Nearly 80 years ago Stewart McDonald, the Federal Housing Administration’s first administrator, observed: “To many people, ‘Mortgage’ became just another word for trouble—an epitaph on the tombstone of their aspirations for home ownership.” Over the last 7 years, the same epitaph has been written for many millions of aspiring homeowners.
When established in 1934 by Congress, FHA implemented strong, commonsense underwriting standards—increasing down payments to a minimum of 20%, establishing reliable and speedy loan pay downs with a 15-20 year loan term, using a residual income test to assure a borrower’s reasonable ability to pay, and requiring demonstration of a good credit history. From 1934 to 1960, these standards helped millions upon millions of Americans safely and confidently achieve the American dream of eventually owning their home free and clear of a mortgage and helped increase the homeownership rate to new heights. Over its first 20 years, the FHA paid only 5,712 claims out of 2.9 million insured mortgages for a cumulative claims rate of 0.2%.
Yet by 1962 Time Magazine would observe: “Homeowners of a new and unattractive breed are plaguing the Federal Housing Administration these days. Known as ‘the walkaways,’ they are people who find themselves unable to meet their mortgage payments—and to solve the problem simply move out their belongings at night, drop their house key in the mailbox and disappear.” What had caused an FHA mortgage to become just another word for trouble?
Powerful interest groups such as the National Association of Realtors convinced politicians to replace FHA’s sound underwriting practices with increasingly risky ones. From 1957 to 1961 Congress raised FHA’s maximum loan to value ratio (LTV) four times so that by 1961 the maximum LTV was 97%.
In 1963 the FHA commissioner issued a report analyzing why is was suffering from mounting foreclosures:
The Congress expects, many home buyers require, and the housing industry needs the high volume of home construction and the active market for existing homes that can be soundly achieved and sustained through the liberality of the terms on which FHA is authorized to insure mortgages….The Federal Housing Administration is deeply committed to a program of accurate underwriting based on adequate analysis, accurate information, and sound judgment. This report will help us to keep our risk-rating processes in line with the changing times.
However, the very next year, FHA abandoned the very risk-rating process it had been relying on.
As a result the increasingly lax standards for FHA insurance once again made foreclosures commonplace. From 1975 to 2011, over 3 million FHA borrowers would lose their homes to foreclosure. Over time, powerful lobbies, politicians, and HUD pushed to replicate FHA’s abandonment of commonsense underwriting at Fannie Mae, Freddie Mac, and other parts of the mortgage market. For 8 million families experiencing foreclosure from 2007 to the present, “mortgage” once again became just another word for trouble.
The only way to bring stability to our housing market is to once again assure that the preponderance of mortgages are safe—ones that have a low risk of turning into trouble under economic stress. This requires a return to common sense underwriting. Today this safety standard is being met with respect to 0% of FHA insured mortgages and only 38% of all new home purchase mortgages nationwide.
EDITORS NOTE: The featured image is courtesy of AEI and Shutterstock.