Mortgage Financing:

FHA's $7 Billion Reestimate Reflects Higher Claims and Changing Loan and Performance Estimates

GAO-05-875: Published: Sep 2, 2005. Publicly Released: Oct 4, 2005.

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The U.S. Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), provides insurance for private lenders against losses on home mortgages. FHA's largest insurance program is the Mutual Mortgage Insurance Fund (Fund), which currently is self-financed and operates at a profit. FHA submitted a "reestimate" of $7 billion for the credit subsidy and interest for the Fund as of the end of fiscal year 2003, reflecting a reduction in estimated profits. Given this substantial reestimate, Congress asked GAO, among other things, to determine what factors contributed to the $7 billion reestimate and the underlying loan performance variables influencing these factors and to assess how the loan performance variables underlying the reestimate could impact future estimates of new loans.

The $7 billion reestimate was due primarily to an increase in estimated and actual claims over what FHA previously estimated. For example, actual claim activity in fiscal year 2003 exceeded estimated claim activity for 2003--by twice as much in some cases--for the majority of loan cohorts. Prepayments also played a role in the reestimate as they were higher than previous estimates. In fact, actual prepayment activity during 2003 exceeded estimated prepayment activity for all cohorts. Because of the additional claims it paid, upfront premiums it refunded, and the annual premiums it lost, FHA's net cash outflows for the year increased, contributing to the $7 billion adjustment of the Fund's credit subsidy. Several recent events may help explain this increase, including changes to underwriting guidelines, competition from the private sector, and an increase in the use of down payment assistance. FHA has taken some steps to tighten underwriting guidelines and better estimate loan performance, though it is not clear that these steps are sufficient to reverse recent increases in actual and estimated claims and prepayments or help FHA to more reliably predict future claim and prepayment activity. Increases in claim and prepayment activity are likely to continue to add risk to FHA's portfolio.

Recommendation for Executive Action

  1. Status: Closed - Implemented

    Comments: The contractor that performs FHA's actuarial reviews enhanced its loan performance models to include certain variables we cited that have been shown to influence credit risk. For example, the models for the 2006, 2007, and 2008 reviews incorporated borrower credit score and the presence of down payment assistance as predictive variables. Additionally, consistent with our recommendation, the actuarial reports for these years included a discussion of the impact of these variables on actuarial forecasts.

    Recommendation: To more reliably estimate program costs, the Secretary of HUD should direct the FHA Commissioner to study and report in the annual actuarial review the impact of variables that have been found in other studies to influence credit risk, such as payment-to-income ratios, credit scores, and the presence of down payment assistance, on the forecasting ability of the loan performance models used in FHA's actuarial reviews of the Fund. FHA also should report in its annual actuarial review the impact of any changes it makes to key variables, such as the burnout variable, on the forecasting ability of the loan performance models.

    Agency Affected: Department of Housing and Urban Development

 

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