FHA’s Predatory Insurance Practices

This Issue’s Highlight

FHA’s Predatory Insurance Practices

The Federal Housing Administration’s (FHA’s) mortgage insurance practices qualify as predatory under the definition set out by the Federal Deposit Insurance Corporation (FDIC’s) inspector general. First, FHA mortgage insurance pricing grossly overcharges hundreds of thousands of lower-risk borrowers. Second, the FHA relies on a borrower’s lack of understanding of the complicated nature of FHA insurance as well as a borrower’s expectation that the FHA would not intentionally permit borrowers to be steered into financially disadvantageous transactions. Third, cross-subsidies allow the FHA to offer abusive loan insurance terms to hundreds of thousands of high-risk borrowers.

This Month’s Features

Spotlight on FHA’s Predatory Insurance Practices

FHA’s Mortgage Insurance Practices Qualify as Predatory under the FDIC Definition

Spotlight on Best Price Execution

Minor Changes over Last Month

Spotlight on Insolvency

FHA’s Private GAAP-Estimated Net Worth Declined to Lowest Level in Seven Months

Spotlight on Delinquency

Various Rates Experience Moderate Drop from September to October

Spotlight on FHA’s Predatory Insurance Practices

FHA’s Mortgage Insurance Practices Qualify as Predatory under the FDIC Definition

Note: A substantially similar version was previously published on RealClearMarkets.com as “The FHA is a predatory lender.”

According to the FDIC’s inspector general: “Predatory lending typically involves imposing unfair and abusive loan terms on borrowers, often through aggressive sales tactics; taking advantage of borrowers’ lack of understanding of complicated transactions; and outright deception.”[1]

Given that the FHA has been responsible for well over three million foreclosures, it has become what it was designed to cure. The FHA described the problem in 1936—“To many people, “Mortgage” became just another word for trouble—an epitaph on the tombstone of their aspirations for home ownership.”[2] The FHA’s mortgage insurance practices qualify as predatory under the FDIC standard.

First, FHA mortgage insurance pricing grossly overcharges lower-risk borrowers. Hundreds of thousands of borrowers have been steered by mortgage lenders and real estate brokers to use FHA mortgage insurance rather than lower cost private alternatives. In FY 2013 alone, nearly 200,000 home purchasers with FHA-insured loans could have saved an estimated $710 million over the life of their loans, or nearly $4,000 in individual savings.

Second, the FHA counts on a borrower’s lack of understanding of the complicated nature of FHA insurance as well as the expectation that the FHA would not intentionally permit borrowers to be steered into financially disadvantageous transactions. FHA premiums add up to about 10 percent of the initial mortgage amount over the average life of a loan. Since the FHA does not price for credit risk, it needs to overcharge low-risk borrowers so it may subsidize the rates charged on high-risk borrowers.

When Congress established the FHA in 1934, cross-subsidization between low- and high-risk borrowers was explicitly prohibited. Today, the FHA program is all about cross-subsidies; the average low-risk borrower with a $150,000 mortgage is overcharged about $9,000, which is used to subsidize high-risk borrowers. This overcharge is much larger than the pricing differential between FHA and private mortgage insurance noted earlier, as the FHA benefits from many subsidies—not paying taxes, no need to earn a return on capital (if it had any capital), and taxpayers absorbing its administrative costs—which enable the organization to mask monumental losses on their high-risk loans.

Third, these cross-subsidies allow the FHA to offer abusive loan insurance terms to hundreds of thousands of high-risk borrowers. For example, the FHA’s underwriting standards permit borrowers with a 600 FICO credit score, 98 percent loan-to-value ratio, and a 43 percent debt-to-income ratio to obtain an FHA-insured loan, even though these borrowers have a one in four chance of foreclosure. Abusive terms such as these harm working-class families and neighborhoods.

The secretary of Housing and Urban Development (HUD) should add a number of protections to HUD’s consumer bill of rights to prevent such predatory practices. First, he should require the FHA to provide private-government best-execution comparisons to FHA applicants so as to ensure low-risk borrowers do not needlessly overpay thousands of dollars when they purchase a home with an insured mortgage loan. If the private market alternative is a better execution, prospective borrowers should be so informed. If HUD Secretary Shaun Donovan fails to do this, Congress should consider adding it to pending FHA reform bills.

Second, the secretary of HUD should require lenders to disclose to prospective borrowers a clear and conspicuous notice both within 72 hours of application and at closing, which sets forth the applicant’s loan-to-value ratio, FICO score, and total debt-to-income ratio, all as used in underwriting the applicant’s FHA loan. This disclosure shall also include the estimated cumulative claim rate for loans insured by the secretary with similar risk characteristics to the applicant’s and the average estimated cumulative claim rate for the most recent fiscal year as determined in the FHA’s annual actuarial study. Such a disclosure would provide prospective borrowers the most transparent information regarding their risk of foreclosure. If Secretary Donovan fails to do this, Congress should immediately enact the Protecting American Taxpayers and Homeowners (PATH) Act, which provides for this much-needed consumer protection.

Finally, Secretary Donovan should reaffirm the promise made in 1936 by Stewart McDonald, the FHA’s first administrator: “Provide a straight, broad highway to debt-free ownership. . . . Thus, the buyer will be protected in his investment.”[3]

Spotlight on Best Price Execution

Minor Changes over Last Month

Table 1 demonstrates the pricing advantages the Ginnie/FHA, Ginnie/US Department of Agriculture (USDA), and Ginnie/Veterans Affairs (VA) divisions have over Fannie Mae. FHA, VA, and USDA pricing advantages have declined slightly compared to last month.

As table 1 demonstrates, the FHA’s price advantage decreases as loan risk decreases (generally represented by FICO score). The impact of this price trend shows up in the FICO scores for the FHA’s business. The FHA’s percentage of its new business with FICO scores above 720 declined in July–September 2013 to 24.2 percent, down from 26.9 percent in April–June 2013, 30.9 percent in July–September 2012, and 37.8 percent in March 2011.[4]

Table 1. Best Price Execution (Ginnie pricing advantages in green) 

image003

Source: Adapted from JPMorgan’s 2012 Securitized Products Outlook, November 23, 2011, 18.

Note: Mortgage-backed securities (MBS) pricing from MBS Live, published by Mortgage News Daily. Comparison based on MBS pricing as of November 19, 2013. On that date, a Ginnie 30-year MBS with a coupon of 3.5 percent had a price of 102.75, and a Fannie 30-year MBS with the same 4.0 percent coupon had a price of 101.78. These prices were then adjusted based on the present value (where necessary) of applicable borrower-paid credit fees, mortgage insurance premiums, and the value of the base servicing fee. Fannie’s guarantee fee was increased by 10 basis points effective April 2012, as mandated by Congress, and by 10 basis points again as announced on August 31, 2012, by the Federal Housing Finance Agency. All publicly announced FHA premium increases are included. USDA and VA premiums are unchanged. FHA, USDA, and VA pricing includes loan-level pricing adjustments made by Carrington Wholesale Services.

On the whole, the five divisions of the Government Mortgage Complex (along with Freddie Mac) have substantial pricing and underwriting advantages over the private sector. The result is that the Government Mortgage Complex’s share of the entire first-mortgage market continues to be at 85–90 percent. 

Spotlight on Insolvency

FHA’s Private GAAP-Estimated Net Worth Declined to Lowest Level in Seven Months

This month, the FHA’s private GAAP-estimated net worth deteriorated slightly. The estimate for October of the FHA’s GAAP net worth is –$27.00 billion, down from –$26.27 billion in September 2013, up from –$30.75 billion in September 2012, and down from –$20.87 billion in September 2011. The capital shortfall stands at $47 billion (using a 2 percent capital ratio) and $54 billion (using a 4 percent capital ratio adjusted to 2.7 percent based on expected recoveries). The Denial Dial was reset to − 2.45 percent.

Please see the notes to table A1 for a detailed explanation, including comprehensive adjustments made based the GAO analysis described here.[5]

Spotlight on Delinquency

Various Rates Experience Moderate Drop from September to October

In October, 14.70 percent of all FHA loans were delinquent, down from 14.97 percent in September 2013 and down from 16.57 percent in October 2012.

The serious delinquency rate decreased modestly to 8.02 percent from 8.09 percent in September 2013 and decreased from 9.54 percent in October 2012.

For the monthly data tabulation, see table A2 in the appendix.

Appendix: Historical Data Tables

Table A1. Insolvency Watch ($ Billions)

image004

Notes: Table A1 estimates the FHA’s current net worth and capital shortfall under accounting rules applicable to a private mortgage insurer (PMI) such as Genworth. Estimates are based on the FHA’s delinquent loans, risk exposure, capital resources, and capital ratio under both the 2 percent statutory requirement for the FHA and the 4 percent of risk-in-force requirement applicable to a PMI. The 4 percent requirement has been adjusted to 2.7 percent based on FHA experiencing an average 30–35 percent recovery against its 100 percent claim payment. As of September 30, 2012, the FHA reported to the Government Accountability Office that its estimated transition-to-claim rate for 90-plus-day delinquencies was 71 percent. As of September 30, 2013, Genworth had loss reserves equaling 23 percent of its risk-in-force on 60–119-days-delinquent loans. This was adjusted to 20 percent for 60–89-days-delinquent loans. See GAO, “Applicability of Industry [GAAP] Requirements Is Limited, but Certain Features Could Enhance Oversight,” September 2013, footnotes 42 and 44, ; and Genworth, Quarterly Financial Supplements, Delinquency Metrics-US Mortgage Insurance Segment, 44.

(accessed August 22, 2013).

*The FHA’s negative cash flow was $994 million per month during Q3 of FY 2013. See exhibit 10, US Department of Housing and Urban Development,FHA Single-Family Mutual Mortgage Insurance Fund Programs, Quarterly Report to Congress, 13. The FHA raised its upfront premium from 1 to 1.75 percent (excluding streamline refinances) effective for case numbers assigned on or after April 9, 2012. Since under private GAAP accounting this amount would not be taken into income immediately, it will be accounted for in the “Estimated liability for excess upfront premiums beyond GAAP allowance.” The amount of this liability was estimated at $9.60 billion as of September 30, 2013.

**Outstanding balance of loans 60-days-plus delinquent based on loan counts on applicable date times average loan balance for loans going to claim of $126,524. Reserve levels have been calculated based on termination and claim loss experience as reported in the report series entitled “Quarterly Report to Congress on the Financial Status of the MMI Fund,” FY 2013 Q3, exhibit 5, http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/rtc/fhartcqtrly (accessed September 18, 2013).

***Total based on the FHA’s total amortized risk-in-force net of loans covered by loan loss reserve.

Table A2. National Delinquency Watch


End Date
30-Days Delinquency Rate and Number of Loans 60-Days-Plus Delinquency Rate and Number of Loans 30-Days-Plus Delinquency Rate and Number of Loans Serious Delinquency Total Loans
Jan. 2011 N/A N/A N/A 8.9% / 612,443 6,882,984
Mar. 2011 N/A N/A N/A 8.3% / 580,480 6,983,893
June 2011 5.79% / 411,258 10.55% / 749,204 16.62% / 1,160,462 8.34% / 592,366 7,103,531
Sept. 2011 5.70% / 413,834 11.08% / 803,899 16.78% / 1,217,733 8.77% / 636,778 7,258,328
Dec. 2011 5.72% / 421,404 12.07% / 889,602 17.79% / 1,311,006 9.73% / 716,786 7,370,426
Jan. 2012 5.35% / 397,018 12.18% / 903,748 17.53% / 1,300,766 9.92% / 735,760 7,418,830
Feb. 2012 4.78% / 355,092 11.70% / 871.870 16.47% / 1,226,962 9.73% / 725,002 7,450,480
Mar. 2012 4.57% / 341,213 11.21% / 837,472 15.78% / 1,178,685 9.47% / 707,930 7,471,708
Apr. 2012 4.77% / 358,174 11.20% / 840,803 15.97% / 1,198,977 9.42% / 707,222 7,507,031
May 2012 4.93% / 372,514 11.29% / 852,608 16.23% / 1,225,222 9.43% / 711,612 7,549,730
June 2012 5.19% / 393,894 11.43% / 867,959 16.61% / 1,261,853 9.48% / 719,984 7,594,689
July 2012 5.04% / 384,349 11.48% / 874,802 16.52% / 1,259,151 9.51% / 725,074 7,622,873
Aug. 2012 4.91% / 375,464 11.44% / 874,656 16.35% / 1,250,120 9.49% / 725,692 7,645,912
Sept. 2012 5.58% / 428,351 11.70% / 898,590 17.30% / 1,326,931 9.62% / 738,303 7,671,677
Oct. 2012 5.02% / 387,000 11.54% / 887,959 16.57% / 1,274,959 9.54% / 734,431 7.693,992
Nov. 2012 4.95% / 382,194 11.53% / 888,901 16.48% / 1,271,095 9.56% / 737,251 7,710,077
Dec. 2012 5.23% / 404,686 11.50% / 890,400 16.72% / 1,295,086 9.40% / 728,394 7,744,925
Jan. 2013 5.07% / 392,536 11.63% / 900,852 16.70% / 1,293,388 9.58% / 741,618 7,744,921
Feb. 2013 4.76% / 369,571 11.21% / 869,952 15.97% / 1,239,523 9.39% / 728,860 7,760,200
Mar. 2013 4.52% / 351,478 10.68% / 829,619 15.21% / 1,181,097 9.03% / 701,628 7,767,181
Apr. 2013 4.36% / 338,957 10.32% / 801.694 14.68% / 1,140,651 8.73% / 678,506 7,770.886
May 2013 4.39% / 341,400 10.06% / 782,193 14.46% / 1,123,593 8.45% / 656,909 7,771,948
June 2013 5.27% / 410,172 10.26% / 798,199 15.53% / 1,208,371 8.47% / 659,314 7,781,196
July 2013 4.87% / 378,903 10.10% / 782,895 14.94% / 1,161,798 8.25% / 641,808 7,776,713
Aug. 2013 5.05% / 393,536 9.98% / 776,768 15.03% / 1,170,304 8.11% / 631,502 7,778,157
Sept. 2013 4.98% / 387,624 9.99% / 777,901 14.97% / 1,165,525 8.09% / 630,077 7.778,663
Oct. 2013 4.81% / 375,530 9.89% / 771,215 14.70% / 1,146,745 8.02% / 625,415 7,801,056

Sources: US Department of Housing and Urban Development, “Neighborhood Watch,” https://entp.hud.gov/sfnw/public (Servicing download, Excel; accessed November 18, 2013) and US Department of Housing and Urban Development, “FHA Outlook,” http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/ooe/olmenu(accessed October 21, 2012). Rates not seasonally adjusted. Serious delinquency includes 90-days-plus delinquency and loans in bankruptcy or foreclosure.

Notes:

[1] FDIC, Office of the Inspector General, Challenges and FDIC Efforts Related to Predatory Lending, Report no. 06-011, June 2006,  www.fdicoig.gov/reports06/06-011.pdf.

[2] Federal Housing Administration, “How to Have the Home You Want,” 1936.

[3] Ibid.

[4] US Department of Housing and Urban Development, “FHA Single-Family Origination Trends,” August 2013, http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/hsgrroom/sforgtr. (July–September 2013 period uses July–August data only.)

[5] January–June 2013 estimates were adjusted based on data contained in exhibits 5 and 8, US Department of Housing and Urban Development, FHA Single-Family Mutual Mortgage Insurance Fund Programs, Quarterly Report to Congress FY 2013 Q3, 9 and 13.

EDITORS NOTE: Edward J. Pinto  is a resident fellow at AEI. The views expressed in FHA Watch are those of the author alone and do not necessarily represent those of the American Enterprise Institute. View a printer-friendly copy of FHA Watch, Vol. 2, No. 11, November 2013. To receive your own copy, e-mail edward.pinto@aei.org.

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