Basil N. Petrou, a financial adviser to the Mortgage Insurance Companies of America and former Treasury Department official, recently addressed a conference in Chicago about the problems of the Federal Housing Administration's loan-insurance program. After the conference, American Banker reporter Christopher Noble spoke with him about some of those problems and what the future holds for FHA loans.
Q: What's wrong with the FHA program right now?
PETROU: During the glory days of FHA in the 1960s and early 1970s, you actually had a program that had, by today's FHA standards, fairly high down-payment requirements.
They were still lower than what was available outside of FHA, but you were expected to have equity in your home. It was also a program that was targeted to the middle and lower-middle class.
The home prices that you could afford with an FHA loan just about equaled what the median house price was in the country.
But in 1978, the FHA effectively reduced the down-payment requirements by 50%. Then it raised the loan limits and continued to raise them throughout the 1980s.
They lowered the down payments even more basically allowing you to finance up front a large [insurance] premium rather than pay it annually.
All this resulted, with the best of intentions, in a program in which people had almost no equity in their homes. The slightest downturn in the economy caused them to have trouble paying their mortgages.
Q: When would you would say FHA hit bottom?
PETROU: I would say in 1988 or 1989. But in 1990, Congress passed some reforms that put in a premium schedule tied to the loan-to-value ratio. They lowered the up-front premium, the fully financeable amount, over a period of years.
And then they made homeowners pay 50 basis points of the mortgage amount [as an insurance premium] each year for a number of years, depending on what the initial loan-to-value ratio was.
Q: Are things better now?
PETROU: I think so. But they raised the loan limit, which does nothing for the middle class. Now the FHA maximum loan is $151,725, which is totally out of the reach of the median-income family making $37,000 or $38,000.
FHA has been focusing on higher and higher home prices, when in fact the median family income has not increased significantly. So you end up with almost a misdirection of the focus of FHA.
Q: How did the program get out of focus?
PETROU: The focus had historically been the house price. And if you look at the 1960s and 1970s during the lower inflation period, home price was an acceptable proxy for income until 1977.
Then home prices started to soar but incomes didn't, and in fact interest rates went up so you could afford less of a house.
Q: What other problems do you see?
PETROU: There is still a problem with 100% mortgage insurance. As the homeowner becomes less and less of an equity participant in the house, I think the lender realizes that what is important is the 100% federal insurance.
Q: Where does the FHA go from here?
PETROU: The worst thing you could possibly do at FHA now is to raise the loan limits and lower down-payment requirements.
Q: The down payment is the biggest obstacle to homeownership. Is this an admission that we need a big obstacle?
PETROU: I think it's an admission that even if the government were willing to absorb the cost of a lot of claims, the reality is that it's hurting the people who go to foreclosure.
I don't have an answer, but it seems like you need to focus on finding affordable housing which is acceptable and affordable to the individual, and in which he has an equity stake.
Q: Do you think things are going to change?
PETROU: I would just hope that whatever changes the new administration is considering, they would realize what has been painfully learned at FHA, which is that raising the loan limit and lowering the down-payment requirements does nothing to help moderate-income people stays in homes.
There's no one answer on changing FHA. I think there needs to be reconsideration of the entire package. But the 1990 reforms are certainly very good and significant in helping FHA return to profitability and to a stable capital situation.