB) is 
responsible for promulgating accounting standards for the U.S. 
Government, and these standards are recognized as generally accepted 
accounting principles for the federal government. FASAB developed 
standards for agencies that describe the types of analysis that would 
be expected for a change to an existing program, including relevant 
historical data and modeling capabilities.

[46] The Cranston Gonzales National Affordable Housing Act requires an 
independent actuarial analysis of the economic net worth and soundness 
of FHA's MMI Fund. 

[47] We did not include mortgages guaranteed by USDA and the VA in our 
analysis because credit score information for these mortgages was not 
readily available.

[48] Foreclosed mortgages were over-sampled in 1992 and 1994. The 
figures presented in the text are weighted according to the sample 
weights provided by HUD.

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