The Federal Housing Administration (FHA) insures mortgages made by approved lenders with its Mutual Mortgage Insurance (MMI) Fund, which collects premiums and pays claims. The recent release of the FHA’s annual report and increase in FHA loan limits makes it a good time to assess the program’s health.
In fulfilling its mission to help more Americans reach homeownership, the FHA tends to insure riskier mortgages. While occupying just 12 percent of the overall mortgage market, the FHA finances 33 percent of purchase activity for first-time homebuyers and 34 percent of all minority purchase activity.
The average income for an FHA purchase borrower is $70,700 versus $113,700 for all purchasers, and the FHA is nearly the only source of reverse mortgages that allow seniors to age in place. Given this mix of business, how is the FHA performing?
The FHA is performing well, thanks to a healthy housing market
Over the past four years, house prices have increased at an average rate of 7 percent. Over the past year alone, this increase in house prices has resulted in the MMI Fund increasing its ratio of net worth to total mortgages from 2.18 to 2.76 percent, with the actual net worth increasing by $7 billion. The MMI Fund was also helped by $209 billion in new FHA mortgages for which future revenue is expected to exceed future expenses. The bottom line is that the FHA continues to be strong and profitable for US taxpayers.
The share of borrowers using down payment assistance has risen
A few other trends are less optimistic. The FHA is a low down payment program with most borrowers paying only the required minimum of 3.5 percent. However, some borrowers receive down payment assistance (DPA) from relatives, state and local government entities, or other parties.
These mortgages tend to be riskier both because the borrowers have not demonstrated the ability to put money aside and because they tend to have less discretionary income to weather setbacks. The annual report shows that the share of FHA mortgages with DPA has increased in the past five years from 30 to 39 percent.
Borrowers who use family assistance perform better than those who use governmental DPA, but not all governmental DPA programs are the same, and it is important to understand the incremental risks from each program. For example, some governmental DPA programs are provided by housing finance agencies that are knowledgeable about the community, require consumer education, and do not mark up interest rates. These programs may be less risky than programs without these characteristics. As more borrowers come to rely upon these programs, it is critical to collect more data on the various DPA programs, both for the health of the MMI Fund and for the financial health of future borrowers.
Cash-out refinances have also increased
Traditionally, cash-out refinances are riskier than purchase money mortgages or rate and term refinances. The FHA compensates for some of the extra risk by reducing the maximum loan-to-value ratio on cash-out refinances from 97.5 percent to 85 percent. Although overall refinances decreased between fiscal year 2017 and fiscal year 2018, from 364,000 to 238,000 loans, cash-out refinances actually increased from 142,000 to 152,000 loans, with their share of the refinance universe rising from 39 to 64 percent.
Of the 2018 refinances, over 35 percent were cash-out refinances where the original loan was a conventional loan, up from 23 percent in 2017. While these loans may be profitable for the FHA and allow homeowners to tap wealth, this trend bears watching.
Access to credit is expanding
Less concerning trends in the FHA program are the downward drift in credit scores and the upward drift in debt-to-income (DTI) ratios. The former largely reflects a return to more normal levels from a market that had become overly tight after the financial crisis, and the latter reflects increases in house prices and interest rates. (A 1 percent increase in interest rates and a 7 percent increase in home prices, which has occurred in the past year, translates into a 20 percent increase in monthly payments.)
While these decreases in credit scores and increases in DTI ratios may increase the FHA’s risk, they are part of the program’s natural cyclicality. That said, we do worry about the increased default posed by risk layering.
Thanks to the strength of the housing economy, the MMI Fund forward market is doing well, with its ratio of net worth to insurance in force (outstanding mortgages) improving from 3.3 to 3.9 percent, well above the statutory minimum.
What are the trends in reverse mortgages?
The same strong housing economy should have improved the performance of reverse mortgages, but these trends are complex. The FHA has also taken actions to improve the program (cuts in the principal limit factor in 2013, escrows for less creditworthy borrowers in 2015, further cuts in the principal limit factor in 2018).
The 2013 and 2015 actions should be showing up in the numbers already, and there are some positive signs:
- Type 1 claims that represent actual losses from disposing properties backing these mortgages declined from $677 million to $612 million.
- Recoveries are also increasing.
However, the FHA estimates that it will lose about 19 percent, or $14 billion, on this program, about the same as last year.
The FHA points out an appraisal bias in this program, but appraisal bias on nonpurchase mortgages has long been a feature of the mortgage market, and the FHA estimates that the appraisal bias is now under 5 percent, falling from much higher levels 10 years ago.
Moreover, this level of appraisal bias should not add much incremental risk given that seniors can tap only about half the equity in their house through the program. We would encourage the FHA to release more loan-level data on the reverse program so that researchers can better understand the drivers of risk in this program—one that appears to be hemorrhaging even in an environment with 7 percent home price appreciation.
In the meantime, policymakers should consider separating the Home Equity Conversion Mortgage Program for the forward program in calculating the statutory minimum ratios.