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United States Government Accountability Office: 
GAO: 

Report to Congressional Requesters: 

September 2013: 

Federal Housing Administration: 

Analysis of Options for Modifying Its Products, Market Presence, and 
Powers: 

GAO-13-682: 

GAO Highlights: 

Highlights of GAO-13-682, a report to congressional requesters. 

Why GAO Did This Study: 

FHA has historically provided mortgage guarantees for home buyers, 
particularly first-time, minority, and lower-income borrowers. In 
2012, FHA insured about $227 billion in single-family mortgages, and 
its overall insurance portfolio was about $1.1 trillion. Its market 
presence expanded during the recent housing crisis as the conventional 
market contracted and Congress increased the limit on the size of 
loans FHA may insure. But FHA’s financial condition has weakened, and 
FHA has not met its 2 percent statutory minimum capital ratio since 
2009. In its most recent budget, the agency stated that its capital 
reserve account might require an infusion of federal funds. 

FHA, industry participants, and researchers have suggested a number of 
options for improving FHA’s long-term viability or for limiting FHA’s 
market presence. These options have potential implications for 
taxpayers, borrowers, and others. This report discusses the options—
which fall into three broad categories: (1) changes to product terms 
and conditions, (2) changes that would restrict FHA’s market presence, 
and (3) changes to FHA’s operations and powers—and their implications. 
It also describes the possible effects of broader housing finance 
reform on FHA. 

GAO interviewed a variety of industry stakeholders and researchers and 
reviewed studies and other documents to identify options for reforming 
FHA and their implications. 

What GAO Found: 

GAO identified a number of proposed options for adjusting product 
terms and conditions to help improve the Federal Housing 
Administration’s (FHA) long-term viability (see figure below). FHA has 
raised the premiums that it charges borrowers several times in recent 
years and has taken steps to tighten its underwriting standards—for 
example, by setting a minimum required credit score. Some mortgage 
market observers have argued that further changes such as revising 
underwriting standards to focus on borrowers’ residual income, 
requiring higher down payments, or reducing seller concessions (that 
is, funds sellers provide to buyers to help pay for closing costs) 
could help FHA better manage credit risk. However, such changes would 
entail trade-offs. For instance, some said that raising down-payment 
requirements would improve loan performance, but others said that this 
move would delay homeownership for many borrowers. Similarly, raising 
premiums could potentially increase revenue, but this potential would 
be constrained if it caused volume to decline. Further, low-risk 
borrowers with fewer down-payment constraints could choose less costly 
loans from other sources, leaving FHA with more high-risk borrowers. 
These changes could have a direct effect on the availability of credit 
for borrowers. 

Figure: Options to Improve FHA’s Long-Term Viability or Reduce Its 
Market Presence: 

[Refer to PDF for imgae: illustration] 

Changes to product terms and conditions: 
* Changing underwriting requirements; 
* Increasing down payments and reducing seller concessions; 
* Raising premiums and using risk-based pricing. 

Changes that restrict FHA’s market presence: 
* Reducing loan limits; 
* Determining eligibility based on income; 
* Reducing insurance coverage to less than 100 percent of the loan 
amount; 
* Risk sharing with private partners. 

Changes to FHA’s operations and powers: 
* Making FHA an independent government corporation; 
* Enhancing its enforcement powers; 
* Increasing its ability to make program changes; 
* Increasing funding for information technology changes; 
* Paying employees outside of federal pay scales; 
* Giving it greater authority to pilot new programs. 

Source: GAO. 

[End of figure] 

GAO also identified options that could either directly or indirectly 
change FHA’s market presence, which increased after the housing 
crisis, or address its financial viability (see figure below). Among 
the proposals that would have a direct effect are those limiting FHA 
insurance to loans below a lowered ceiling or to borrowers who met new 
income guidelines. Many stakeholders and FHA itself view FHA’s current 
loan limits, which range from $271,050 to $729,750 for one-unit 
properties in the contiguous United States, as too high. Some note 
that the agency may insure larger loans than the housing enterprises 
Fannie Mae and Freddie Mac. The current FHA limits were put in place 
in response to declines in mortgage lending during the housing crisis, 
when the private sector’s role in financing mortgages shrank. However, 
as the market has improved, some have noted that lowering loan limits 
would allow private capital to return to the market and focus FHA on 
low- and moderate-income and first-time home buyers, a shift that many 
observers consider appropriate. Other proposed changes, such as 
reducing insurance coverage to less than 100 percent of the loan 
amount or entering into risk-sharing agreements with private partners, 
may indirectly reduce FHA’s market presence. However, applying a 
partial coverage model would limit availability of credit to some 
borrowers. For some lenders, the additional exposure might prompt the 
purchase of additional insurance coverage from third parties, the cost 
of which would be passed on to borrowers. Some argue that under a risk-
sharing structure private partners would assume and better manage 
credit risk. But creating such a structure would require careful 
consideration of how risks are borne, how pricing is determined, how 
incentives are aligned between FHA and its partners, and how FHA’s 
role in stabilizing mortgage markets would be impacted. Others point 
to the additional counterparty risk posed by risk-sharing 
arrangements, which would necessitate greater federal oversight. 
Finally, these options might also affect FHA’s ability to respond to 
changing market conditions. 

Figure: FHA’s Share of Loan Originations, 2001-2012: 

[Refer to PDF for image: multiple line graph] 

Fiscal year: 2001; 
Purchase mortgage market share: 14.2%; 
Overall market share (includes home purchase and refinance mortgages): 
9.1%. 

Fiscal year: 2002; 
Purchase mortgage market share: 11.1%; 
Overall market share (includes home purchase and refinance mortgages): 
6.4%. 

Fiscal year: 2003; 
Purchase mortgage market share: 8.5%; 
Overall market share (includes home purchase and refinance mortgages): 
5.5%. 

Fiscal year: 2004; 
Purchase mortgage market share: 6.6%; 
Overall market share (includes home purchase and refinance mortgages): 
4.7%. 

Fiscal year: 2005; 
Purchase mortgage market share: 4.5%; 
Overall market share (includes home purchase and refinance mortgages): 
3.1%. 

Fiscal year: 2006; 
Purchase mortgage market share: 4.5%; 
Overall market share (includes home purchase and refinance mortgages): 
3.3%. 

Fiscal year: 2007; 
Purchase mortgage market share: 6.1%; 
Overall market share (includes home purchase and refinance mortgages): 
5.1%. 

Fiscal year: 2008; 
Purchase mortgage market share: 24.1%; 
Overall market share (includes home purchase and refinance mortgages): 
19.8%. 

Fiscal year: 2009; 
Purchase mortgage market share: 32.6%; 
Overall market share (includes home purchase and refinance mortgages): 
21.1%. 

Fiscal year: 2010; 
Purchase mortgage market share: 32.3%; 
Overall market share (includes home purchase and refinance mortgages): 
17.4%. 

Fiscal year: 2011; 
Purchase mortgage market share: 26.5%; 
Overall market share (includes home purchase and refinance mortgages): 
14%. 

Fiscal year: 2012; 
Purchase mortgage market share: 26.1%; 
Overall market share (includes home purchase and refinance mortgages): 
14.6%. 

Source: GAO analysis of HUD data. 

[End of figure] 

FHA and industry observers have also suggested changes to FHA’s 
structure and powers that could enhance its flexibility and capacity 
to manage risk. Some of these changes would bring FHA’s corporate 
powers more in line with those of other government corporations and 
increase its autonomy, providing it with enhanced enforcement powers 
and greater authority to change program requirements and invest in 
staff and technology. FHA has already requested additional enforcement 
authority. FHA and other observers have also argued that FHA needs 
greater power to change loan products or loan features without a 
lengthy rulemaking process and additional information technology 
resources—resources for which FHA must currently compete within HUD. 
Expanding FHA’s operational and managerial powers would give the 
agency more flexibility, and increasing its enforcement powers would 
allow it to more effectively oversee lenders. But any expansion of FHA’
s authority may need to be limited and transparency requirements 
heightened, including for the rulemaking process. Even with no changes 
to its existing organizational structure and authorities, FHA can do 
more to enhance program efficiency and effectiveness and protect 
taxpayers. GAO has made a number of recommendations aimed at improving 
FHA’s loss mitigation efforts, management of real-estate owned 
inventories, risk assessment, human capital management, and 
information technology systems. In response to these recommendations, 
FHA has taken steps, such as developing a plan for conducting an 
inaugural risk assessment and a workforce analysis and succession plan.
Finally, efforts to further regulate housing finance and the 
continuing uncertainty over resolution of Fannie Mae and Freddie Mac 
present challenges to any efforts to reform FHA. Following the 
collapse of the mortgage market, Congress passed a number of mortgage 
reforms that could impact FHA’s market share and role because they 
could affect the price at which the conventional market will be able 
to serve future home buyers of varying credit risk profiles. 
Similarly, the administration has put forth several options for 
reforming the federal role in the mortgage market, including reform of 
Fannie Mae and Freddie Mac. Each of these options could have an impact 
on FHA’s role in the mortgage market. Partly for this reason, GAO 
identified modernization of the federal role in housing finance as a 
high-risk area in early 2013. Any changes to the federal tools that 
support housing finance should be made in concert and with full 
recognition of the interdependence among FHA, the enterprises, and 
federal regulation. 

View [hyperlink, http://www.gao.gov/products/GAO-13-682]. For more 
information, contact Mathew J. Scirè at (202) 512-8678 or 
sciremj@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Changes to Product Terms and Conditions Could Help Mitigate Risk and 
Increase Financial Viability but Could Also Limit Borrowers' Access to 
Credit: 

Proposed Changes That Restrict the Borrowers FHA Serves Would Affect 
the Agency's Role in the Mortgage Market: 

Greater Operational and Managerial Powers Could Give FHA Greater 
Flexibility but Could Limit Congressional Direction: 

Broader Housing Market Reforms Could Impact FHA's Role: 

Agency Comments: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Descriptions of Compensating Factors: 

Table 2: FHA Down-Payment Requirements and Related LTV Ratios: 

Table 3: Increases to FHA Annual Premiums Effective April 1, 2013: 

Figures: 

Figure 1: FHA's Share of Loan Originations, 2001-2012: 

Figure 2: Estimates of the Fund's Capital Ratio, 2001-2012: 

Figure 3: End-of-Year Balances in the Fund's Capital Reserve Account, 
2008-2012: 

Figure 4: Percentage of FHA Purchase Loans by Borrower Income, 2000-
2013: 

Abbreviations: 

APA: Administrative Procedure Act 

APOR: average prime offer rate: 

APR: annual percentage rate: 

CFPB: Bureau of Consumer Financial Protection: 

DTI: debt service-to-income: 

FCRA: Federal Credit Reform Act of 1990: 

FHA: Federal Housing Administration: 

FHFA: Federal Housing Finance Agency: 

HECM: Home Equity Conversion Mortgages for Seniors: 

HERA: Housing and Economic Recovery Act of 2008: 

HPML: higher-priced mortgage loan: 

HUD: Department of Housing and Urban Development: 

IT: information technology: 

LTV: loan-to-value: 

MBA: Mortgage Bankers Association: 

MBS: mortgage-backed securities: 

NPRM: notice of proposed rulemaking: 

OMB: Office of Management and Budget: 

PTI: payment-to-income: 

QM: qualified mortgage: 

QRM: qualified residential mortgage: 

RHS: Rural Housing Service: 

TOTAL: Technology Open to Approved Lenders: 

USDA: Department of Agriculture: 

VA: Department of Veterans Affairs: 

[End of section] 

GAO:
United States Government Accountability Office: 
441 G St. N.W. 
Washington, DC 20548: 

September 9, 2013: 

The Honorable Jeb Hensarling: 
Chairman: 
Committee on Financial Services: 
House of Representatives: 

The Honorable Randy Neugebauer: 
Chairman: 
Subcommittee on Housing and Insurance: 
Committee on Financial Services: 
House of Representatives: 

The Department of Housing and Urban Development's (HUD) Federal 
Housing Administration (FHA) has helped millions of families purchase 
homes through its single-family mortgage insurance programs, which 
insure private lenders against losses on mortgages that finance 
purchases of properties or that refinance existing FHA mortgages. In 
2012, FHA insured about $227 billion in single-family mortgages, and 
its overall insurance portfolio was about $1.1 trillion. In recent 
years, FHA has experienced a dramatic increase in its market share, 
partly because the conventional mortgage market contracted during the 
2007-2009 financial crisis. At the same time, FHA has faced fiscal 
challenges. Since 2009, its Mutual Mortgage Insurance Fund (the Fund) 
has not met statutory reserve requirements, as measured by the Fund's 
estimated capital ratio.[Footnote 1] The Fund is required to maintain 
a capital ratio of at least 2 percent. Also, declining balances in the 
fund's capital reserve account and significant underestimates of 
program costs have heightened the possibility that FHA will require 
additional funds to pay all future insurance claims on its existing 
portfolio. 

FHA has made a number of changes to address its fiscal challenges. 
However, mortgage market observers have stated that further actions 
are needed and have proposed options that could improve FHA's long-
term viability or reduce its market presence. These suggestions range 
from changes to its product features to broad changes to its 
organizational structure. You asked us to examine these options and 
their implications. This report discusses the implications of options 
related to (1) changing FHA's product terms and conditions for single-
family mortgage insurance, (2) restricting FHA's presence in the 
single-family housing market, and (3) altering FHA's operations and 
powers within its single-family program.[Footnote 2] It also discusses 
the possible effects of broader housing finance reform on FHA. Options 
that included changes to FHA's capital reserve requirements were not 
within the scope of our review. However, we previously recommended 
that in place of FHA's 2-percent capital requirement, Congress or FHA 
specify the economic conditions the Fund would be expected to 
withstand without drawing on the U.S. Treasury.[Footnote 3] 
Additionally, in another report issued today, we compare the reserving 
practices and capital requirements of FHA to those of private mortgage 
insurers.[Footnote 4] 

To examine the options that have been proposed for improving FHA's 
long-term viability or limiting its market presence, we identified 
relevant academic and industry studies from our previous products and 
ongoing work and from a literature search of databases. We reviewed 
these studies and other documents--including from FHA and HUD--to 
summarize and categorize options for FHA reform. The categories we 
identified were potential changes to product terms and conditions, 
changes that affect FHA's mortgage market presence, and changes to 
FHA's operational powers and structure. We also reviewed studies and 
other documents to identify the potential implications of these 
options, including how the options affect cost and risk to the 
taxpayer, borrowers' access to credit, FHA's role and the market it 
serves, and other mortgage market participants. We conducted 
interviews with mortgage industry observers from industry, academic, 
government, and consumer organizations to obtain their views on the 
options and related implications that we identified and to obtain any 
additional relevant studies or papers. Appendix I contains additional 
information on our scope and methodology. 

We conducted this performance audit from April 2013 to September 2013 
in accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Background: 

FHA is a wholly owned government corporation within HUD.[Footnote 5] 
It was established in 1934 under the National Housing Act to broaden 
homeownership, shore up and protect lending institutions, and 
stimulate employment in the building industry.[Footnote 6] 

FHA's Single-Family Mortgage Insurance: 

FHA's single-family programs insure private lenders against losses 
from borrower defaults on mortgages that meet FHA criteria for 
properties with one to four housing units. FHA primarily insures 
forward mortgages for initial home purchases and refinancing, but also 
insures reverse mortgages that permit persons 62 years and older to 
convert their home equity into cash advances through its Home Equity 
Conversion Mortgages for Seniors (HECM) program.[Footnote 7] FHA 
provides most of its single-family mortgage insurance through programs 
supported by the Fund.[Footnote 8] FHA's single-family insurance 
programs are administered by the Deputy Assistant Secretary for Single 
Family Housing, who reports to the Assistant Secretary for Housing-
Federal Housing Commissioner. 

FHA is a government mortgage insurer in a market that also includes 
private mortgage insurers. Private mortgage insurance policies provide 
lenders coverage on a portion (generally 20 to 30 percent) of the 
mortgage balance. However, borrowers who have difficulty meeting down-
payment and credit score requirements for conventional loans may find 
it easier to qualify for a loan with FHA insurance, which covers 100 
percent of the principal balance of the loan involved in a claim and 
other eligible costs. Generally, borrowers are required to purchase 
mortgage insurance when the loan-to-value (LTV) ratio (the amount of 
the mortgage loan divided by the value of the home multiplied by 100) 
exceeds 80 percent. FHA-insured borrowers are required to make minimum 
cash investments of 3.5 percent, which may come from the borrowers' 
own funds or from certain third-party sources. Borrowers are also 
permitted to finance their mortgage insurance premiums, a practice 
that can create an effective LTV ratio of close to 100 percent. 
Congress has set limits on the size of the forward mortgages FHA may 
insure, which can vary by county. For the period from January 1, 2013, 
through December 31, 2013, the limits range from $271,050 to $729,750 
for one-unit properties in the contiguous United States. 

FHA's Role in Mortgage Financing: 

FHA's single-family mortgage programs have played a prominent role in 
mortgage financing in the wake of the 2007-2009 financial crisis and 
housing downturn. In 2012, FHA insured about $227 billion in single-
family mortgages, and its overall insurance portfolio was about $1.1 
trillion. The agency has played a particularly large role among 
minority, lower-income, and first-time homebuyers. In 2012, about 78 
percent of FHA-insured loans went to first-time homebuyers, about 32 
percent of whom were minorities. FHA is generally thought to promote 
stability in the market by ensuring the availability of mortgage 
credit in areas that may be underserved by the private sector or that 
are experiencing economic downturns. As the recent housing crisis and 
economic recession set in, the contraction of other segments of the 
mortgage market and legislated increases in the loan amounts eligible 
for FHA insurance resulted in higher demand for FHA-insured mortgages. 
FHA officials also noted that even if their volume had not increased, 
the agency's share of the market would have increased because other 
segments of the market declined or were completely eliminated. 
According to HUD's Housing Market Conditions, FHA's share of the 
market for home purchase mortgages (in terms of loan originations) 
grew sharply, rising from approximately 4.5 percent in 2006 to 
approximately 26.1 percent in 2012.[Footnote 9] Looking at the entire 
mortgage market (including refinance activity), FHA's share of the 
market also rose dramatically, and stood at 14.6 percent in 2012 (see 
figure 1). 

Figure 1: FHA's Share of Loan Originations, 2001-2012: 

[Refer to PDF for image: multiple line graph] 

Fiscal year: 2001; 
Purchase mortgage market share: 14.2%; 
Overall market share (includes home purchase and refinance mortgages): 
9.1%. 

Fiscal year: 2002; 
Purchase mortgage market share: 11.1%; 
Overall market share (includes home purchase and refinance mortgages): 
6.4%. 

Fiscal year: 2003; 
Purchase mortgage market share: 8.5%; 
Overall market share (includes home purchase and refinance mortgages): 
5.5%. 

Fiscal year: 2004; 
Purchase mortgage market share: 6.6%; 
Overall market share (includes home purchase and refinance mortgages): 
4.7%. 

Fiscal year: 2005; 
Purchase mortgage market share: 4.5%; 
Overall market share (includes home purchase and refinance mortgages): 
3.1%. 

Fiscal year: 2006; 
Purchase mortgage market share: 4.5%; 
Overall market share (includes home purchase and refinance mortgages): 
3.3%. 

Fiscal year: 2007; 
Purchase mortgage market share: 6.1%; 
Overall market share (includes home purchase and refinance mortgages): 
5.1%. 

Fiscal year: 2008; 
Purchase mortgage market share: 24.1%; 
Overall market share (includes home purchase and refinance mortgages): 
19.8%. 

Fiscal year: 2009; 
Purchase mortgage market share: 32.6%; 
Overall market share (includes home purchase and refinance mortgages): 
21.1%. 

Fiscal year: 2010; 
Purchase mortgage market share: 32.3%; 
Overall market share (includes home purchase and refinance mortgages): 
17.4%. 

Fiscal year: 2011; 
Purchase mortgage market share: 26.5%; 
Overall market share (includes home purchase and refinance mortgages): 
14%. 

Fiscal year: 2012; 
Purchase mortgage market share: 26.1%; 
Overall market share (includes home purchase and refinance mortgages): 
14.6%. 

Source: GAO analysis of HUD data. 

[End of figure] 

A number of other private-sector and government institutions 
participate in the mortgage market. 

* Private lenders offer home purchase and refinance mortgages and 
often work with mortgage brokers, independent contractors that 
originate the loan products of multiple lenders.[Footnote 10] 

* The Department of Veterans Affairs' (VA) Loan Guaranty Service and 
the Department of Agriculture's (USDA) Rural Housing Service (RHS) 
administer federal programs that insure or guarantee single-family 
mortgages made by private lenders. 

* Private mortgage insurance companies offer mortgage insurance that 
protects private lenders against losses in the event the borrower 
defaults on the mortgage. Fannie Mae and Freddie Mac, two government-
sponsored enterprises (the enterprises), purchase mortgages from 
lenders across the country, financing their purchases through 
borrowing or by issuing securities backed by the mortgages (mortgage-
backed securities or MBS). The enterprises are currently under 
conservatorship.[Footnote 11] 

* Ginnie Mae is another wholly owned government corporation in HUD. It 
guarantees the timely payment of principal and interest of MBS backed 
by pools of federally insured or guaranteed mortgage loans, such as 
FHA, VA, or RHS. 

FHA's Mutual Mortgage Insurance Fund: 

The Omnibus Budget Reconciliation Act of 1990 required HUD to take 
steps to ensure that the Fund attained a capital ratio of at least 2 
percent by November 2000 and maintained at least that level 
thereafter.[Footnote 12] The capital ratio is the Fund's economic 
value divided by the insurance-in-force (outstanding insurance 
obligations). The act also required an annual independent actuarial 
review of the Fund's economic net worth and soundness. This actuarial 
review is now a requirement in the Housing and Economic Recovery Act 
of 2008, which also requires an annual report to Congress on the 
results of the review. The Fund's capital ratio dropped sharply in 
2008 and fell below the statutory minimum in 2009, when economic and 
market developments created conditions that simultaneously reduced the 
Fund's economic value (the numerator of the ratio) and increased the 
insurance-in-force (the denominator of the ratio). According to annual 
actuarial reviews of the Fund, the capital ratio fell from about 7 
percent in 2006 to 3 percent in 2008 and dropped to below 2 percent in 
2009 (see figure 2). In 2012, the ratio fell below zero to negative 
1.44 percent. 

Figure 2: Estimates of the Fund's Capital Ratio, 2001-2012: 

[Refer to PDF for image: vertical bar graph] 

Minimum capital ratio: 2%. 

Fiscal year: 2001; 
Capital ratio: 4.03%. 

Fiscal year: 2002; 
Capital ratio: 4.85%. 

Fiscal year: 2003; 
Capital ratio: 5.59%. 

Fiscal year: 2004; 
Capital ratio: 5.9%. 

Fiscal year: 2005; 
Capital ratio: 6.5%. 

Fiscal year: 2006; 
Capital ratio: 7.38%. 

Fiscal year: 2007; 
Capital ratio: 6.97%. 

Fiscal year: 2008; 
Capital ratio: 3.22%. 

Fiscal year: 2009; 
Capital ratio: 0.53%. 

Fiscal year: 2010; 
Capital ratio: 0.5%. 

Fiscal year: 2011; 
Capital ratio: 0.24%. 

Fiscal year: 2012; 
Capital ratio: -1.44%. 

Source: GAO analysis of FHA data. 

[End of figure] 

Under the Federal Credit Reform Act of 1990 (FCRA), FHA and other 
federal agencies must estimate the net lifetime costs--known as credit 
subsidy costs--of their loan insurance or guarantee programs and 
include the estimated costs to the government in their annual budgets. 
Credit subsidy costs represent the net present value of expected 
lifetime cash flows, excluding administrative costs.[Footnote 13] When 
estimated cash inflows (such as borrower insurance premiums) exceed 
expected cash outflows (such as insurance claims), a program is said 
to have a negative credit subsidy rate and generates offsetting 
receipts that reduce the federal budget deficit. When the opposite 
occurs, the program is said to have a positive credit subsidy rate and 
therefore requires appropriations. Generally, agencies must produce 
annual updates of their subsidy estimates--reestimates--on the basis 
of information about actual performance and estimated changes in 
future loan performance. FCRA recognized the difficulty of making 
credit subsidy estimates that mirrored actual loan performance and 
thus provided permanent and indefinite budget authority for 
reestimates that reflected increased program costs.[Footnote 14] 
Upward reestimates increase the federal budget deficit unless 
accompanied by reductions in other government spending or an increase 
in receipts. 

As the capital ratio declined, the Fund's condition also worsened from 
the federal budgetary perspective. FHA annually estimates the subsidy 
costs of new activity for its loan insurance program and also 
reestimates, or annually updates, prior subsidy cost estimates. 
Historically, FHA estimated that its loan insurance program had a 
negative subsidy cost. On the basis of these estimates, FHA 
accumulated substantial balances in a capital reserve account, which 
represents amounts in excess of those needed for estimated claims or 
other costs and was used to cover reestimates reflecting unanticipated 
increases to those costs (such as higher-than-expected claims). In 
recent years, FHA has transferred billions of dollars annually from 
the capital reserve account to cover increases in estimated credit 
subsidy costs of the Fund (upward subsidy reestimates). As a result, 
balances in the capital reserve account fell dramatically, from $19.3 
billion at the end of 2008 to an estimated $3.3 billion at the end of 
2012 (see figure 3). 

Figure 3: End-of-Year Balances in the Fund's Capital Reserve Account, 
2008-2012: 

[Refer to PDF for image: vertical bar graph] 

Fiscal year 2008: $19.3 billion; 
Fiscal year 2009: $10.7 billion; 
Fiscal year 2010: $4.4 billion; 
Fiscal year 2011: $4.7 billion; 
Fiscal year 2012: $3.3 billion. 

Source: GAO analysis of FHA data. 

[End of figure] 

If the reserve account were to be depleted, FHA could draw on 
permanent and indefinite budget authority to cover reestimates 
indicating additional increases in estimated credit subsidy costs. The 
President's budget for 2014 contained a $22.4 billion upward 
reestimate in FHA's credit subsidy costs for the Fund. The budget 
indicated that the reestimate would be funded by depleting FHA's 
capital reserve account in 2013, using premiums collected in 2013 from 
new endorsements, and potentially drawing on $943 million in permanent 
and indefinite budget authority. However, to the extent that such 
premiums collected in 2013 are different than FHA estimated, FHA may 
need to draw on more or less permanent and indefinite budget authority. 

Changes to Product Terms and Conditions Could Help Mitigate Risk and 
Increase Financial Viability but Could Also Limit Borrowers' Access to 
Credit: 

Mortgage industry observers have suggested changes to FHA's product 
terms and conditions to lower its exposure to risk and improve its 
capital position. These proposed changes include tightening its 
underwriting standards and increasing down payments and premiums 
charged. However, implementing one or a combination of these options 
could affect borrowers' access to credit, create an adverse selection 
problem for FHA, or affect the agency's role in terms of the types of 
borrowers it serves.[Footnote 15] 

Proposed Changes to FHA's Underwriting Standards Would Involve Trade-
offs That Could Affect Target Populations: 

Lenders must comply with FHA's underwriting criteria when making FHA-
insured loans. Underwriting is a risk analysis that uses information--
such as a borrower's credit history and cash assets, among other 
things--collected during the origination process to decide whether to 
approve a loan. In order to qualify for an FHA-insured loan, a 
borrower must have a decision credit score of at least 500.[Footnote 
16] In addition, a borrower's payment-to-income (PTI) ratio may exceed 
31 percent and debt service-to-income (DTI) ratio may exceed 43 
percent only if compensating factors are documented.[Footnote 17] 

With some exceptions, lenders are required to use FHA's Technology 
Open to Approved Lenders (TOTAL)--a mortgage scorecard--to underwrite 
loans.[Footnote 18] TOTAL evaluates the overall creditworthiness of an 
applicant based on a number of credit variables and determines the 
associated risk level for an FHA-insured loan. FHA requires lenders to 
manually underwrite loans that are not accepted by TOTAL to determine 
if the loan should be accepted or rejected.[Footnote 19] Among other 
things, manual underwriting involves evaluating compensating factors 
to justify the approval of an FHA-insured mortgage. Table 1 describes 
the compensating factors lenders may consider when manually 
underwriting an FHA-insured loan for a borrower whose PTI ratio 
exceeds 31 percent or DTI ratio exceeds 43 percent. 

Table 1: Descriptions of Compensating Factors: 

Compensating factor: Housing expense payments; 
Description: The borrower has successfully demonstrated the ability to 
pay housing expenses greater than or equal to the proposed monthly 
housing expenses for the new mortgage over the past 12-24 months. 

Compensating factor: Down payment; 
Description: The borrower makes a large down payment of 10 percent or 
higher toward the purchase of the property. 

Compensating factor: Accumulated savings; 
Description: The borrower has demonstrated an ability to accumulate 
savings and a conservative attitude toward using credit. 

Compensating factor: Previous credit history; 
Description: A borrower's previous credit history shows that he/she 
has the ability to devote a greater portion of income to housing 
expenses. 

Compensating factor: Compensation or income not reflected in effective 
income; 
Description: The borrower receives documented compensation or income 
that is not reflected in effective income, but directly affects 
his/her ability to pay the mortgage. This type of income includes food 
stamps and similar public benefits. 

Compensating factor: Minimal housing expense increase; 
Description: There is only a minimal increase in the borrower's 
housing expense. 

Compensating factor: Substantial cash reserves; 
Description: The borrower has substantial documented cash reserves (at 
least 3 months worth) after closing. The lender must judge if the 
substantial cash reserve asset is liquid or readily convertible to 
cash, and can be done so absent retirement or job termination, when 
determining if the asset can be included as cash reserves, or cash to 
close. 

Compensating factor: Substantial nontaxable income; 
Description: The borrower has substantial nontaxable income. 

Compensating factor: Potential for increased earnings; 
Description: The borrower has a potential for increased earnings, as 
indicated by job training or education in his/her profession. 

Compensating factor: Primary wage-earner relocation; 
Description: The home is being purchased because the primary wage 
earner is relocating, and the secondary earner has an established 
employment history, is expected to return to work, and has reasonable 
prospects for securing employment in a similar occupation in the new 
area. 

Source: FHA. 

[End of table] 

FHA recently revised TOTAL to tighten its underwriting standards. For 
example, according to FHA officials, the agency revised the cut 
points--the points of separation within a population of mortgage 
scores that divide applications that are accepted in TOTAL from those 
that are not--in order to set the lifetime claim rate of its highest-
risk loans at about 13 percent. In addition, some mortgage industry 
observers we spoke to said that lenders may apply additional, more 
stringent underwriting requirements, known as credit overlays. For 
example, a lender could require that borrowers have a minimum credit 
score of 620 in order to qualify for an FHA-insured loan. 

Some of the literature we reviewed and those we spoke to suggested 
that FHA could further tighten its underwriting standards in order to 
reduce the risk to the Fund, as well as the agency's high market 
share. However, as described in the following examples, tightening of 
FHA's underwriting requirements may affect certain borrowers' ability 
to obtain mortgage credit and FHA's ability to serve families that are 
able to sustain a mortgage, but do not qualify for conventional 
financing. 

Increasing FHA's Minimum Credit Score Requirement: 

Some mortgage industry observers have suggested raising FHA's minimum 
credit score requirement to, for example, 580 or 620. We previously 
found that lower credit scores were associated with a higher 
likelihood of default.[Footnote 20] FHA officials also told us that 
lower credit scores increase the likelihood of delinquency and default 
among borrowers. Accordingly, increasing the credit score requirement, 
all else being equal, could make FHA less subject to adverse selection 
based on its credit policy and help to reduce the level of risk in the 
overall portfolio. 

However, FHA data also show that the percentage of borrowers with FHA-
guaranteed loans and credit scores below 620 was relatively small in 
2009--approximately 10 percent of loans endorsed by FHA. Thus, 
implementing a credit score floor of 620--the conventional mortgage 
standard--likely would not significantly reduce FHA's market share, 
absent any other changes to FHA's underwriting standards, other 
program requirements, or the current lending volume. 

Some mortgage industry observers noted that increasing FHA's credit 
score requirement would decrease access to mortgage credit and delay 
or prevent homeownership for borrowers with lower credit scores. One 
paper we reviewed noted that more restrictive credit score 
requirements excluded a larger share of borrowers from the market in 
relation to the percentage of defaults they prevented.[Footnote 21] 
One mortgage industry observer also said that a higher minimum credit 
score requirement likely would have a disparate impact on minority 
borrowers. In addition, in a 2007 paper, the Federal Reserve found 
that different demographic groups had substantially different credit 
scores.[Footnote 22] The study found that on average blacks and 
Hispanics have lower credit scores than non-Hispanic whites and Asians. 

Implementing a Residual Income Requirement: 

Some mortgage industry observers also suggested that FHA implement a 
residual income requirement. Residual income is the amount of net 
income remaining after the deduction of payments for debts and 
obligations (including the mortgage), and is thus a measure of a 
borrower's ability to make such payments without creating a 
substantial financial burden on the household. These observers pointed 
to VA's mortgage insurance program, which requires that lenders 
calculate the balance available for family support and compare that 
figure to the residual income guidelines that are based on family 
size, loan amount, and geographic location. For example, the guideline 
for a family of two living in the midwest with a loan of $80,000 or 
more is a minimum of $738 in residual income. For the same family in 
the west, it is a minimum of $823. Lenders also consider the 
borrower's DTI ratio, but according to VA, that is a secondary 
underwriting factor to the residual income.[Footnote 23] 

One industry observer we spoke to said that implementing a residual 
income test could be difficult, though not impossible, because 
determining whether borrowers were capable of paying for other 
expenses presented practical challenges. One paper we reviewed noted 
the lack of adequate empirical data and models documenting the 
relationship between residual income, DTI ratios, and loan 
performance.[Footnote 24] This paper concluded that without such 
information, it would be difficult to determine the residual income 
thresholds that would most effectively produce high-quality mortgages 
without excluding lower-income borrowers from access to credit. 

Increasing FHA's Down-Payment Requirement and Reducing Seller 
Concessions Could Increase Borrowers' Cash Contributions: 

In addition to meeting the underwriting requirements outlined earlier, 
a borrower generally must make a cash investment (down payment) in the 
property to obtain an FHA-insured mortgage.[Footnote 25] The amount of 
the down payment required depends on the borrower's credit score (see 
table 2). Down payment funds may come from the borrower's own savings 
or from certain third-party sources.[Footnote 26] 

Table 2: FHA Down-Payment Requirements and Related LTV Ratios: 

Credit score: 500-579 credit score; 
Minimum down payment: 10%; 
Related LTV ratio/maximum FHA-insured financing[A]: 90%. 

Credit score: 580 and above credit score[B]; 
Minimum down payment: 3.5; 
Related LTV ratio/maximum FHA-insured financing[A]: 96.5. 

Source: FHA. 

[A] LTV ratio is calculated on the base loan amount, excluding up-
front premiums. According to FHA, nearly all insured borrowers finance 
the up-front premium, which today is 1 percent of the base mortgage 
amount. For a loan with a minimum down payment of 3.5 percent, the 
resulting LTV ratio with the financed premium would be higher than 
96.5. We discuss up-front premiums below. Borrowers must still provide 
cash for the down payment, or obtain those funds from an approved 
third-party source. 

[B] HUD has proposed setting a 95 percent LTV maximum (5 percent down 
payment) on loans of $625,500 or more. 

[End of table] 

In addition, borrowers also must pay for related closing costs. 
Currently, FHA permits a seller to pay up to 6 percent of the lesser 
of the purchase price or the appraised value of a home on behalf of a 
buyer to help fund these closing costs. Such payments are referred to 
as "seller concessions." In July 2010, FHA proposed reducing allowable 
seller concessions to 3 percent of the lesser of the purchase price or 
the appraised value of a home in order to align its policy with 
conventional mortgage lenders and reduce the risk exposure to the 
Fund. In announcing the change, FHA noted that the then current level 
exposed FHA to excess risk by creating incentives to inflate the 
appraised value of homes.[Footnote 27] In February 2012, FHA amended 
this plan in a proposed rule that permitted seller concessions in the 
amount of the lesser of 3 percent of the purchase price or the 
appraised value of a home, or $6,000, whichever was greater.[Footnote 
28] According to FHA officials, the agency is in the process of 
addressing comments on the proposed rule. The officials said that they 
did not know when the rule would be finalized. 

Increasing FHA's Down-Payment Requirement: 

Some of the literature we reviewed and mortgage industry observers we 
interviewed suggested increasing FHA's requirement from 3.5 percent 
to, for example, 5 percent. Some said that increasing FHA's down-
payment requirements would help to decrease risk in its portfolio. A 
substantial amount of the research we reviewed for a 2005 report on 
risks associated with FHA products indicated that LTV ratios and 
credit scores were among the most important factors in estimating the 
risk level associated with individual mortgages.[Footnote 29] Our own 
analysis corroborated these findings. We found that, in general, 
mortgages with higher LTV ratios (smaller down payments) and lower 
credit scores were riskier than mortgages with lower LTV ratios and 
higher credit scores. 

Others noted that increases to FHA's down-payment requirements would 
delay or prevent homeownership for many borrowers who often lack 
sufficient funds to make a large down payment. Supporting this 
argument, in 2011 FHA found that over 40 percent of all borrowers 
would not have had the additional funds to make a 5 percent down 
payment, based on information collected from loan applications. 
[Footnote 30] In addition, one mortgage industry observer said that 
increased down-payment requirements could have a disparate impact on 
minorities. 

Reducing Seller Concessions: 

Some of those we spoke to and the literature we reviewed said that FHA 
should reduce seller concessions. According to FHA, about 21 percent 
of loan originations in 2009 and 2010 had seller concessions of more 
than 3 percent of the property value.[Footnote 31] Allowing higher 
seller concessions makes FHA-insured loans more accessible than 
conventional loans because borrowers do not have to invest as much 
cash at closing. For example, according to FHA, under current policy, 
concessions on higher-priced homes can reach almost $44,000. FHA and 
one mortgage industry observer suggested that reducing seller 
concessions could reduce the risk of exposure to the Fund from 
incentives that inflated the appraised value of homes. Our work on 
seller-funded down-payment assistance demonstrated that funds provided 
by seller-funded nonprofits had the effect of increasing the selling 
price of the home, leaving the borrower with less equity and FHA with 
more risk than they would have otherwise.[Footnote 32] This suggests 
that transactions involving seller concessions could result in higher 
sales prices than would occur without seller concessions. 

Conversely, some have highlighted the importance of providing 
assistance to those borrowers who have difficulty accumulating 
sufficient funds to become homeowners. For example, one mortgage 
industry observer we spoke with said that reducing allowable seller 
concessions would be like increasing the down-payment requirement. In 
commenting on FHA's proposed rule, representatives of this group said 
that FHA must strike a balance between managing risks and ensuring 
that its product is offered as widely as possible to qualified 
borrowers. They said that the proposed changes in seller concessions 
would adversely impact homebuyers seeking FHA-insured mortgages. 
Because of similar concerns, FHA revised its original proposal for 
reducing seller concessions. In its revised proposed rule, FHA noted 
that an across-the-board reduction to 3 percent would have had a 
disproportionately negative impact on borrowers with low and moderate 
incomes who were purchasing modestly priced homes. Therefore, the 
agency revised its proposal to allow concessions of the greater of 3 
percent or $6,000, so that borrowers purchasing homes valued at less 
than $200,000 could receive seller concessions of more than 3 percent. 

Pricing Changes Could Raise the Cost of Credit for Some Borrowers: 

FHA has raised premiums several times in recent years, but such 
increases have not been risk-based. Most recently, FHA increased the 
annual insurance premiums most borrowers pay between 0.05 and 0.10 
percentage points. FHA now charges the maximum allowable premium for 
loans of $625,500 or more, and although FHA also increased premiums 
for smaller-value loans, these premiums still remain below the maximum 
FHA is permitted to charge (see table 3). FHA can continue to raise up-
front and annual premiums to the statutory maximums (generally 3 
percent of the original insured principal mortgage amount for up-front 
premiums and between 1.5 and 1.55 percent of the remaining insured 
principal amount for annual premiums). In addition, since June 3, 
2013, FHA has required most new borrowers to continue paying annual 
premiums, regardless of the value of their loans.[Footnote 33] 
Previously, premiums could be canceled after the first 5 years once 
the principal amount declined to 78 percent of the original value. 
According to FHA, the reversal of the premium cancellation policy and 
the increase in premiums would generate approximately $3 billion for 
the Fund for every $100 billion in new endorsements. 

Table 3: Increases to FHA Annual Premiums Effective April 1, 2013: 

Term greater than 15 years: 

Base loan amount: Less than or equal to $625,500; 
Loan-to-value: Less than or equal to 95%; 
Previous mortgage insurance premium: 1.20%; 
Current mortgage insurance premium: 1.30%; 
Statutory maximum: 1.50%. 

Base loan amount: Less than or equal to $625,500; 
Loan-to-value: Greater than 95%; 
Previous mortgage insurance premium: 1.25%; 
Current mortgage insurance premium: 1.35%; 
Statutory maximum: 1.55%. 

Base loan amount: Greater than $625,500; 
Loan-to-value: Less than or equal to 95%; 
Previous mortgage insurance premium: 1.45%; 
Current mortgage insurance premium: 1.50%; 
Statutory maximum: 1.50%. 

Base loan amount: Greater than $625,500; 
Loan-to-value: Greater than 95%; 
Previous mortgage insurance premium: 1.50%; 
Current mortgage insurance premium: 1.55%; 
Statutory maximum: 1.55%. 

Term less than or equal to 15 years: 

Base loan amount: Any amount; 
Loan-to-value: Less than or equal to 78%; 
Previous mortgage insurance premium: 0%; 
Current mortgage insurance premium: 0.45%; 
Statutory maximum: 1.50%. 

Base loan amount: Less than or equal to $625,500; 
Loan-to-value: 78.01 to 90%; 
Previous mortgage insurance premium: 0.35%; 
Current mortgage insurance premium: 0.45%; 
Statutory maximum: 1.50%. 

Base loan amount: Less than or equal to $625,500; 
Loan-to-value: Greater than 90% to less than or equal to 95%; 
Previous mortgage insurance premium: 0.60%; 
Current mortgage insurance premium: 0.70%; 
Statutory maximum: 1.50%. 

Base loan amount: Less than or equal to $625,500; 
Loan-to-value: Greater than 95%; 
Previous mortgage insurance premium: 0.60%; 
Current mortgage insurance premium: 0.70%; 
Statutory maximum: 1.55%. 

Base loan amount: Greater than $625,500; 
Loan-to-value: 78.01 to 90%; 
Previous mortgage insurance premium: 0.60%; 
Current mortgage insurance premium: 0.70%; 
Statutory maximum: 1.50%. 

Base loan amount: Greater than $625,500; 
Loan-to-value: Greater than 90% to less than or equal to 95%; 
Previous mortgage insurance premium: 0.85%; 
Current mortgage insurance premium: 0.95%; 
Statutory maximum: 1.50%. 

Base loan amount: Greater than $625,500; 
Loan-to-value: Greater than 95%; 
Previous mortgage insurance premium: 0.85%; 
Current mortgage insurance premium: 0.95%; 
Statutory maximum: 1.55%. 

Source: FHA. 

[End of table] 

Further Increases to Premiums: 

Some mortgage industry observers said that FHA could raise its up-
front and annual premiums. For example, FHA could raise premiums to 
the statutory maximums, as outlined in table 3 above. One mortgage 
industry observer we spoke to and some of the literature we reviewed 
indicated that increases in FHA's premiums could result in more 
revenue for the Fund, provided that the increases did not reduce the 
volume of new FHA-insured mortgages enough to offset the increased 
revenue. 

However, we and others have noted that increases in the cost of 
mortgage insurance could increase the likelihood of adverse selection 
for FHA if its pricing were far different from its 
competitors.[Footnote 34] That is, low-risk borrowers with fewer down-
payment constraints could choose less costly loans from other sources, 
effectively making private mortgage insurance more competitive with 
FHA insurance. This shift in borrowers potentially could result in an 
increase in the overall risk of FHA's portfolio because FHA would be 
insuring relatively more high-risk borrowers. In this case, an 
increase in premiums can result in both lower premium revenue as low-
risk borrowers no longer purchase FHA insurance, and an increased 
claim rate among the remaining higher-risk borrowers. 

Further, others have noted that increased premiums could price some 
borrowers out of the market. As previously discussed, some mortgage 
industry observers have noted that many FHA borrowers have limited 
cash assets to pay for down-payment and closing costs. According to 
FHA, nearly all FHA-insured borrowers finance the up-front premium, so 
the net effect of increasing it would likely be to raise the 
borrowers' mortgage payments. 

FHA officials said that the agency was unlikely to implement further 
increases in annual premiums in the near future. They said that FHA 
loans could become unaffordable to some borrowers when interest rates 
increase. We also found that FHA's recently announced policy 
lengthening the duration of premium assessments might have an adverse 
impact on borrowers. Mortgagee Letter 2013-04, implemented on June 3, 
2013, mandates that the monthly mortgage insurance premium on FHA 
loans with LTV ratios exceeding 90 percent apply for the life of the 
loan, rather than terminating after the first 5 years once the 
principal amount declines to 78 percent LTV. FHA has acknowledged that 
this policy change will increase the annual percentage rate (APR) on 
FHA mortgages and may result in mortgages whose interest rates qualify 
them as higher-priced mortgage loans (HPML).[Footnote 35] Under 
Regulation Z, HPMLs must meet certain requirements, including those 
related to repayment ability, prepayment penalties, and escrows. 
[Footnote 36] After consulting with the Bureau of Consumer Financial 
Protection (also known as CFPB), FHA issued guidance to lenders that 
explained their responsibilities for meeting both HPML and FHA 
requirements. 

Implementing Risk-Based Pricing: 

Some of the literature we reviewed and mortgage industry observers we 
spoke to suggested that FHA assess premiums using "risk-based 
pricing." Risk-based pricing takes into account borrowers' risk 
attributes such as credit score, DTI ratio, product type, and LTV 
ratio. As described earlier, FHA's current premiums are based on the 
size and term of the loan and the LTV ratio and do not consider credit 
score and other risk factors, a practice FHA refers to as "average 
pricing." Using this method, low-risk borrowers pay the same actual 
price for insurance coverage as high-risk borrowers. For example, all 
FHA borrowers with loans at or below $625,500, LTV ratios less than or 
equal to 95 percent, and terms of greater than 15 years pay the same 
premiums, even though other measures of risk, such as credit scores, 
indicate that they represent a variety of risks. Risk-based pricing 
could address the adverse selection problem that is a possibility 
under average pricing (that is, when premiums charged do not align 
with the actual risks of borrowers so that low-risk borrowers are 
charged too much for insurance and thus seek it elsewhere). One 
mortgage industry observer also noted that it would more accurately 
align FHA's revenues with its potential claims. 

Conversely, others have argued that risk-based pricing would place FHA 
in the position of having to raise the mortgage financing costs of 
borrowers with weaker credit. To the extent that relatively low-risk 
borrowers might face lower premiums, they likely would not leave FHA. 
But other borrowers could face higher premiums, and those who could 
not qualify either for an FHA or conventional mortgage could be priced 
out of the market. For example, in 2007 we found that an FHA proposal 
to implement risk-based pricing would have affected the availability 
of FHA insurance for about 20 percent of the home purchase borrowers 
that FHA insured in 2005.[Footnote 37] This group would not have 
qualified for mortgage insurance under the parameters of the proposal 
because of high LTV ratios and low credit scores. FHA officials said 
that they are aware that the agency risks losing some lower-risk 
borrowers under its current pricing scheme. Therefore, they said that 
the agency has set pricing so that it covers the expected losses of 
the highest risk loans that its underwriting permits, with the idea 
that if FHA were to face increasing competition for its lower-risk 
borrowers, it would be charging a sufficiently high premium to cover 
expected losses on all newly insured loans. 

Proposed Changes That Restrict the Borrowers FHA Serves Would Affect 
the Agency's Role in the Mortgage Market: 

As noted earlier, FHA's share of loan originations has increased in 
recent years. During 2006, FHA insured approximately 4.5 percent of 
purchase mortgages. At its peak in 2009, it insured 32.6 percent of 
purchase mortgages, and in 2012 still insured 26.1 percent of purchase 
mortgages originated that year. Mortgage industry observers have 
proposed options that would limit FHA's market presence as a way of 
either reducing FHA's liability or better ensuring that it serves a 
certain market--that is, low-or moderate-income borrowers and first-
time homebuyers. These options include changes that would have a 
direct effect on FHA's market share, such as reducing loan limits from 
current levels and determining borrower eligibility based on income. 
Options that could have an indirect effect on FHA's market presence 
include reducing FHA's insurance coverage to less than 100 percent of 
the value of the loan and entering into risk-sharing agreements with 
private partners. Concerns have been raised that options affecting 
FHA's market presence might also affect its ability to serve its 
traditional countercyclical role to stabilize the housing market 
during times of increased stress or credit contraction. 

Reducing Loan Limits Could Focus FHA on Low-to Moderate-Income 
Borrowers and Reduce Its Market Share: 

Congress raised the loan limits on FHA-backed forward mortgages 
following the recent housing crisis and has continued to extend the 
higher limits. Currently, the loan limits vary by county, ranging from 
$271,050 to $729,750 for one-unit properties in the contiguous United 
States. These limits are set to expire on December 31, 2013. Mortgage 
industry observers have recommended that FHA's loan limits be lowered 
to reduce FHA's market share. Some recommend reducing the loan limits 
to what they were prior to the crisis, while others propose reducing 
them further.[Footnote 38] FHA data show that large loans are a small 
portion of FHA's loan pool. Loans that exceeded $450,000 (somewhat 
higher than the national conforming loan limit) comprised only 4 
percent of active FHA loans as of October 31, 2011.[Footnote 39] As of 
this date, 82 percent of FHA's active pool included loans with a 
balance of $271,050 or less. Because of the small number of high-value 
loans that FHA has endorsed, a reduction in loan limits might not have 
a large effect on its overall market share. However, for certain high-
cost markets, a reduction in FHA's loan limits would have a greater 
impact. For example, according to FHA, in fiscal year 2012 about 24 
percent of the loans FHA insured in Hawaii and about 10 percent of 
those it insured in California exceeded $450,000. Further, more than 
half of the loans over $450,000 endorsed during this time period were 
for properties located in California. We previously found that a 
possible reduction in the conforming loan limit could result in 
certain homebuyers in high-cost markets such as California needing to 
either provide a larger down payment or seek alternate financing. 
[Footnote 40] 

Industry observers have proposed approaches to reducing the current 
loan limits.[Footnote 41] For example, one researcher suggests 
limiting loans to no more than 100 percent of county median house 
price. The Mortgage Bankers Association (MBA) testified that Congress 
should allow the current limits to expire at the end of 2013 and 
reduce the loan ceiling to match the enterprises' conforming loan 
limits. FHA officials said that at the end of 2013 the loan limits 
would return to the levels established in HERA--limits that FHA has 
determined are appropriate for 2014.[Footnote 42] 

Further, a reduction in loan limits would allow FHA to focus on low-to 
moderate-income borrowers and first-time homebuyers, the groups that 
many industry observers see as FHA's traditional market. In a February 
2013 report, the Bipartisan Policy Center Housing Commission stated 
that a key objective for FHA should be to return to what it sees as 
FHA's traditional mission of serving primarily first-time homebuyers--
something that could be achieved in part through a gradual reduction 
in loan limits.[Footnote 43] A number of observers suggest that FHA is 
serving a population of borrowers far beyond those targeted by its 
traditional mission. For example, one observer noted that reducing 
FHA's loan limits by approximately 50 percent would still enable the 
agency to reach its intended population of first-time, minority, and 
low-income borrowers. Observers also noted that loan limits act as a 
proxy for income, with lower limits focusing FHA's efforts on low-
wealth borrowers. As noted above, about 78 percent of FHA-insured 
loans went to first-time homebuyers in 2012. 

A reduction in loan limits may have implications for FHA's financial 
condition, however. According to some industry observers, high-value 
loans improve the performance of the Fund and provide additional 
revenue beyond what a population of only low-and moderate-income 
borrowers would provide. FHA data show lower delinquency rates and 
serious delinquency rates among loans with the highest balances (6 
percent and 4 percent, respectively, of all active loans over $625,000 
as of October 31, 2011). In contrast, loans under $271,000 had a 
delinquency rate of 17 percent and a serious delinquency rate of 9 
percent. Factors other than loan size could contribute to these 
delinquency rates. For example, FHA officials noted that many high-
value loans were endorsed following the housing crisis when the 
economy had improved and may perform better as a result. FHA officials 
could not point to analysis that would support the argument that high-
value loans, all else being equal, perform any differently than 
smaller loans in terms of default, or the severity of the resulting 
losses. Nonetheless, FHA officials stated that a broader pool of 
insurable loans helps to better manage portfolio risk. 

According to a number of industry observers, by reducing loan limits 
the agency would effectively step back from the high-wealth market, 
allowing private lenders to step back into the market during the 
recovery. Some industry observers have raised concerns about FHA 
crowding out private capital. They note that lower loan limits would 
not have a significant effect on FHA lending but would allow high-
wealth buyers to be served in the conventional market, a shift they 
consider appropriate at this time. However, some industry observers 
have noted that the higher loan limits, which have been in effect 
since 2008, have allowed FHA to fulfill its countercyclical role of 
providing credit to borrowers when the private market was generally 
frozen. One organization stressed that the housing recovery was not 
complete, that lending remained constrained in many markets, and that 
Congress should be cautious about lowering loan limits. Industry 
observers also note that the elevated loan limit was particularly 
important in high-cost markets and that FHA continues to serve a 
significant role in these markets today. One observer argued that the 
relatively low FHA loan limits in effect prior to the crisis limited 
FHA's presence in high-value areas that suffered a more severe 
contraction during the housing crisis, which helped mitigate FHA's 
losses. Some said that FHA loan limits should be relatively 
constrained during most years, but raised when needed to provide 
stability in housing finance. Others noted that whatever loan limit 
FHA might use, it should be adjusted to allow for the variability in 
home prices across the country. FHA told us that it needs to have the 
flexibility to alter market-limiting policies--for example, by 
reinstating high loan limits quickly--to properly execute its 
countercyclical role. 

Eligibility Limits Based on Income Rather Than Loan Amount Would 
Target Lower-Income Borrowers, but Could Also Restrict Access to 
Credit: 

Some mortgage industry observers have suggested that eligibility 
should be based on borrowers' income in order to refocus FHA on its 
traditional role of providing mortgage credit to low-and moderate-
income borrowers.[Footnote 44] FHA data show that 64 percent of its 
purchase loans and 47 percent of its refinance loans in fiscal year 
2012 were made to low-and moderate-income borrowers. As shown in 
figure 4, the income levels of borrowers approved for purchase loans 
have varied over time. During the recent housing crisis, the 
proportion of FHA-insured mortgages made to low-income borrowers 
dropped substantially just as the proportion to high-income borrowers 
increased. Between 2005 and 2008, the share of FHA borrowers that had 
low incomes dropped about 16 percent, while the share that had high 
incomes increased about 14 percent. FHA has continued to endorse a 
larger proportion of high-income loans through 2012. These shifts are 
consistent with the increased loan limits in effect during the period. 
That is, loan limit increases expanded FHA's portion of the market 
that would be sought after by households with relatively higher income. 

Figure 4: Percentage of FHA Purchase Loans by Borrower Income, 2000-
2013: 

[Refer to PDF for image: horizontal bar graph] 

Fiscal year: 2000; 
Number of endorsements: 614,193; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 46.71%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 33.86%; 
High-income borrowers (More than 120 percent of area median income): 
17.04%; 

Fiscal year: 2001; 
Number of endorsements: 806,818; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 47.37%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 33.52%; 
High-income borrowers (More than 120 percent of area median income): 
17.03%. 

Fiscal year: 2002; 
Number of endorsements: 862,898; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 50.27%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 32.22%; 
High-income borrowers (More than 120 percent of area median income): 
15.6%. 

Fiscal year: 2003; 
Number of endorsements: 658,640; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 52.35%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 31.18%; 
High-income borrowers (More than 120 percent of area median income): 
14.85%. 

Fiscal year: 2004; 
Number of endorsements: 586,110; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 53.68%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 30.75%; 
High-income borrowers (More than 120 percent of area median income): 
14.57%. 

Fiscal year: 2005; 
Number of endorsements: 353,844; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 52.52%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 31.24%; 
High-income borrowers (More than 120 percent of area median income): 
15.33%. 

Fiscal year: 2006; 
Number of endorsements: 313,998; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 48.37%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 32.98%; 
High-income borrowers (More than 120 percent of area median income): 
18.28%. 

Fiscal year: 2007; 
Number of endorsements: 278,395; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 41.05%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 35.16%; 
High-income borrowers (More than 120 percent of area median income): 
23.79%. 

Fiscal year: 2008; 
Number of endorsements: 631,655; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 36.33%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 34.38%; 
High-income borrowers (More than 120 percent of area median income): 
29.29%. 

Fiscal year: 2009; 
Number of endorsements: 995,550; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 42.85%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 30.18%; 
High-income borrowers (More than 120 percent of area median income): 
26.95%. 

Fiscal year: 2010; 
Number of endorsements: 1,118,759; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 48.52%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 27.63%; 
High-income borrowers (More than 120 percent of area median income): 
23.83%; 

Fiscal year: 2011; 
Number of endorsements: 788,194; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 46.77%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 27.29%; 
High-income borrowers (More than 120 percent of area median income): 
25.93%. 

Fiscal year: 2012; 
Number of endorsements: 743,532; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 47.97%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 27.36%; 
High-income borrowers (More than 120 percent of area median income): 
24.66%. 

Fiscal year: 2013; 
Number of endorsements: 401,596; 
Percentage of loans made to: 
Low-income borrowers (up to 80 percent of area median income): 46.55%; 
Moderate- and middle-income borrowers (81-120 percent of area median 
income): 27.88%; 
High-income borrowers (More than 120 percent of area median income): 
25.56%. 

Source: FHA data. 

Note: Data for fiscal year 2013 are from October 2012 through April 
2013. 

[End of figure] 

According to some of the literature, income limits would affect the 
market that FHA serves, targeting FHA's guaranty to low-and moderate-
income borrowers. In recent congressional hearings, industry observers 
encouraged a system of assessing borrowers according to area median 
income targets to determine program eligibility.[Footnote 45] In a 
2011 white paper on reforming the housing finance market that was 
developed by the U.S. Department of the Treasury (Treasury) and HUD, 
the administration presented one option for reform that would strictly 
limit FHA eligibility to low-and moderate-income borrowers, leaving 
the risk for high-income borrowers to the private market.[Footnote 46] 

A change to income-based eligibility could restrict certain borrowers' 
access to credit. In its white paper, the administration cautioned 
that some borrowers, who may be ineligible when their income exceeds a 
threshold, may find it difficult to afford the cost of a conventional 
30-year fixed-rate mortgage. Observers point to the additional costs, 
such as higher premiums and interest rates, that some borrowers might 
face if they must seek conventional mortgage insurance. Multiple 
observers have noted that even borrowers with relatively strong 
incomes have difficulty accumulating sufficient savings for a down 
payment, especially in high-cost areas. 

Several industry observers and FHA said that a system of income 
verification to determine FHA eligibility would also be difficult to 
implement. For example, one observer we interviewed noted that FHA's 
current loan application process required prospective borrowers to 
provide documentation of qualifying income, but said that additional 
sources of income were not considered. According to this observer, if 
maximum income levels were in place, lenders would have to gather 
documentation for all income sources and assess the borrower's income 
against all liabilities and expenses, which could give borrowers an 
incentive to under report income. FHA officials told us that basing 
eligibility on income would create compliance risks for lenders and 
would be time consuming. Yet another industry observer added that 
income verification could also affect lenders' behavior, making them 
fearful of increased liability under indemnification agreements if 
they failed to correctly identify all borrower income to verify a 
borrower's eligibility.[Footnote 47] The FHA Commissioner noted that 
income verification was difficult to implement in other programs, such 
as the Low-Income Housing Tax Credit Program.[Footnote 48] FHA 
officials told us that loan limits, rather than income limits, could 
help FHA focus the market it served. 

Further, while income limits could be structured to vary by geographic 
area, as loan limits now do, implementation could be difficult. Some 
observers described to us the complexity of implementing and 
monitoring income limits that vary by geographic area, and one 
suggested that a national income ceiling rather than income limits set 
by area median income might be a more expedient policy. FHA officials 
and industry observers told us that determining program eligibility 
based on appropriate loan limits is an effective substitute for income 
limits in order to target the program to low-and moderate-income 
borrowers. 

Some observers have further argued that limiting eligibility based on 
income could affect FHA's ability to manage credit risk. Some argue 
that FHA-insured loans made to borrowers with higher income perform 
better than loans to lower-income borrowers. However, we have not seen 
analysis that would support the argument that income alone is a 
predictor of credit risk. Limiting eligibility based on income may 
reduce the number of insured loans, which could constrain FHA's 
ability to manage risk. An industry observer noted that FHA was 
intended to be more universally available than a program for only the 
lowest-risk borrowers might be. FHA officials noted the importance of 
maintaining a broad-based insurance pool. FHA officials also stated 
that they were not aware of studies concluding that serving only low-
income borrowers would improve the agency's financial condition. 

Finally, this option could limit FHA from serving its countercyclical 
role in the future. In its white paper, the administration warned that 
reducing FHA's market share too much--for example, by serving only 
low- and moderate-income borrowers--could affect its ability to ensure 
access to capital during a crisis.[Footnote 49] The paper emphasized 
that without sufficient government support to mitigate a credit 
crisis, downturns could be more severe, increasing costs to the 
taxpayer. 

Reducing FHA's Insurance Coverage Would Reduce Losses, but Might Not 
Protect Taxpayers and Could Increase Costs for Borrowers: 

Currently, FHA insures 100 percent of the principal balance of the 
loan involved in a claim and other eligible costs. Some mortgage 
industry observers have suggested that FHA's loan coverage be reduced 
in order to limit FHA's risk and market share. VA's guaranty program 
is often cited as a model, as it insures only 25 to 50 percent of the 
original principal in the case of a default. Various levels of reduced 
loan coverage have been suggested for FHA, ranging from 90 percent 
coverage, which some observers say would have little impact, down to 
25 percent coverage. 

Industry observers proposing this change point to a reduction in 
taxpayer risk as a key benefit.[Footnote 50] They argue that a lower 
level of insurance coverage would reduce FHA's liability for defaulted 
loans by reducing the severity of the agency's loss. We have also 
found that a reduction in insurance coverage could have a beneficial 
effect on the Fund. In May 1997, we examined the potential effects of 
reducing FHA's insurance coverage and found that lower coverage would 
reduce both the volume of FHA-insured loans and income from premiums 
but would also reduce FHA's losses and ultimately have a beneficial 
effect on the Fund.[Footnote 51] Others have noted that a reduction in 
loan coverage could provide lenders an incentive to improve 
underwriting quality, thus reducing the risk of default. Some have 
cited the relatively superior delinquency and default rates in the VA 
program as evidence of careful origination by lenders that must assume 
some credit risk for VA-guaranteed loans.[Footnote 52] Nonetheless, it 
is important to note that VA limits its eligibility to veterans who 
have served in a branch of the armed services and received an 
honorable discharge, certain currently serving members of the Reserves 
or National Guard, and spouses of veterans under certain 
circumstances. It therefore starts with a universe of eligible 
borrowers that are different from the population that might seek an 
FHA-insured mortgage. Also, as mentioned in the previous section, VA 
underwriting differs somewhat from that of FHA, with greater attention 
given to the veteran's residual income. Further, the VA program 
provides supplemental servicing to borrowers that face difficulty 
making mortgage payments. These and other differences need to be 
considered before it can be concluded that differences in insurance 
coverage explain the differences between VA and FHA default rates. 

Industry observers also discussed the impact of a reduction in 
insurance coverage on borrowers' access to credit. Because lenders 
would be exposed to additional risk, they could increase fees and 
interest rates, which some industry observers noted in testimonies to 
Congress. Also, for some lenders the additional exposure might prompt 
the purchase of additional insurance coverage from third parties, the 
cost of which could be passed on to borrowers. We have reported that 
without the guaranty for FHA-endorsed mortgages, lenders would likely 
make fewer and more costly loans, making homeownership more expensive, 
limiting borrowers' access to credit, and reducing FHA's presence in 
underserved communities.[Footnote 53] Our analysis showed that if 
lenders imposed stricter underwriting criteria or increased fees and 
interest rates, high-risk borrowers would be disproportionately unable 
to access FHA-endorsed mortgages. We found that reducing insurance 
coverage would limit FHA's ability to stabilize distressed communities 
and housing markets during regional economic downturns. 

Further, some industry observers testified to Congress or told us that 
reduced FHA insurance coverage could simply transfer taxpayer risk 
from FHA to Ginnie Mae.[Footnote 54] That is, any additional risk 
borne by the lender would pose additional risk to Ginnie Mae as the 
guarantor of the securities issued by that lender. This risk would 
require Ginnie Mae to provide more intense monitoring of its 
counterparties' financial condition, potentially increasing the fees 
it required to provide its guarantee. FHA officials agreed that Ginnie 
Mae would assume additional counterparty risk with a reduction in 
coverage. Ginnie Mae officials noted that issuers would likely seek 
additional third-party assurance, most likely through additional 
mortgage insurance, to manage the additional risks they might face. As 
a result, borrowers could face further costs. Issuers could also take 
other steps, such as limiting the amount of FHA-insured lending they 
would permit or overlaying additional credit requirements, which would 
limit their participation in the program. In addition, MBA testified 
that this option would limit the ability of independent mortgage 
bankers and other small lenders to manage risk. It noted that small 
mortgage lenders were not structured to take on large amounts of 
credit risk and might restrict credit to borrowers, or leave the 
mortgage industry. 

Other observers note that reducing FHA's loan coverage would 
facilitate the return of private capital. For example, one stated that 
the 100 percent coverage that FHA provides combined with its expanded 
market share created a barrier to the reentry of private capital to 
U.S. residential mortgage finance. The same observer noted that 
capital regulations and other requirements strongly favor obligations 
with a government guarantee over those supported by private capital. 

Proposals for Entering into Risk-Sharing Agreements with Private 
Partners Vary: 

FHA does not currently engage in single-family risk sharing. To 
protect the taxpayer by sharing risk with the private market, various 
industry observers have suggested that the agency explore this option. 
In 2002, the Millennial Housing Commission recommended that Congress 
authorize FHA to initiate single-family risk-sharing demonstration 
programs, stating that FHA should have broader authority to choose its 
partners, loss position, and types of credit enhancements (including 
reinsurance as well as insurance or reinsurance on pooled loans). 
[Footnote 55] The report also stated that while FHA could absorb risk 
better than private lenders, potential partners could have superior 
risk assessment and management systems and might be able to provide 
access to new products and delivery systems targeting communities with 
underserved borrowers that FHA did not yet reach. In 2007, we found 
that a public-private risk-sharing arrangement would recognize the 
government's ability to spread risk.[Footnote 56] We also found that 
private mortgage industry participants generally were more flexible 
and responsive to market pressures and better able to innovate and 
adopt new technologies quickly. Industry observers have continued to 
promote various forms of risk sharing to improve FHA's financial 
condition.[Footnote 57] 

Two main approaches for risk sharing have been proposed by industry 
observers: 

* Coinsurance. This approach would create agreements between FHA and 
private mortgage insurers. The private mortgage insurer would conduct 
an independent underwriting of the borrower and the mortgage being 
sought. If the borrower and the mortgage underwriting terms met the 
conditions that both FHA and the private insurer agreed on, the 
private insurer would take the first loss on the loan, and FHA would 
cover the remaining loss. One industry observer suggested that the 
agency should reduce taxpayer risk by assuming losses only after 
private partners absorbed first losses of 25 to 35 percent. Another 
risk-sharing arrangement between FHA and other partners could be a 
model similar to FHA's Multifamily Risk-Sharing Programs through which 
the agency shares proportional risk at varying levels between 10 and 
90 percent with Fannie Mae, Freddie Mac, and housing finance agencies 
among others. 

* Reinsurance. Large portfolio lenders and the enterprises will at 
times enter into reinsurance contracts with approved counterparties to 
sell portions of credit risk in their loan portfolios. According to a 
private mortgage insurer testifying before a congressional committee, 
this approach has the benefit of minimizing impacts on lenders and the 
potential to be implemented more quickly than a coinsurance 
arrangement. The representative noted that FHA should have the 
flexibility to selectively test such arrangements. 

Risk sharing could affect taxpayers' risk, according to industry 
observers. It could protect the taxpayer, not only because private 
partners would assume some of the risk but also because the quality of 
the underwriting might improve because private partners would want to 
minimize the likelihood of loss. However, to the extent that FHA would 
offer both full mortgage insurance and engage in risk sharing, it 
could be subject to adverse selection. That is, private partners could 
seek relatively low-risk borrowers for the shared-risk product, 
leaving FHA with the riskiest borrowers. One report notes that under 
risk-sharing agreements, private partners may act in other ways that 
are contrary to FHA's interest.[Footnote 58] For example, according to 
this report, if FHA takes only a catastrophic loss position, the 
partner may have little incentive to minimize FHA's losses once the 
partner's maximum exposure level has been reached. Sharing risk on a 
pro rata basis, starting with the first dollar of loss and ending with 
the last dollar of loss, creates stronger incentives for FHA's risk-
sharing partners to use sound underwriting terms and service their 
loans diligently. We have found that this is particularly true when 
there is a more equal division of risk.[Footnote 59] If FHA agrees to 
assume the first portion of loss on default, the partner may not feel 
the need to protect against a high incidence of claims as long as the 
loss severity is not expected to reach its maximum level of exposure. 
The partner would also need to be sufficiently capitalized or 
otherwise protected to withstand its portion of the loss. Also, one 
observer warned that FHA would be at risk because it lacked the 
capacity to analyze risk-sharing proposals, which could place it in a 
weak position with partners. Consistent with this, FHA officials told 
us that FHA would need to increase its staff and analytic capacity to 
safely implement risk-sharing agreements. 

Risk sharing would also affect the role that Ginnie Mae plays in 
guaranteeing timely payment of principal and interest on mortgage-
backed securities. That is, like reducing FHA's loan guarantee 
coverage below 100 percent, risk sharing changes the nature of Ginnie 
Mae's exposure to counterparty risk, according to observers. Ginnie 
Mae would need to undertake assessment of a new class of 
counterparties--the private partner providing the insurance coverage--
while continuing to assess the counterparty risk of its issuers, one 
observer noted. Ginnie Mae officials confirmed that any FHA risk-
sharing agreements would increase the agency's counterparty risk and 
noted that they would probably require issuers to hold more capital to 
mitigate this risk. One paper emphasized that risk sharing would also 
require FHA to monitor counterparty risk and provided a number of 
approaches for doing so.[Footnote 60] 

Ultimately, any risk-sharing arrangement would need to carefully 
consider the structure of premiums and the way they were shared 
between parties. Identifying the type and level of premium needed by 
the federal government requires considering not only expected losses 
from loans that default and losses exceeding a predetermined level, 
but also unexpected losses from infrequent but costly adverse market 
conditions on both the national and regional level. Some argue that 
the federal government would still absorb catastrophic risk regardless 
of how risk sharing and premiums are structured. In this case, FHA 
would need to receive premiums across a broad spectrum of the market. 

In addition, like other options for improving FHA's viability, risk 
sharing could impact other mortgage market participants and reduce 
borrowers' access to credit, according to observers. Depending on how 
FHA structured risk sharing, including how widely it would be applied 
to FHA's future endorsements, this option could reduce participation 
by smaller mortgage lenders, particularly community banks, which might 
have difficulty meeting the eligibility criteria for such a program, 
according to some industry observers. Others have expressed concern 
that risk sharing could raise the cost of the mortgage credit, as 
private investors would demand a market rate of return. While this 
trade-off might be viewed as acceptable in terms of improved 
underwriting, in times of market contraction risk sharing could 
significantly raise the cost and limit the availability of credit to 
borrowers, according to one observer. That is, FHA's role in 
stabilizing mortgage markets could be affected by its partners' 
willingness to continue underwriting during market contractions. This 
may limit FHA's ability to serve as a countercyclical force during 
such national or regional housing downturns. 

Some of the literature we read stressed the importance of FHA serving 
a countercyclical role, as it has in the past, including by mitigating 
the effect of the 2007-2009 financial crisis on the housing market. 
One observer cautioned that broad changes, such as risk sharing, 
applied to FHA's entire portfolio, or too quickly implemented without 
a full understanding of the potential effects of the change, could 
reduce its flexibility to adjust to larger housing market shifts. 
Others have stated that risk sharing might constrain the agency's 
countercyclical flexibility because FHA and its private partners might 
not have the same incentives. During a downturn, private partners in 
risk-sharing arrangements would likely lack the incentive to serve 
deteriorating markets. Further, if FHA could endorse only loans that 
involved a private partner, a contraction of private credit could 
prevent it from expanding when such action was needed most. Another 
observer encouraged a small, discretionary or piloted approach to any 
risk-sharing program, suggesting that it was not necessary to make 
this option mandatory for each new endorsement. FHA officials 
cautioned that risk sharing should only be considered in the context 
of broad mortgage market reform, which has yet to be resolved. 

Greater Operational and Managerial Powers Could Give FHA Greater 
Flexibility but Could Limit Congressional Direction: 

Although FHA is a wholly owned government corporation within HUD, it 
does not have the corporate powers other government corporations have. 
Some mortgage industry observers have suggested that making FHA an 
independent government corporation--more autonomous from HUD--could 
give it greater operational and managerial flexibility and the ability 
to be nimble when faced with changes in the housing market or problems 
in its programs. For example, FHA could have enhanced enforcement 
powers, greater authority to make changes to program requirements, and 
additional authorities to invest in technology and staff. Some of 
these authorities would bring FHA's corporate powers more in line with 
other government corporations. However, FHA and others said that these 
flexibilities could be implemented within FHA's existing 
organizational structure. But even within the existing structure, many 
of these options would require congressional action to implement. 
Further, these reform options are not mutually exclusive--that is, one 
or more options could be implemented--and implementation of these 
options would involve trade-offs between, for example, congressional 
direction and agency flexibility, or between efforts to minimize costs 
to borrowers and to make the program self-sustaining. 

Making FHA an Independent Government Corporation Could Provide It with 
More Flexibility: 

Some mortgage industry observers have suggested that making FHA an 
independent government corporation could increase its flexibility to 
respond to changing market conditions and mitigate risks. FHA is a 
wholly owned government corporation within HUD but does not have some 
of the powers that other government corporations have.[Footnote 61] 
Specifically, Congress sometimes exempts government corporations from 
key management laws to provide them with greater flexibility than 
federal departments and agencies typically have in hiring employees, 
paying these employees competitive salaries/benefits, disclosing 
information publicly, and procuring goods and services. In 1995, we 
assessed the extent to which FHA and other government corporations had 
to comply with 15 selected federal statutes.[Footnote 62] FHA reported 
that it had to comply with 14 of the 15 federal statutes, while other 
government corporations reported greater flexibility.[Footnote 63] For 
example, Amtrak reported full adherence to two statutes. In addition, 
when FHA was moved within HUD in 1965, Congress assigned the corporate 
powers of FHA to the Secretary of HUD, who has delegated them to the 
Assistant Secretary for Housing/FHA Commissioner. 

Some observers have suggested that one way to give FHA increased 
flexibility would be to increase its corporate powers. For example, a 
1994 National Academy of Public Administration study stated that FHA's 
commissioner did not have the flexibility to adjust FHA products to 
respond to changing market conditions, such as fluctuating interest 
rates, and that the commissioner had to operate within the budgeting 
and administrative parameters of a traditional federal agency. 
[Footnote 64] The report recommended that Congress transfer the 
corporate powers of FHA from the HUD secretary to the corporation, 
permitting it to function with greater operational autonomy within 
HUD. It also recommended that Congress vest management of FHA in a 
single administrator appointed by the President, with Senate 
confirmation for a 6-year term of office. Under this proposal, the 
administrator would be compensated at the same level as the chief 
executive officer of comparable government corporations. In 2002, the 
Millennial Housing Commission made a similar proposal, but its 
proposal would combine FHA and Ginnie Mae and establish a corporate 
board of directors.[Footnote 65] Recently, some observers have 
suggested similar structures. 

Other observers have suggested moving FHA outside of HUD. For example, 
one paper suggested organizing FHA as an independent government 
agency, a government-sponsored enterprise, or even a privatized entity 
structured as an assigned risk pool that would spread risk for 
otherwise uninsurable borrowers across insurance carriers in 
proportion to the size of their portfolios.[Footnote 66] According to 
the author, any of these structures could make underwriting, pricing, 
and administration more efficient while achieving what he viewed as 
the agency's social objectives of providing credit enhancements 
through insurance to serve otherwise marginal low-income, first-time, 
and often minority homebuyers. He further stated that the FHA 
commissioner should have an appointment independent of HUD and for a 
term that would extend beyond a single administration term. Another 
observer testified that setting up FHA outside of HUD would reduce 
incentives for future administrations to impose policies on FHA that 
limited its flexibility and increased risks. However, two observers we 
interviewed said that making FHA an independent corporation outside of 
HUD would make it more difficult for Congress to hold it accountable. 
FHA, which was created in 1934, operated outside of a cabinet 
department for decades before becoming part of HUD, which was created 
in 1965. In addition, some people we interviewed said that FHA should 
remain affiliated with HUD so that it could collaborate closely with 
other department offices on housing policy and remain part of a 
cabinet-level agency. 

According to the literature, making FHA more autonomous could provide 
it the flexibility to determine the best way to meet policy goals set 
by Congress or HUD and mitigate risk. For example, in a congressional 
testimony an observer suggested that FHA be provided the authority, 
without further congressional action, to create or alter specific 
insurance programs. Such authority, the observer argued, would enable 
FHA to react promptly to changes in market and other conditions. In 
addition, the observer stated that hiring, salaries, personnel 
management, and procurement could be freed from federal government 
constraints in order to be more consistent and competitive with the 
private sector. Some of the literature we reviewed noted that FHA had 
exercised greater control over its resources when it was independent 
of HUD. 

However in June 2007, we found that making FHA an independent 
government corporation could have budgetary and oversight implications 
that would need to be considered.[Footnote 67] For example, Congress 
would have to determine the extent to which (1) the corporation's 
earnings in excess of those needed for operations and reserves would 
be available for other government activities and (2) the corporation 
would be subject to federal budget requirements. Also, if the 
corporation were created outside of HUD, Congress would have to 
consider whether oversight of the corporation would require a new 
institution or could be done by an existing organization. In addition, 
an observer said that making FHA an independent government corporation 
or providing it with certain flexibilities, such as powers to change 
its products, could make FHA loans more attractive to borrowers who 
should be served by the private sector. Although such autonomy would 
also permit FHA greater capacity to manage risk, two observers we 
interviewed suggested that any additional autonomy or flexibility 
should be accompanied by clear direction on FHA's mission to serve 
borrowers not otherwise served by the private sector. 

FHA Could Gain Greater Flexibility without Changing Its Organizational 
Structure: 

FHA and others have said that although making the agency an 
independent government corporation could increase the agency's 
flexibility, the agency could be given increased flexibility without 
such changes. For example, mortgage industry observers have suggested 
giving FHA enhanced enforcement powers, greater authority to make 
changes to program requirements, and additional authorities to invest 
in technology and staff. Many of these options would require 
congressional action to implement. Notwithstanding the potential 
benefit and costs of these options, there are a number of steps that 
FHA could undertake under its existing authority, including actions we 
have previously recommended. 

Giving FHA Enhanced Enforcement Powers: 

In order to originate FHA-insured loans, lenders must be approved by 
FHA to participate in its mortgage insurance programs. Virtually all 
of the lending institutions approved to participate in FHA's single-
family mortgage insurance programs have direct endorsement authority, 
meaning that they can underwrite loans and determine their eligibility 
for FHA mortgage insurance without HUD's prior review. Direct 
endorsement lenders can apply to participate in the Lender Insurance 
Program, which enables high-performing lenders to approve mortgages 
for FHA insurance without a pre-endorsement review by HUD. To hold 
lenders accountable for program violations or poor performance, FHA 
may (1) suspend their direct endorsement authority, (2) terminate 
their loan origination or underwriting authority through its Credit 
Watch program, or (3) take enforcement action through the Mortgagee 
Review Board.[Footnote 68] 

In its proposed budget for fiscal year 2014, FHA requested a number of 
additional enforcement powers. Specifically: 

* Since 2010, FHA has asked for enhanced indemnification authority for 
direct endorsement lenders.[Footnote 69] Currently, FHA has authority 
to require indemnification only for lenders that participate in FHA's 
Lender Insurance Program. According to FHA, granting the agency this 
authority would enable it to obtain indemnification from all of its 
approved lenders for loans that do not comply with its guidelines. 
Legislation proposed in March 2013 includes a provision intended to 
address this issue.[Footnote 70] 

* HUD may terminate a lender's approval to originate or underwrite FHA-
insured loans in a specific geographical area if a lender's branch 
office default and claim rate exceeds the established Credit Watch 
Termination thresholds.[Footnote 71] However, FHA is also seeking 
authority to terminate origination and underwriting approval on a 
broader geographic basis, stating that such authority would enhance 
its ability to review lender performance. If a lender was found to 
have an excessive rate of early defaults or claims, FHA would have 
greater flexibility in terminating the lender's ability to originate 
or underwrite single-family mortgages for FHA insurance. FHA has been 
seeking this authority since 2010. Again, the 2013 proposed 
legislation includes such a provision. 

* To help make loss mitigation more effective, FHA is seeking 
authority to, on a case-by-case basis, transfer servicing of loans to 
institutions better equipped to reduce losses.[Footnote 72] 
Specifically, this authority would allow FHA to require any of the 
following actions when a servicer underutilized FHA's loss-mitigation 
tools or the agency deemed the action necessary to protect the 
interests of the Fund: (1) transfer servicing from the current 
servicer to a specialty servicer designated by FHA; (2) require a 
servicer to enter into a subservicing arrangement with an entity 
identified by FHA; or (3) require a servicer to engage a third-party 
contractor to assist in some aspect of loss mitigation such as 
borrower outreach. According to FHA, such authority would permit the 
agency to better avoid losses from poor servicing of FHA-insured 
loans, yielding better results for borrowers and FHA. 

* Finally, FHA is seeking greater flexibility in establishing the 
metrics it uses to compare lender performance so that it can more 
effectively assess lender performance during all market conditions. As 
discussed previously, FHA is currently required by statute to compare 
lenders' default and claim rates by geographic area. With enhanced 
authority to set alternative performance metrics, FHA said it would be 
able to compare a lender's rate of early defaults and claims (for 
insured single-family mortgage loans) with the rates of other lenders 
on any basis determined appropriate. Examples of metrics include 
geographic area, varying underwriting standards, or populations served. 

The majority of the observers we interviewed said that FHA needed 
authority for enhanced enforcement actions. For example, some said 
that FHA needed these additional powers to more effectively manage 
risk and avoid unnecessary losses. Others suggested additional 
options--for example, requiring lenders to take back loans that 
defaulted within the first 6 months. However, one observer said that 
the prospect of tough administrative and legal actions already 
provided strong incentives for lenders to carefully follow FHA program 
guidelines. Two stakeholders we interviewed stated that increased 
scrutiny of lenders by FHA and others had increased concern among 
lenders about the risks of litigation. As a result, lenders have moved 
to further restrict credit in recent years. Many FHA lenders have 
taken the step of imposing additional requirements (known as credit 
overlays) on FHA loans, potentially making it more difficult for 
borrowers to obtain FHA loans. 

Giving FHA Greater Authority to Change Program Requirements, Including 
Emergency Powers: 

FHA and some mortgage industry observers have suggested that the 
agency should have more authority to make changes to program 
requirements, including emergency powers. Currently, FHA must go 
through the rulemaking process or seek legislative authority to make 
major changes to its programs. For example, after problems with loans 
with seller-funded down-payment assistance were identified, it was 
several years before these loans were disallowed. HUD's latest annual 
report on the Fund noted that the effect of loans with seller-funded 
down-payment assistance on the Fund was expected to be more than $15 
billion in losses.[Footnote 73] Problems associated with these loans 
are well documented. A March 2005 HUD contractor study found that 
property sellers who provided down-payment assistance through 
nonprofits often raised sale prices of the homes involved to recover 
the required payments that went to the organizations.[Footnote 74] As 
noted previously, in November 2005, we also found that loans with this 
type of assistance had inflated prices and defaulted more often than 
loans without such assistance.[Footnote 75] In October 2007, FHA 
published a rule that prohibited seller-funded down-payment 
assistance. Subsequently, the rule was struck down by the courts on 
procedural grounds. Congress ultimately prohibited the use of this 
assistance in January 2009. 

FHA is currently trying to address losses from its HECM program 
(reverse mortgages that permit persons 62 years and older to convert 
their home equity into cash advances), but has not been able to make 
programmatic changes that it has determined might stem them. In a 
testimony on HUD's fiscal year 2014 proposed budget, the Secretary 
attributed the potential need for $943 million in permanent and 
indefinite budget authority for the Fund in fiscal year 2013 to losses 
in the HECM program.[Footnote 76] FHA has proposed a number of changes 
to the HECM program, such as mandating the use of escrow accounts to 
ensure continued and timely payment of property charges, including 
taxes and insurance. However, FHA officials said that the average time 
for a rulemaking of this type was about 18 months--a length of time 
that exposed the agency and the Fund to risks that could be avoided 
if, for example, it could make changes through a mortgagee letter. 
Recently, FHA was provided authority to establish through mortgagee 
letters any requirements that HUD "determines are necessary to improve 
the fiscal safety and soundness" of the HECM program.[Footnote 77] FHA 
officials told us that a mortgagee letter could be issued within 30 to 
60 days. Another approach to dealing with the issue would be to limit 
the ability of borrowers to withdraw up-front the maximum amount 
allowable under the program. HUD noted that the vast majority of 
borrowers in the HECM program take out 80 percent or more of the 
maximum amount possible in one initial cash draw, and that this 
increases the likelihood that they have insufficient funds to pay 
items such as property taxes. In its November 2012 annual report to 
Congress, FHA announced that it would take immediate action to reduce 
the amount borrowers are permitted to draw out at the time of 
origination of their HECM loan. The report notes that the change would 
protect FHA from losses and reduce the likelihood of borrower default 
due to nonpayment of taxes and insurance. Although FHA points to other 
actions that will be needed to reform the HECM program, this example 
demonstrates the importance of FHA exercising the authority it already 
has. 

Several proposals have been put forward that would increase FHA's 
ability to make changes to its programs. One observer has recommended 
that Congress give the HUD secretary special emergency powers to 
suspend FHA insurance programs or make emergency modifications to a 
program when the HUD secretary finds that current program terms expose 
the taxpayers to an elevated risk of loss and fail to serve the public 
interest. In addition, a paper that lays out the current 
administration's plan to reform the nation's housing finance market 
stated that the administration should work with Congress to give FHA 
more flexibility to respond to stress in the housing market and manage 
its risk more effectively.[Footnote 78] It added that doing so would 
mean giving FHA flexibility to adjust fees and programmatic parameters 
more quickly than it can today. Regardless, two observers pointed to 
the need for offsetting any additional flexibility that might be 
afforded to FHA with clear limits to this authority, such as limits on 
the duration of such changes absent a formal rulemaking process. 

Two observers we interviewed expressed concern about giving FHA 
greater authority to make significant program changes, stating that 
such authority should be reserved for Congress. One noted that during 
the recent housing crisis Congress showed that it was able to act 
quickly to change FHA program requirements when needed by increasing 
the loan limit requirements. Also, he told us that FHA did not need 
congressional action to change its programs. For instance, FHA could 
create an interim rule to quickly handle a problem while going through 
the official rulemaking process to make a permanent change.[Footnote 
79] Similarly, the other observer said that FHA could make some 
changes through mortgagee letters and the rulemaking process. However, 
according to FHA, HUD's Office of General Counsel has advised that not 
all procedures or policies may be changed by interim rule and interim 
rules can be particularly sensitive to litigation and a legal stay. 
Thus it is the General Counsel's opinion that statutory authority is 
often the safest and fastest route to make changes. 

Providing FHA with Additional Funding to Upgrade Information 
Technology: 

FHA has reported that the more than 40 information systems its single-
family programs use are outdated, unable to sustain the increasing 
volume of insurance applications, and costly to maintain. In addition, 
recent increases in FHA's business volume have exacerbated its 
information technology (IT) constraints. A consultant FHA hired to 
examine technology constraints and identify risks related to 
processing workloads (for single-family programs) reported in 2009 
that critical elements of IT infrastructure were at capacity, causing 
work slowdowns and poor customer service. For example, network 
overloads slowed systems in the afternoon, when work hours overlapped 
at the homeownership centers (which are in different time zones). To 
partially address these issues, HUD upgraded the mainframe's system 
capacity and made changes to certain applications to improve response 
time. Nevertheless, during a period in which transaction levels 
continued to increase, FHA had reached the limit of hardware and 
software capacity on IT systems. 

Moreover, the audit of FHA's 2011 and 2012 financial statements 
identified a significant deficiency related to IT systems and stated 
that FHA management and the HUD Office of the Chief Information 
Officer should mitigate persistent IT control deficiencies.[Footnote 
80] The audit report noted that expensive and manual compensating 
controls, including monthly reconciliations of data among the 
interfaced systems, were needed to manage the numerous systems and 
that security and access controls had weaknesses. We found in November 
2011 that the large number of systems resulted in hundreds of 
interfaces, which meant that changing one system required extensive 
effort to maintain the interfaces across systems.[Footnote 81] The 
multiple systems and interfaces also presented challenges for 
maintaining appropriate accessibility levels, security controls, and 
privacy standards. 

To address system constraints, FHA has initiated the FHA 
Transformation Initiative to improve FHA's management of insurance 
programs through the development and implementation of a modern 
financial services information technology environment that is expected 
to improve loan endorsement processes, collateral risk capabilities, 
and fraud prevention.[Footnote 82] For fiscal years 2010 and 2011, HUD 
reported that the Transformation Initiative funding made available was 
$58.5 million.[Footnote 83] According to FHA, the agency maintains an 
aggressive, robust, and varied project management and applications 
development portfolio aimed at deploying new and modernizing existing 
mortgage insurance capabilities and business processes. In June 2013, 
we found that HUD had not yet fully implemented key project management 
practices in executing and managing the IT projects associated with 
the FHA Transformation Initiative.[Footnote 84] Specifically, while 
the department had developed project management documents such as 
charters and requirements management plans, none of these documents 
included all of the key details that could facilitate effective 
management of its projects such as full descriptions of the work 
necessary to complete the projects, cost and schedule baselines, or 
prioritized requirements, among other things. A lack of project 
management expertise along with HUD's inadequate development and use 
of a project management framework and governance structure contributed 
to these deficiencies. Therefore, we recommended that HUD establish a 
plan of action to fully implement best practices, provide needed 
project management expertise, and improve the development and use of 
its project management framework and governance structure. HUD agreed 
with our recommendations to improve its framework and governance, but 
did not agree with the entirety of the recommendation to develop a 
plan of action or the need for providing project management expertise. 
The department described actions it would take to improve its project 
management practices in order to address the deficiencies identified. 

However, some mortgage industry observers said FHA should be provided 
with additional funding to enhance its information technology. The 
congressionally appointed Millennial Housing Commission found that 
FHA's dependence on the appropriations process for budgetary resources 
and competition for funds within HUD had led to underinvestment in 
technology, increasing the agency's operational risk and making it 
difficult for FHA to work efficiently with lenders and other industry 
partners.[Footnote 85] Some observers we spoke with also cited 
competition for funds within HUD, and most supported providing FHA 
additional funding for these enhancements. One benefit of this option 
is that the technology enhancements could improve FHA's operations. 
For example, an observer said that it supported the recent efforts 
that FHA had taken to improve its risk management and protect the 
safety and soundness of the agency, but added that these efforts could 
not be sustained without, among other things, state-of-the-art 
technology. 

FHA officials also told us that the agency's limited resources meant 
implementing technology improvements using a piecemeal approach, 
although it would be better if FHA could upgrade and integrate all of 
its systems at the same time. Specifically, the agency stated that 
sustained and timely funding through using receipts or direct 
appropriation would enable FHA to budget and procure support and 
services more strategically, systematically, and consistently. 

In the current budget environment, funding for technology enhancement 
is limited. FHA technology investments must compete with other HUD 
technology investments. Some observers argue that FHA should be 
granted the authority to use a portion of its insurance premiums for 
technology enhancement.[Footnote 86] In a June 2007 report on FHA 
modernization, we found that Congress could grant FHA specific 
authority to invest a portion of the Fund's current resources--that 
is, negative subsidies that accrue in the Fund's reserves--in 
technology enhancement.[Footnote 87] However, FHA has not met its 
statutory capital ratio requirement since 2009 and using premium 
income for technology enhancement would further reduce the ratio. Even 
in more prosperous times, using the Fund's current resources would 
have implications. Specifically, in our June 2007 report we found that 
using the Fund's current resources for information technology would 
diminish its ability to withstand severe economic conditions and would 
also increase the federal government's budget deficit, all other 
things being equal. Further, requiring FHA to use program revenue to 
pay for administrative costs could require it to increase the premiums 
charged to borrowers. To the extent that having greater control over 
resources might improve agency efficiency and effectiveness, FHA may 
limit any potential premium increases needed to cover administrative 
expenses. 

Allowing FHA to Pay Its Employees Outside of Federal Pay Scales: 

Congress also could consider allowing FHA to compensate its employees 
outside of federal pay scales. In November 2011, we reported that from 
2006 to 2010, Single Family Housing field staffing levels remained 
relatively constant, while key workload items, such as volume-driven 
loan reviews and the management of foreclosed homes, grew 
considerably.[Footnote 88] As a result, it may be difficult for FHA 
staff to mitigate risk. Some federal agencies, such as the Securities 
and Exchange Commission, the Federal Deposit Insurance Corporation, 
and FHFA, are permitted to pay salaries above normal federal pay 
scales in recognition of the special skills demanded by sophisticated 
financial market operations.[Footnote 89] FHA and some mortgage 
industry observers have suggested that FHA be given similar authority. 
FHA officials told us that in order to appropriately manage the Fund, 
FHA needs a mix of staff with industry expertise, including those with 
strong operations management, and that flexibility in compensation 
would help FHA accomplish the right balance. An observer suggested 
that giving the HUD secretary authority to hire risk management, 
analytic, and technological system staff on a more generous pay scale 
could close some of the gap between private market participants and 
those charged with protecting taxpayers from economic harm. In 
addition, another observer recommended that FHA have the ability to 
more broadly use retention allowances and recruitment bonuses. This 
option could help FHA to recruit experienced staff to help the agency 
adapt to changes. Some suggest that, as with investments in 
technological enhancements, enhancements in compensation could be 
funded with the Fund's premium income. The effect would be to provide 
FHA greater flexibility, but also would require program participants 
to absorb administrative costs that are currently borne by direct 
federal appropriation or would reduce resources available to pay 
claims and reduce the capital ratio. 

Giving FHA Greater Authority to Pilot New Products: 

Some mortgage industry observers have suggested that Congress give FHA 
authority to implement pilot programs. For example, one noted that too 
often the statutory and regulatory environment for FHA leads to "all 
or nothing" policy changes, although private mortgage industry 
participants frequently tested new strategies before applying them to 
an entire portfolio. She recommended that FHA be given authority to 
implement pilot programs quickly with the goal of better 
understanding, measuring, and mitigating risk. In addition, the 
Millennial Housing Commission found that the statutes and regulations 
to which FHA was subject dramatically increased the time necessary to 
develop and implement new products. It recommended that Congress 
expressly authorize FHA to introduce new products without requiring a 
new statute for each. In a June 2007 report, we found that such 
authority would offer FHA greater flexibility to keep pace with the 
rapidly changing mortgage market.[Footnote 90] However, we determined 
that Congress would have less control over FHA's product offerings and 
that in some cases it might take years before a new product's risks 
were well understood. 

In a February 2005 report, we recommended that FHA consider using 
pilots for new products and for any planned significant changes to its 
existing products.[Footnote 91] Because FHA officials had questioned 
the circumstances under which they could use pilots when not required 
to do so by Congress, we also recommended that FHA seek the authority 
to offer new products on a limited basis, such as through pilots, if 
the agency determined that it lacked sufficient authority. In comments 
on the report, HUD did not specifically state whether it agreed with 
the recommendations. Rather, it stated that it was in basic agreement 
with GAO that all policy options, implications, and implementation 
methods should be evaluated when considering or proposing a new FHA 
product. For this review, however, FHA officials told us that FHA had 
the appropriate level of authority to pilot programs and had 
successfully piloted several. For example, FHA piloted a program that 
allowed lenders to sell foreclosure properties securing nonperforming 
FHA-insured loans to third parties at a reserve price slightly below 
the property value without conveying the properties to FHA. According 
to FHA, the agency plans to expand the program after finding that this 
method of disposing of properties yields lower losses for the Fund 
than FHA's normal disposition process. 

Managing within Existing Authority: 

Even with no changes to its existing organizational structure and 
authorities, FHA can do more to enhance program efficiency and 
effectiveness and protect taxpayers. We have made a number of 
recommendations aimed at improving FHA's information technology, loss 
mitigation efforts, management of real-estate owned inventories, risk 
assessment, and human capital management.[Footnote 92] As previously 
mentioned, we recommended in June 2013 that HUD establish a plan of 
action to fully implement best practices in management of information 
technology, provide needed project management expertise, and improve 
the development and use of its project management framework and 
governance structure.[Footnote 93] In addition, in June 2012 we 
recommended that FHA periodically analyze the effectiveness and the 
long-term costs and benefits of its loss mitigation strategies and 
actions to more fully understand their strengths and risks and protect 
taxpayers from absorbing avoidable losses to the maximum extent 
possible.[Footnote 94] This report found that several agencies, 
including FHA, were not conducting analyses to determine the 
effectiveness of their loss mitigation actions. The experiences of 
Treasury, the enterprises, and our econometric analysis strongly 
suggested that such analyses could improve outcomes and cut program 
costs. In November 2012, FHA announced revisions that were designed to 
reduce the number of full claims against the Fund. Specifically, FHA 
changed the steps that loan servicers must take to assist home buyers 
in bringing their mortgage payments current. We requested and plan to 
assess the analysis HUD completed as the basis for this change in 
FHA's loss mitigation strategies to determine whether it fully 
responds to our recommendation. And as noted previously, FHA has 
proposed additional revisions to its loss mitigation and foreclosure 
processes that would require congressional action. 

FHA could also mitigate losses on mortgages that it insures by 
improving its recovery rate for foreclosures by, for example, 
improving the foreclosure process itself and the process for selling 
its inventory of foreclosed properties. In 2002, we found that FHA's 
existing procedures could delay the start of critical steps necessary 
to preserve the value of foreclosed properties and sell them quickly. 
[Footnote 95] We pointed to the fact that FHA divided custody of 
foreclosed properties between servicers and contractors, which could 
prevent the initiation of critical maintenance necessary to make 
properties attractive to potential buyers. We recommended that HUD 
make establishing unified property custody a priority. In 2012, FHA 
announced that it was expanding a pilot that would permit such unified 
custody. Under the expanded pilot, FHA permitted loan servicers to 
maintain custody of properties from foreclosure sales through final 
disposition, relieving FHA of the responsibility for managing and 
selling these properties. Because this program is a pilot, FHA 
continues to take into its inventory foreclosed properties. According 
to FHA, it has taken steps to improve recovery through techniques such 
as using best execution modeling to ensure an optimal asset 
disposition approach. In June 2013, we recommended a number of ways 
that FHA could improve on the performance of these properties--for 
instance, by ensuring that price reductions were based on an 
evaluation of market conditions rather than on standardized schedules. 
[Footnote 96] FHA agreed with these recommendations and identified 
actions that it had taken or planned to take in response to them. 

In a November 2011 report, we recommended specific improvements that 
FHA could make to its risk assessment processes and human capital 
management.[Footnote 97] We recommended that FHA (1) integrate two 
ongoing efforts to assess risk, (2) conduct an annual risk assessment, 
and (3) establish ongoing mechanisms to anticipate and address risks 
that might be caused by changing conditions. To improve human capital 
management, we recommended that FHA develop workforce and succession 
plans for the Office of Single Family Housing. Since our report, FHA 
has taken several actions, including developing a plan for conducting 
an inaugural risk assessment and a workforce analysis and succession 
plan. 

Finally, we previously reported on opportunities to increase 
collaboration among the agencies responsible for overlapping and 
fragmented housing programs and activities, including those that 
support homeownership, with the potential for realizing efficiencies. 
In 2000, we suggested that Congress consider requiring RHS and HUD to 
examine the benefits and costs of merging programs serving similar 
markets and providing similar products.[Footnote 98] In 2012, we found 
that the administration had formed a task force to evaluate the 
potential for coordinating or consolidating loan programs at HUD, RHS, 
and VA.[Footnote 99] However, we found that the task force's efforts 
had not yet incorporated key collaborative practices. We therefore 
recommended that HUD, USDA, and VA, and the Director of the Office of 
Management and Budget (OMB) take steps to establish a more rigorous 
approach to collaboration. In addition, we recommended that officials 
from HUD, Treasury, USDA, and VA evaluate and report on the specific 
opportunities for consolidating similar housing programs, including 
those that would require statutory changes. HUD and OMB expressed 
concern about implementing the recommendations while HUD was focused 
on the ongoing housing recovery. As we stated in the report, in 
addition to focusing on the ongoing housing crisis and government 
support for the housing market, focusing on achieving efficiencies and 
cost savings and the delivery of government support for housing is 
important. Given its financial condition, now more than ever it is 
important that FHA optimize its effectiveness across all aspects of 
its operations. 

Broader Housing Market Reforms Could Impact FHA's Role: 

Following the collapse of the mortgage market, policymakers proposed a 
number of mortgage reforms that could impact FHA's market share and 
role. These reforms could affect the willingness of the conventional 
market to serve future home buyers of varying credit risk profiles and 
the fees that lenders would charge for conventional loans. The 
administration has put forth several options for reforming the federal 
role in the mortgage market, including reforming the enterprises 
(Fannie Mae and Freddie Mac). Each of these options has potential 
implications for FHA. Some of our recent work--a 2009 report on 
options for resolving the enterprises and our 2013 high-risk series--
discussed the trade-offs associated with options for resolving the 
enterprises, as well as how these efforts could affect FHA.[Footnote 
100] 

Recent Statutory and Regulatory Changes Could Affect FHA's Market 
Share: 

Recent statutory and regulatory changes related to qualified mortgages 
(QM) and qualified residential mortgages (QRM) have the potential to 
affect FHA's market share. The 2010 Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) required lenders to make a 
reasonable and good faith determination, based on verified and 
documented information, that borrowers seeking residential mortgages 
have a reasonable ability to repay the loan according to its terms. 
[Footnote 101] The Dodd-Frank Act also established a presumption of 
compliance with the ability-to-repay requirements for a certain 
category of mortgages called QM. The ability to repay provisions are 
similar to those implemented by the Board of Governors of the Federal 
Reserve System (Federal Reserve Board) in 2008 but cover all 
mortgages.[Footnote 102] The Dodd-Frank Act shifted rulemaking 
authority for these provisions and QM from the Federal Reserve Board 
to the CFPB. On January 30, 2013, CFPB published its final rule on 
ability to repay and QMs (effective January 10, 2014).[Footnote 103] 

Among other things, CFPB's final rule establishes general underwriting 
criteria for QMs, including that the borrower have a DTI ratio of less 
than or equal to 43 percent. As previously discussed, FHA underwriting 
standards allow some borrowers to have DTI ratios that are greater 
than 43 percent. While acknowledging that many borrowers with high DTI 
ratios likely could afford mortgages, CFPB was concerned that lenders 
would not make loans to these consumers in light of the current 
economic conditions. As a result, CFPB expanded the definition of a QM 
to include any loan that is eligible to be purchased, guaranteed, or 
insured by various federal agencies, including FHA, VA, USDA, and 
USDA's RHS, or by the enterprises while they are operating under 
conservatorship. This rule is temporary and in general will remain in 
effect until these agencies finalize their own QM regulations. 
According to FHA, the agency is currently developing its QM 
regulations. 

The Dodd-Frank Act also requires mortgage securitizers to retain a 
financial exposure of no less than 5 percent of the credit risk of any 
securitized residential mortgage that does not meet a separate set of 
criteria (to be defined by regulators) that are associated with a 
lower risk of default.[Footnote 104] Securitized mortgages that meet 
these criteria are exempt from this risk retention requirement and are 
considered QRM. All FHA-insured mortgages are exempt from the risk-
retention requirement, and Fannie Mae and Freddie Mac mortgages are 
exempt as long as the agencies are in conservatorship. Federal 
regulators published a proposed QRM rule on April 29, 2011, that 
included a 20 percent down-payment requirement.[Footnote 105] However, 
federal regulators issued another proposed rule on August 28, 2013. 
[Footnote 106] The new proposed rule offers two approaches. The first 
approach would define a QRM to have the same meaning as the term QM 
defined by the CFPB and, thus, would not include a down-payment 
requirement. The alternative approach, which according to the 
regulators "was not selected as the preferred approach," would require 
lenders to retain risk in any loan with a down payment of less than 30 
percent. 

Because the QM and QRM regulations will affect whether and at what 
price the conventional market will be willing to serve higher-risk 
borrowers, some have suggested that they could push these borrowers to 
FHA. For example, a recent HUD paper outlined several factors that may 
make higher-risk borrowers migrate to FHA: (1) conventional lenders 
are unlikely to originate non-QM loans (which by definition are also 
non-QRM loans, as QRM is a subset of QM) because they will face 
significantly higher capital retention requirements; (2) lenders that 
are willing to originate non-QM loans will do so only at a higher cost 
to the borrower; and (3) the April 2011 QRM proposal is quite narrow, 
requiring for example, that borrowers make a 20 percent down payment, 
which may be a difficult threshold for first-time borrowers to 
meet.[Footnote 107] Another paper we reviewed concurred, positing that 
the April 2011 proposed QRM rule could make it extremely difficult to 
securitize high-LTV loans made to first-time home buyers and other 
borrowers who could prudently manage low down-payment mortgages, 
resulting in a flood of loans to the enterprises and FHA.[Footnote 
108] Depending on how the enterprises are ultimately resolved, most of 
these loans could flow to FHA. 

The Resolution of Fannie Mae and Freddie Mac Could Impact FHA's Role: 

On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac into 
conservatorship because of concern that their deteriorating financial 
condition threatened the stability of the financial markets. According 
to FHFA, the two enterprises had a worldwide debt and other financial 
obligations totaling $5.4 trillion at the time they were placed in 
conservatorship. Defaulting on those obligations would have 
significantly disrupted the U.S. financial system. While the 
conservatorships can remain in place indefinitely as efforts are 
undertaken to stabilize Fannie Mae and Freddie Mac and restore 
confidence in financial markets, FHFA has said that the 
conservatorships were not intended to be permanent. Recent policy 
changes and proposals on how to restructure or wind down the two 
enterprises are likely to have an impact on FHA's role in the mortgage 
market. 

In August 2012, FHFA directed the enterprises to increase their 
guarantee fees on single-family mortgages by an average of 10 basis 
points. According to FHFA, the increase represented a step toward 
encouraging greater participation in the mortgage market by private 
firms. One impact of this change could be to push business to FHA. 
[Footnote 109] 

In addition, in February 2011, Treasury and HUD jointly issued a 
proposal for reforming the federal role in housing finance.[Footnote 
110] The proposal would make private markets the primary source of 
mortgage credit and would place the burden of losses on the private 
market. In addition, banks would be required to adhere to underwriting 
standards that were more conservative than those currently in place 
and that would require homeowners to hold more equity in their homes. 
The plan also includes proposals for reducing the roles of Fannie Mae 
and Freddie Mac, and ultimately winding down both institutions, while 
at the same time ensuring access to quality, affordable housing. To 
this end, the report presents several proposals for structuring the 
government's long-term role in a housing finance system in which the 
private sector is the dominant provider of mortgage credit: 

* Option 1. A privatized system of housing finance with the government 
insurance role limited to FHA, USDA, and VA assistance for narrowly 
targeted groups of borrowers. 

* Option 2. A privatized system of housing finance with assistance 
from FHA, USDA, and VA for narrowly targeted groups of borrowers and a 
guarantee mechanism that could be scaled up during times of crisis. 

* Option 3. A privatized system of housing finance with FHA, USDA, 

* and VA assistance for low-and moderate-income borrowers and 
catastrophic reinsurance behind significant private capital. 

Under each of these options, FHA would continue to play a central role 
in providing mortgage credit to low-and moderate-income borrowers. 

In a 2009 report, we also identified several options for revising the 
structure of the enterprises and outlined a framework for identifying 
the trade-offs associated with them: 

* reconstitute the enterprises as for-profit corporations with 
government sponsorship but place additional restrictions on them, 

* establish the enterprises as government corporations or agencies, or: 

* privatize or terminate the enterprises.[Footnote 111] 

In evaluating the trade-offs associated with these options, we noted 
that the credit needs of certain groups no longer served by the 
enterprises could be met by FHA. However, we also pointed out that 
some have questioned FHA's capacity to manage large increases in its 
business, which could raise taxpayer risks. In addition, we previously 
had identified "modernizing the U.S. financial regulatory system" as a 
high-risk area. Because of continuing uncertainty over the resolution 
of Fannie Mae and Freddie Mac, the potential impact of their 
resolution on FHA, and concerns about FHA's financial condition, in 
February 2013 we included FHA in this high-risk area, now called 
"modernizing the U.S. financial regulatory system and the federal role 
in housing finance."[Footnote 112] 

As of March 31, 2013, over 90 percent of new mortgage volume had 
federal backing, either through FHA and Ginnie Mae or the enterprises. 
The heightened federal role in mortgage lending and the increased 
reliance on FHA insurance highlights the need for policymakers to 
ensure that changes made to FHA and the enterprises recognize the 
interdependence of these entities and that changes to federal 
regulations governing the mortgage market consider the interaction 
between public and private capital and reflect the roles and 
capacities of the agencies. Ultimately, FHA's place in the housing 
finance system will depend on how the private market reacts to new 
regulations and how the federal government resolves Fannie Mae and 
Freddie Mac. It will also depend on which, if any, of the options 
outlined in this report policymakers pursue and how they are 
implemented. 

Agency Comments: 

We provided a draft report to HUD for review and comment, and HUD had 
no comments. 

As agreed with your offices, 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 to the 
Secretary of Housing and Urban Development and other interested 
parties. In addition, the report will be available at no charge on 
GAO's website at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-8678 or sciremj@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs are listed 
on the last page of this report. GAO staff who made major 
contributions to this report are listed in appendix II. 

Signed by: 

Mathew J. Scirè: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

Our objectives were to examine options that have been proposed for 
improving the long-term viability of the Federal Housing 
Administration (FHA) or reducing its market presence and the 
implications of these options. Specifically, we discuss the 
implications of options related to (1) changing FHA's product terms 
and conditions for single-family mortgage insurance, (2) restricting 
FHA's presence in the single-family housing market, and (3) enhancing 
FHA's operations and powers within its single-family program. In 
addition, we discuss the possible effects of broader housing finance 
reform on FHA. 

To identify proposed options for improving the long-term viability of 
FHA or limiting its market presence, we obtained relevant academic and 
industry studies based on our past and ongoing work and conducted a 
literature search of relevant databases. We reviewed and summarized 
the literature identifying options for change at FHA, including 
congressional testimonies and other documents from mortgage market 
participants (such as the Mortgage Bankers Association) and 
researchers (such as the Urban Institute, Cato Institute, and others). 
As noted above, we sorted these options into three categories: changes 
related to product terms and conditions, changes that could affect the 
market FHA serves, and changes related to FHA's organizational 
structure or powers. We also reviewed and summarized the literature 
for implications associated with the proposed options (including the 
effects on the cost or risk to the taxpayer, borrowers' access to 
credit, FHA's role and the market it serves, and other mortgage market 
participants). Finally, we reviewed these materials for information on 
broader housing refinance issues that may affect FHA, including 
mortgage reforms and proposals for reform of Fannie Mae and Freddie 
Mac, two government-sponsored enterprises. We assessed the reliability 
of the key studies we used and determined them to be reliable for our 
purposes. We also obtained and reviewed documentation from the 
Department of Housing and Urban Development, FHA, and Ginnie Mae. This 
documentation included FHA's mortgagee letters, which we reviewed to 
determine existing program policies and procedures and recent changes. 

We obtained FHA data on (1) loans originated in 2009, including credit 
scores and down-payment percentages, (2) the effect of a potential 
increase in the down-payment requirement on loans for which 
applications were submitted in August 2010 through July 2011, (3) the 
percentage of loan originations in 2009 and 2010 that had seller 
concessions of more than 3 percent of the property value, (4) the 
percentage of loans that FHA insured in fiscal year 2012 that were 
above $450,000, by state, (5) the income distribution of FHA borrowers 
in fiscal years 2000-2013 (October through April), and (6) delinquency 
rates for all active loans as of October 31, 2011, by loan size. To 
determine the reliability of this information, we reviewed information 
on the data and queried FHA officials about how its data are 
collected, verified, and maintained to identify potential data 
limitations. The FHA officials agreed these data were generally 
accurate and complete. Based on this work, we concluded that the data 
we received from FHA were sufficiently reliable for our purposes. We 
also used data published by Inside Mortgage Finance on mortgage 
originations for the first quarter of 2013. To determine the 
reliability of these data, we reviewed information on the data source 
and queried a knowledgeable official about the accuracy of the data. 
We determine the data were sufficiently reliable for our purposes. 

Finally, we conducted interviews with mortgage industry participants, 
researchers, consumer groups, and three former FHA commissioners to 
discuss the proposed options and, in particular, their implications. 
Specifically, we interviewed representatives from the following 
organizations: 

* American Enterprise Institute, 

* Cato Institute, 

* Center for American Progress, 

* Center for Responsible Lending, 

* Harvard Business School, 

* Harvard University's Joint Center for Housing Studies, 

* Hudson Institute, 

* Independent Community Bankers of America, 

* Mortgage Bankers Association, 

* Mortgage Insurance Companies of America, 

* National Association of Home Builders, 

* National Association of Realtors, 

* National Community Reinvestment Coalition, 

* National Council of State Housing Agencies, and: 

* Urban Institute. 

We also interviewed FHA and Ginnie Mae officials. At each interview, 
we sought to obtain any additional relevant studies or papers. 

We conducted this performance audit from April 2013 to September 2013 
in accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our: 

findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Mathew J. Scirè, (202) 512-8678 or sciremj@gao.gov. 

Staff Acknowledgments: 

In addition to the individual named above, Paige Smith, Assistant 
Director; Stephen Brown; Marcia Carlsen; Emily Chalmers; Cory 
Marzullo; John McGrail; Marc Molino; Josephine Pérez; Andrew Stavisky; 
Julie Trinder; and Heneng Yu made major contributions to this report. 

Footnotes: 

[1] The capital ratio is the economic value divided by the insurance-
in-force. The economic value of the Fund is the sum of existing 
capital resources plus the net present value of future cash flows. 

[2] FHA insures both forward and reverse single-family mortgages. 
Reverse mortgages permit borrowers to convert their home equity into 
cash advances. This report primarily focuses on FHA's forward single-
family insurance program. 

[3] GAO, Mortgage Financing: FHA's Fund Has Grown, but Options for 
Drawing on the Fund Have Uncertain Outcomes, [hyperlink, 
http://www.gao.gov/products/GAO-01-460] (Washington, D.C.: Feb. 28, 
2001). 

[4] GAO, FHA Mortgage Insurance: Applicability of Industry 
Requirements Is Limited, but Certain Features Could Enhance Oversight, 
[hyperlink, http://www.gao.gov/products/GAO-13-722] (Washington, D.C.: 
Sept. 9, 2013). 

[5] A government corporation is generally a federally chartered entity 
created to serve a public function of a predominantly business nature. 

[6] FHA was created as a separate entity by the National Housing Act 
on June 27, 1934. It was later abolished as a separate entity and made 
an entity within HUD by the Department of Housing and Urban 
Development Act on September 9, 1965. 

[7] With forward mortgages, the borrower's monthly loan payments to 
the lender add to the borrower's home equity and decrease the loan 
balance. With reverse mortgages, the borrower receives payments from 
the lender. The lender adds the principal and interest to the loan 
balance, reducing the homeowner's equity. 

[8] FHA also administers mortgage insurance programs that help to 
finance multifamily properties, health care facilities, hospitals, and 
manufactured homes under a separate insurance fund. 

[9] U.S. Department of Housing and Urban Development, Office of Policy 
Development and Research, U.S. Housing Market Conditions 4th Quarter 
2012 (Washington, D.C.: February 2013). 

[10] Mortgage origination involves such functions as accepting loan 
applications and obtaining employment verifications and credit reports 
on the borrowers. It is distinct from mortgage underwriting, which 
refers to a risk analysis that uses information collected during the 
origination process to decide whether to approve a loan. 

[11] On September 6, 2008, the enterprises' regulator--the Federal 
Housing Finance Agency (FHFA)--placed them into conservatorship out of 
concern that their deteriorating financial condition threatened the 
stability of the financial markets. 

[12] Pub. L. No. 101-508. 

[13] For a mortgage insurance program, cash inflows consist primarily 
of fees and premiums charged to insured borrowers and proceeds from 
sales of foreclosed properties, and cash outflows consist mostly of 
payments to lenders to cover the cost of claims. 

[14] Budget authority is the authority federal law provides to enter 
into financial obligations that will result in immediate or future 
outlays involving federal funds. Permanent budget authority is 
available as the result of previously enacted legislation and is 
available without further legislative action. Indefinite budget 
authority is budget authority that, at time of enactment, is for an 
unspecified amount. 

[15] In an insurance context, adverse selection occurs when individual 
insurance buyers may differ in their underlying risk factors in ways 
that are not fully observed by the insurer. If an insurer offers 
policy terms and rates designed to cover its costs based on the 
average risks of a group of potential buyers, the result may be that 
those buyers who are riskier than average purchase the insurance, and 
impose larger than average claims on the insurer, while those buyers 
who are less risky than average do not purchase the insurance. 

[16] FHA implemented this minimum required credit score in October 
2010. A credit score is a numeric summary of the information in an 
individual's credit reports that represents his or her potential 
credit risk. Three national credit bureaus calculate credit scores, 
which range from a low of 300 to a high of 850. A decision credit 
score is based on the middle of the three national credit bureau 
scores, or the lower of the two scores when all three are not 
available. 

[17] The PTI ratio is the total monthly mortgage payment divided by 
gross income. The DTI ratio is the total mortgage payment plus 
recurring obligations divided by gross income. 

[18] Lenders use TOTAL in conjunction with automated underwriting 
systems. 

[19] On July 15, 2010, FHA issued a proposed rule that would impose 
stricter reserve and DTI ratio requirements for loans that TOTAL 
refers for manual underwriting as well as for loans that need to be 
manually underwritten because the borrowers have no credit scores. As 
of August 30, 2013, the rule had not been finalized. 

[20] See GAO, Home Mortgages: Provisions in a 2007 Mortgage Reform 
Bill (H.R. 3915) Would Strengthen Borrower Protections, but Views on 
Their Long-term Impact Differ, [hyperlink, 
http://www.gao.gov/products/GAO-09-741] (Washington, D.C.: July 31, 
2009) and Mortgage Financing: Additional Action Needed to Manage Risks 
of FHA-Insured Loans with Down Payment Assistance, [hyperlink, 
http://www.gao.gov/products/GAO-06-24] (Washington, D.C.: Nov. 9, 
2005). 

[21] Roberto G. Quercia, Lei Ding, and Carolina Reid, Balancing Risk 
and Access: Underwriting Standards and Qualified Residential Mortgages 
(Center for Community Capital and Center for Responsible Lending: 
January 2012). This study examined the way different qualified 
residential mortgage guidelines could affect access to mortgage credit 
and loan performance. It estimated the additional impacts on defaults 
and access resulting from setting qualified residential mortgage 
underwriting guidelines over and above the proposed product 
restrictions for qualified mortgages, which exclude loans with 
features associated with higher default rates such as lack of income 
documentation, hybrid adjustable-rate mortgages with teaser payments, 
interest only and balloon payments, and negative amortization. The 
authors used a nationally representative database on loan performance 
that included information on loan characteristics and borrower 
characteristics to conduct this analysis. Later in this report we 
discuss qualified residential mortgage and qualified mortgage rules in 
more detail. 

[22] See Board of Governors of the Federal Reserve System, Report to 
the Congress on Credit Scoring and Its Effects on the Availability and 
Affordability of Credit (Washington, D.C.: August 2007). 

[23] VA program guidance notes that a DTI ratio of greater than 41 
percent requires close scrutiny unless the residual income exceeds the 
relevant residual income guideline by at least 20 percent. 

[24] Quercia, Ding, and Reid, Balancing Risk and Access. 

[25] Down payment is considered equity in the property, and thus 
affects a borrower's LTV ratio. For example, if a borrower makes a 5 
percent down payment, the LTV ratio at origination would be 95 
percent, assuming no other investments. 

[26] In 2009, Congress eliminated seller-funded down-payment 
assistance (that is, assistance from nonprofit organizations that 
received at least part of their funding from property sellers). In a 
report and subsequent testimony, we discussed the risks associated 
with seller-funded down-payment assistance, including the higher 
delinquency and insurance claim rates and the fact that FHA-insured 
homes bought with seller-funded nonprofit assistance typically 
appraised at and sold for about 2 to 3 percent more than comparable 
homes bought without such assistance. See GAO, Seller-Funded Down-
Payment Assistance Changes the Structure of the Purchase Transaction 
and Negatively Affects Loan Performance, [hyperlink, 
http://www.gao.gov/products/GAO-07-1033T] (Washington, D.C.: June 22, 
2007) and [hyperlink, http://www.gao.gov/products/GAO-06-24]. 

[27] 75 Fed. Reg. 41217 (July 15, 2010). 

[28] 77 Fed. Reg. 10695 (Feb. 23, 2012). 

[29] See GAO, Mortgage Financing: Actions Needed to Help FHA Manage 
Risks from New Mortgage Loan Products, [hyperlink, 
http://www.gao.gov/products/GAO-05-194] (Washington, D.C.: Feb. 11, 
2005). 

[30] FHA based its analysis on information lenders collected from 
borrowers' loan applications between August 2010 and July 2011. 
Specifically, lenders are required to verify the amount of liquid 
assets each borrower has available to close the loan. They report to 
HUD both that amount and the assets remaining after closing. The 
difference between these two numbers is the required cash payment to 
close the loan. That cash requirement includes not only the down 
payment, but also any loan origination fees, prepaid items, and 
initial escrows required of the borrower and not paid by other 
sources. Thus, the total cash paid at closing can be much higher than 
just the down-payment requirement. From this information, HUD derived 
the number of borrowers with LTV ratios above 95 percent that would 
not have had sufficient funds to pay down the loan to a 95 percent LTV 
(or make a 5 percent down payment). 

[31] Property value is the lesser of the purchase price and the 
appraisal amount. 

[32] See [hyperlink, http://www.gao.gov/products/GAO-06-24]. 

[33] For any mortgage involving an original principal obligation 
(excluding financed up-front premiums) less than or equal to 90 
percent LTV, the annual premium will be assessed until the end of the 
mortgage term or for the first 11 years of the mortgage term, 
whichever occurs first. For any mortgage involving an original 
principal obligation (excluding financed up-front premiums) with an 
LTV greater than 90 percent, FHA will assess the annual premium until 
the end of the mortgage term or for the first 30 years of the term, 
whichever occurs first. See HUD Mortgagee Letter 2013-04. 

[34] See GAO, Federal Housing Administration: Modernization Proposals 
Would Have Program and Budget Implications and Require Continued 
Improvements in Risk Management, [hyperlink, 
http://www.gao.gov/products/GAO-07-708] (Washington, D.C.: June 29, 
2007). 

[35] Regulation Z generally defines an HPML as a loan secured by the 
consumer's home with an APR that exceeds the average prime offer rate 
(APOR) for a comparable transaction by 1.5 or more percentage points 
for loans secured by a first lien, or by 3.5 or more percentage points 
for loans secured by a subordinate lien. An APOR means an annual 
percentage rate that is derived from average interest rates and other 
loan pricing terms of low-risk mortgages. 12 C.F.R. § 1026.35(a). 

[36] See 12 C.F.R. § 1026.35(b), (e). 

[37] See [hyperlink, http://www.gao.gov/products/GAO-07-708]. In 
addition, in May 2008, HUD announced that it would implement risk-
based premiums based on credit scores and LTV ratios for most of its 
single-family mortgage programs. 73 Fed. Reg. 27704 (May 13, 2008); 
HUD Mortgagee Letter 2008-16. However, in July of the same year, the 
Housing and Economic Recovery Act of 2008 placed a 1-year moratorium 
on FHA's implementation of the new pricing structure. Pub. L. No. 110-
289, § 2133. In its notice implementing the moratorium, HUD stated 
that it would issue another notice when the moratorium concluded. 73 
Fed. Reg. 51505 (Sept. 3, 2008); HUD Mortgagee Letter 2008-22. HUD has 
not, to date, announced an end to the moratorium. 

[38] In January 2007, FHA single-family loan limits ranged from 
$200,160 to $362,790 for one-unit properties. 

[39] Fannie Mae and Freddie Mac are restricted by law to purchasing 
single-family mortgages with origination balances below a specific 
amount known as the "conforming loan limit." Loans above this limit 
are known as jumbo loans. A permanent formula for the annual 
establishment of the conforming loan limit was established under the 
Housing and Economic Recovery Act of 2008 (HERA). The 2013 national 
conforming loan limit for one-unit properties is $417,000. In certain 
high-cost areas designated by statute (Alaska, Hawaii, Guam, and the 
U.S. Virgin Islands) or by the Federal Housing Finance Agency, the 
conforming loan limit for one-unit properties extends to $721,050 
depending on geographic area. 

[40] GAO, Housing Finance: Implications of Alternative Methods of 
Adjusting the Conforming Loan Limit, [hyperlink, 
http://www.gao.gov/products/GAO/RCED-95-6] (Washington, D.C.: Oct. 5, 
1994). 

[41] See, for example, Bipartisan Policy Center Housing Commission, 
Housing America's Future: New Directions for National Policy 
(Washington, D.C.: February 2013); Jason Gold and Andrew Winkler, 
Guidelines for Federal Housing Administration Reform (Washington, 
D.C.: Progressive Policy Institute, March 2013); Robert Van Order and 
Anthony Yezer, FHA Assessment Report: The Role of the Federal Housing 
Administration in a Recovering U.S. Housing Market (Washington, D.C.: 
George Washington University School of Business, June 2011); and 
Edward J. Pinto, How FHA Hurts Working-Class Families and Communities 
(Washington, D.C.: American Enterprise Institute, December 2012). 

[42] Pub. L. No. 110-289, § 2112(a)(1). 

[43] Bipartisan Policy Center Housing Commission, Housing America's 
Future. 

[44] See, for example, Gold and Winkler, Guidelines for Reform; and 
Pinto, How FHA Hurts Working-Class Families. 

[45] Congress recently held multiple hearings on options for FHA 
reform, including before the Committee on Financial Services, U.S. 
House of Representatives, on February 6, 2013; before the Subcommittee 
on Housing and Insurance, Committee on Banking, Housing, and Urban 
Affairs, United States Senate, on February 28, 2013; and before the 
Committee on Financial Services, U.S. House of Representatives, on 
April 10, 2013. 

[46] The Department of the Treasury and the Department of Housing and 
Urban Development, Reforming America's Housing Finance Market: A 
Report to Congress (Washington, D.C.: February 2011). 

[47] FHA is authorized to require certain lenders to sign 
indemnification agreements under which the lender is to repay FHA for 
any losses that it incurs after a loan defaults and the property has 
been sold. 

[48] Enacted in 1986, the Low-Income Housing Tax Credit Program 
provides an incentive for developers and investors to provide 
affordable rental housing for households whose income is at or below 
specified income levels. 26 U.S.C. § 42. The program is jointly 
administered by the Internal Revenue Service and housing finance 
agencies, state-chartered authorities established to help meet the 
affordable housing needs of the residents of their states. The program 
is an indirect financing source and resembles a grant program in that 
housing finance agencies are responsible for allocating the credit on 
a competitive basis to owners of qualified low-income rental projects. 

[49] Treasury and HUD, Reforming America's Housing Finance Market. 

[50] See, for example, Mark Calabria, Fixing Mortgage Finance: What to 
Do with the Federal Housing Administration, no. 123 (Washington, D.C.: 
Cato Institute, February 2012). 

[51] See GAO, Homeownership: Potential Effects of Reducing FHA's 
Insurance Coverage for Home Mortgages, [hyperlink, 
http://www.gao.gov/products/GAO/RCED-97-93] (Washington, D.C.: May 1, 
1997). 

[52] See, for example, Calabria, Fixing Mortgage Finance, and Pinto, 
How FHA Hurts Working-Class Families. 

[53] See [hyperlink, http://www.gao.gov/products/GAO/RCED-97-93]. 

[54] Ginnie Mae guarantees the timely payment of principal and 
interest on securities issued by financial institutions and backed by 
pools of federally insured or guaranteed mortgage loans. Ginnie Mae is 
a wholly owned government corporation and defines its mission as 
expanding affordable housing by linking capital markets to the 
nation's housing markets. Ginnie Mae relies on approved issuers to 
issue and service their mortgage-backed securities, and on agencies, 
such as FHA and VA, to guarantee the underlying mortgages against 
borrower default. Ginnie Mae faces counterparty risk when an issuer 
fails or defaults, which would require Ginnie Mae to ensure that 
investors receive monthly principal and interest payments and service 
the underlying loans. 

[55] The Millennial Housing Commission was established by Congress in 
2000 to study the federal role in meeting the nation's housing 
challenges. It issued a report in 2002, which includes recommendations 
for a variety of reforms to federal housing programs. See Meeting Our 
Nation's Housing Challenges: Report of the Bipartisan Millennial 
Housing Commission (Washington, D.C.: May 2002). 

[56] See [hyperlink, http://www.gao.gov/products/GAO-07-708]. 

[57] Industry observers have proposed multiple methods of sharing 
risk. We discuss some of these proposals. 

[58] Sarah Rosen Wartell, Single-Family Risksharing: An Evaluation of 
its Potential as a Tool for FHA, prepared for the Millennial Housing 
Commission, June 2002. 

[59] See GAO, Housing Finance: FHA's Risk-Sharing Programs Offer 
Alternatives for Financing Affordable Multifamily Housing, [hyperlink, 
http://www.gao.gov/products/GAO/RCED-98-117] (Washington, D.C.: Apr. 
23, 1998). 

[60] Rosen Wartell, Single-Family Risksharing. According to the 
author, counterparty risk management in risk sharing might involve: 
(1) monitoring carefully the performance of the product for which the 
parties share risk, understanding not only your own revenue 
expectations and risk exposure, but that of the counterparty; (2) 
understanding the other business lines of the risk-sharing partner and 
monitoring carefully their performance; (3) monitoring the financial 
health of the risk-sharing partner and its ability to meet its 
obligations, especially in economic stress conditions; (4) requiring 
appropriate segregation of revenues from the risk-sharing product; (5) 
mandating that the partner maintain certain reserves, levels of 
liquidity, and capital ratios; and (6) mandating that the partner 
maintain certain ratings from independent ratings agencies. 

[61] FHA was created as a separate entity by the National Housing Act 
on June 27, 1934. It was later abolished as a separate entity and made 
an entity within HUD by the Department of Housing and Urban 
Development Act on September 9, 1965. 

[62] The 15 federal statues we considered were the Privacy Act of 1974 
(5 U.S.C. 552a), Freedom of Information Act of 1966 (5 U.S.C. 552), 
Government in the Sunshine Act (5 U.S.C. 552b), Title 5: Employee 
Classification (5 U.S.C. 5101-5115), Title 5: Pay Rates and Rate 
Systems (5 U.S.C. 5331-5338 and 5341-5349), Federal Property and 
Administrative Services Act of 1949 (41 U.S.C. 251-260), Federal Tort 
Claims Act (28 U.S.C. 2671, et seq.), Federal Managers Financial 
Integrity Act of 1982 (31 U.S.C. 3512 (b), (c)), Anti-Deficiency Act 
(31 U.S.C. 1341), Government Corporation Control Act of 1945 (31 
U.S.C. 9101, et seq.), Government Performance and Results Act of 1993 
(Pub. L. No. 103-62, Aug. 3, 1993), Chief Financial Officers Act of 
1990 (Pub. L. No. 101-576, Nov. 15, 1990, as amended), Inspector 
General Act of 1978 (5 U.S.C. app.), Federal Credit Reform Act of 1990 
(2 U.S.C. 661-661f), and Ethics in Government Act of 1978 (Pub. L. No. 
95-521, Oct. 26, 1978, as amended). See GAO, Government Corporations: 
Profiles of Existing Government Corporations, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-96-14] (Washington, D.C.: Dec. 13, 
1995). 

[63] At that time, FHA told us that it was not subject to the Federal 
Property and Administrative Services Act of 1949 but had 
administratively adopted the statute's requirements. Ginnie Mae, 
another corporation within HUD, reported full adherence to 12 of the 
15 statutes. 

[64] See National Academy of Public Administration, Renewing HUD: A 
Long-Term Agenda for Effective Performance, report prepared for HUD 
(Washington, D.C.: July 1994). Because FHA's organizational structure 
has changed little since 1994, we determined that this report was 
still relevant. 

[65] Millennial Housing Commission, Meeting Our Nation's Housing 
Challenges. 

[66] Kerry D. Vandell, "FHA Restructuring Proposals: Alternatives and 
Implications," Housing Policy Debate, vol. 6, issue 2 (1995). 

[67] [hyperlink, http://www.gao.gov/products/GAO-07-708]. 

[68] Under the Credit Watch Program, FHA has the authority to address 
deficiencies in a lender's performance by terminating a lender's 
approval to originate or underwrite FHA-insured loans in an area where 
its default and claim rate exceeds the established thresholds. The 
termination of a lender's approval using the Credit Watch default and 
claim analyses is separate and apart from any action taken by the 
Mortgagee Review Board. The Mortgagee Review Board is empowered to 
take administrative action against FHA-approved lenders that are not 
in compliance with FHA lending requirements such as entering into 
settlement agreements with lenders to bring them into compliance or 
withdrawing a lender's FHA approval so the lender cannot participate 
in FHA programs. The Board can also impose civil money penalties, 
probation, and suspension and issue letters of reprimand. 

[69] Indemnification agreements require lenders to repay FHA for any 
losses that it incurs after a loan defaults and the property has been 
sold. 

[70] The FHA Emergency Fiscal Solvency Act, H.R. 1145 (2013). 

[71] Under Credit Watch, FHA considers terminating a lender's 
authority to originate loans in a specific geographical area if a 
lender's branch office default and claim rate exceeded the national 
average and also exceeded the average local HUD field office default 
and claim rate by 200 percent. If a lender had more than one branch 
office facing Credit Watch termination action in a particular period, 
FHA can decide to evaluate the overall performance of the lender in 
the field office jurisdiction and, if unacceptable, terminate a 
lender's ability to originate and underwrite loans in the entire 
jurisdiction. 

[72] When home buyers fall behind on their mortgage obligations, FHA 
instructs mortgage servicers (typically large financial institutions) 
to assist the home buyers in bringing their mortgage payments current, 
because foreclosure proceedings can impose high costs on financial 
institutions and homeowners. These and other efforts are referred to 
as "loss mitigation." 

[73] HUD, Annual Report to Congress Regarding the Financial Status of 
the FHA Mutual Mortgage Insurance Fund, Fiscal Year 2012 (Washington, 
D.C.: Nov. 16, 2012). 

[74] Concentrance Consulting Group, An Examination of Downpayment Gift 
Programs Administered by Nonprofit Organizations, prepared for the 
U.S. Department of Housing and Urban Development (Washington, D.C.: 
March 2005). 

[75] See [hyperlink, http://www.gao.gov/products/GAO-06-24]. 

[76] Shaun Donovan, Secretary of the U.S. Department of Housing and 
Urban Development, FY 2014 Budget Request for the Department of 
Housing and Urban Development, testimony before the Senate Committee 
on Appropriations Subcommittee on Transportation, Housing and Urban 
Development, and Related Agencies, 113th Cong., 1st sess., April 11, 
2013. 

[77] Pub. L. No. 113-29 (enacted August 9, 2013). 

[78] Treasury and HUD, Reforming America's Housing Finance Market. 

[79] The basic process by which agencies develop and issue regulations 
is spelled out in the Administrative Procedures Act (APA) (5 U.S.C. §§ 
551-570a). APA generally requires agencies to (1) publish a notice of 
proposed rulemaking (NPRM) in the Federal Register; (2) allow 
interested persons an opportunity to comment on the rulemaking process 
by providing "written data, views, or arguments;" (3) issue a final 
rule accompanied by a statement of its basis and purpose; and (4) 
publish the final rule at least 30 days before it becomes effective. 
However, prior notice and public comment is not always required. APA 
allows agencies to issue final rules without the use of an NPRM in 
certain cases, including when the agency determines for "good cause" 
that notice and comment procedures are "impracticable, unnecessary, or 
contrary to the public interest" (5 U.S.C. § 553(b)(B)). One common 
type of rule often issued without an NPRM is the interim final rule, 
which generally is effective immediately but provides an opportunity 
for public comment after the rule's issuance. 

[80] A significant deficiency is one or a combination of deficiencies 
in internal control that is less severe than a material weakness, yet 
important enough to merit attention by those charged with governance. 

[81] GAO, Federal Housing Administration: Improvements Needed in Risk 
Assessment and Human Capital Management, [hyperlink, 
http://www.gao.gov/products/GAO-12-15] (Washington, D.C.: Nov. 7, 
2011). 

[82] This environment is expected to provide case management for the 
life cycle of a loan and capture data from the loan origination and 
underwriting processes. 

[83] HUD, HUD Transformation Initiatives Information Technology Fiscal 
Year 2011 Expenditure Plan (Washington, D.C.: December 2011). 

[84] GAO, Information Technology: HUD Needs to Improve Key Project 
Management Practices for Its Modernization Efforts, [hyperlink, 
http://www.gao.gov/products/GAO-13-455] (Washington, D.C.: June 12, 
2013). 

[85] Millennial Housing Commission, Meeting Our Nation's Housing 
Challenges. 

[86] Currently, FHA does accumulate reserves to cover the costs 
associated with insurance claims but may not use them for 
administrative expenses, such as salaries and technology. Rather, 
these expenses are paid from direct federal appropriations. The 
administrative expenses of other federal credit programs such as RHS' 
single-family guaranteed loan program are also paid through direct 
appropriations rather than through program revenue. On the other hand, 
another federal credit program, the Export-Import Bank, is required to 
pay for administrative expenses out of fees it collects. 

[87] [hyperlink, http://www.gao.gov/products/GAO-07-708]. 

[88] [hyperlink, http://www.gao.gov/products/GAO-12-15]. 

[89] In 1989, the Financial Institutions Reform, Recovery and 
Enforcement Act (Pub. L. No. 101-73) authorized certain financial 
regulators to determine their own compensation and benefits so that 
they could more effectively compete in the marketplace for qualified 
applicants. In 2002, the Investor and Capital Markets Fee Relief Act 
(Pub. L. No. 107-123) and in 2008, the Housing and Economic Recovery 
Act of 2008 gave the Securities and Exchange Commission and FHFA, 
respectively, similar authority as those federal banking regulatory 
agencies. These agencies are permitted by statute to pay salaries in 
excess of the Title 5 ceilings. 

[90] See [hyperlink, http://www.gao.gov/products/GAO-07-708]. 

[91] See [hyperlink, http://www.gao.gov/products/GAO-05-194]. 

[92] See, for example, [hyperlink, 
http://www.gao.gov/products/GAO-13-455] and [hyperlink, 
http://www.gao.gov/products/GAO-12-15]. 

[93] [hyperlink, http://www.gao.gov/products/GAO-13-455]. 

[94] GAO, Foreclosure Mitigation: Agencies Could Improve Effectiveness 
of Federal Efforts with Additional Data Collection and Analysis, 
[hyperlink, http://www.gao.gov/products/GAO-12-296] (Washington, D.C.: 
June 28, 2012). 

[95] GAO, Single-Family Housing: Opportunities to Improve Federal 
Foreclosure and Property Sale Processes, [hyperlink, 
http://www.gao.gov/products/GAO-02-305] (Washington, D.C.: Apr. 17, 
2002). 

[96] See GAO, Federal Housing Administration: Improving Disposition 
and Oversight Practices May Increase Returns on Foreclosed Property 
Sales, [hyperlink, http://www.gao.gov/products/GAO-13-542] 
(Washington, D.C.: June 20, 2013). 

[97] [hyperlink, http://www.gao.gov/products/GAO-12-15]. 

[98] See GAO, Rural Housing: Options for Optimizing the Federal Role 
in Rural Housing Development, [hyperlink, 
http://www.gao.gov/products/GAO/RCED-00-241] (Washington, D.C.: Sept. 
15, 2000). 

[99] See GAO, Housing Assistance: Opportunities Exist to Increase 
Collaboration and Consider Consolidation, [hyperlink, 
http://www.gao.gov/products/GAO-12-554] (Washington, D.C.: Aug. 16, 
2012). 

[100] See GAO, Fannie Mae and Freddie Mac: Analysis of Options for 
Revising the Housing Enterprises' Long-term Structures, [hyperlink, 
http://www.gao.gov/products/GAO-09-782] (Washington, D.C.: Sept. 10, 
2009), and High-Risk Series: An Update, [hyperlink, 
http://www.gao.gov/products/GAO-13-283] (Washington, D.C.: Feb. 14, 
2013). 

[101] Pub. L. No. 111-203, sec. 1411 (15 U.S.C. sec 1539c(a)). 

[102] In 2008, the Federal Reserve Board adopted a rule under the 
Truth in Lending Act (Regulation Z) prohibiting lenders from making 
"higher-priced mortgage loans" without assessing borrowers' ability to 
repay the loans. The Federal Reserve Board implemented this rule in 
response to lending practices--for example, using loose underwriting 
standards and attracting borrowers with misleading rates--that 
ultimately contributed to the housing crisis and recession. Lenders 
have had to follow these requirements since October 2009. See 73 Fed. 
Reg. 44522 (July 30, 2008). 

[103] See 78 Fed. Reg. 6408 (Jan. 30, 2013). 

[104] Through securitization, the purchasers (securitizers) package 
mortgages into pools and issue securities, for which the mortgages 
serve as collateral. These securities pay interest and principal to 
their investors. 

[105] See 76 Fed. Reg. 24090 (Apr. 29, 2011). 

[106] As of August 30, 2013, the proposed rule had not yet been 
published in the Federal Register. 

[107] See HUD, Office of Policy Development and Research, The FHA 
Single-Family Insurance Program: Performing a Needed Role in the 
Housing Finance Market (Washington, D.C.: December 2012). 

[108] Basil N. Petrou, Managing Partner of Federal Financial 
Analytics, Inc., Establishing the Proper Role of the Federal Housing 
Administration in the U.S. Mortgage-Finance System, testimony before 
the House Financial Services Committee, 113th Cong., 1st sess., 
February 6, 2013. 

[109] Both the enterprises and Ginnie Mae compete in the mortgage 
securitization market--the enterprises through the issuance of 
securities and Ginnie Mae through the guarantee of timely payment of 
principal and interest on securities issued by others. 

[110] Treasury and HUD, Reforming America's Housing Finance Market. 

[111] See [hyperlink, http://www.gao.gov/products/GAO-09-782]. 

[112] See [hyperlink, http://www.gao.gov/products/GAO-13-283]. 

[End of section] 

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