Mortgage Financing:

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

GAO-05-194: Published: Feb 11, 2005. Publicly Released: Mar 14, 2005.

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

FHA and many other mortgage institutions provide many low and no down payment products with requirements that vary in terms of eligibility, borrower investment, underwriting, and risk mitigation. While these products are similar, there are some important differences, including that FHA has lower loan limits, allows closing costs and the up-front insurance premium to be financed in the mortgage, and permits the down payment funds to come from nonprofits that receive funds from sellers. FHA also differs in that it does not require prepurchase counseling. A substantial amount of research GAO reviewed indicates that LTV ratio and credit score are among the most important factors when estimating the risk level associated with individual mortgages. GAO's analysis of the performance of low and no down payment mortgages supported by FHA and others corroborates key findings in the literature. Generally, mortgages with higher LTV ratios (smaller down payments) and lower credit scores are riskier than mortgages with lower LTV ratios and higher credit scores. Some practices of other mortgage institutions offer a framework that could help FHA manage the risks associated with introducing new products or making significant changes to existing products. Mortgage institutions may impose limits on the volume of the new products they will permit and on who can sell and service these products. FHA officials question the circumstances in which they can limit volumes for their products and believe they do not have sufficient resources to manage a product with limited volumes. Mortgage institutions sometimes require additional credit enhancements, such as higher insurance coverage; and sometimes require stricter underwriting, such as credit score thresholds, when introducing a new low or no down payment product. FHA is authorized to require an additional credit enhancement by sharing risk through co-insurance but does not currently use this authority. FHA has used stricter underwriting criteria but this has not included credit score thresholds.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: In October 2008, Congress passed the Hope for Homeowners Act which authorized a program to refinance mortgage borrowers at risk of default or foreclosure into new FHA-insured loans. Consistent with our matter for consideration, Congress took a number of steps to mitigate the risk that this new FHA product may pose. For example, Congress required lower loan-to-value ratios and higher insurance premiums for these loans than for traditional FHA-insured mortgages. Additionally, participating borrowers are required to share a portion of their home equity with FHA if they refinance the mortgage or sell the property.

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

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: The intent of this recommendation was captured by an FHA pilot program that Congress established under the Housing and Economic Recovery Act of 2008 (HERA). The 5-year program, which has yet to be started, will pilot an automated process for providing alternative credit rating information to lenders for borrowers who have insufficient credit histories. HERA places limits on the number of mortgages that may be insured under the pilot program and gives FHA the authority to place other limitations on the availability of the mortgages.

    Recommendation: If Congress provides the authority for FHA to implement a no down payment mortgage product or other products about which the risks are not well understood, the Secretary of HUD should direct the Assistant Secretary for HUD-Federal Housing Commissioner to consider piloting the initial product or limiting its initial availability and asking Congress for the authority if HUD officials determine they currently do not have this authority.

    Agency Affected: Department of Housing and Urban Development

  2. Status: Closed - Implemented

    Comments: The intent of this recommendation was addressed when the Congress imposed stricter underwriting criteria (e.g., lower loan-to-value ratios) and required greater credit enhancements (e.g., higher insurance premiums) for HOPE for Homeowners loans than for traditional FHA-insured mortgages.

    Recommendation: If Congress provides the authority for FHA to implement a no down payment mortgage product or other products about which the risks are not well understood, the Secretary of HUD should direct the Assistant Secretary for HUD-Federal Housing Commissioner to consider incorporating stricter underwriting criteria such as appropriate credit score thresholds or borrower reserve requirements.

    Agency Affected: Department of Housing and Urban Development

  3. Status: Closed - Implemented

    Comments: The intent of this recommendation was addressed when Congress imposed stricter underwriting criteria (e.g., lower loan-to-value ratios) and required greater credit enhancements (e.g., higher insurance premiums) for HOPE for Homeowners loans than for traditional FHA-insured mortgages.

    Recommendation: If Congress provides the authority for FHA to implement a no down payment mortgage product or other products about which the risks are not well understood, the Secretary of HUD should direct the Assistant Secretary for HUD-Federal Housing Commissioner to consider utilizing other techniques for mitigating risks including use of credit enhancements and prepurchase counseling.

    Agency Affected: Department of Housing and Urban Development

 

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