No, the FHA should not be pushed to the brink again
Some hailed the Department of Housing and Urban Development's annual report on the Federal Housing Administration’s financial status as evidence that the government mortgage insurance program should lower its fees. And they said that the FHA should consider expanding its footprint in the housing finance market.
But HUD Secretary Ben Carson made clear that while the FHA's financial health has improved, it should "maintain its focus on providing access to mortgage financing to low- and moderate-income families that cannot be fulfilled through traditional underwriting."
The FHA serves an important countercyclical role in the housing finance system; however, it is important that policymakers recognize that there is a vibrant conventional market that is able to serve many borrowers and prudently help them access affordable mortgage finance. Further, because FHA-backed mortgages protect 100% of the risk, expanding the FHA would mean expanding taxpayer exposure to that risk. This is simply not necessary.
Indeed, low down payment lending is critically important to the U.S. housing system. It gives many first-time homebuyers access to the conventional mortgage market without requiring them to put a full 20% down. In the third quarter of 2019, nearly 80% of first-time homebuyers used these mortgages — 35% of which were backed by private mortgage insurance. With the private sector taking the first-loss risk exposure on these loans, the federal government, and thus taxpayers, are far more protected from mortgage credit risk.
The FHA-insured market and the conventional market should complement one another rather than compete. The conventional market — where the credit risk is backed by private capital — is well positioned to play a bigger role in facilitating access to affordable credit. It can do so without unnecessarily saddling the government or taxpayers with risk.
This better enables the FHA to focus on its mission of supporting those borrowers who do not have access to traditional financing — and to ensure it can play its countercyclical role through all market cycles.
In 2018, conventional loans with private MI helped more than one million low down payment borrowers — nearly 60% of which were first-time homebuyers and nearly 40% had incomes below $75,000. And in the first three quarters of 2019, nearly 47% of insured loans had private MI and the industry supported almost $275 billion in new originations. On the other hand, the FHA has over $1.2 trillion of outstanding risk exposure in 2019, according to the HUD report.
For borrowers, conventional low down payment mortgages with private MI are a good deal, because they are affordable despite a higher loan-to-value ratio and the insurance cancels once 20% equity is built. This results in direct savings for the borrower, compared to the FHA where premiums are typically paid for the life of the loan. Further, according to a recent analysis by the Urban Institute, loans with private MI were more affordable than loans backed by FHA for the majority of credit score and down payment cohorts for low down payment borrowers. And for the housing system these loans are a good deal because compared to FHA-backed mortgages, there is less risk exposure for taxpayers. Plus, private mortgage insurers serve as a second set of eyes during the underwriting process to ensure that borrowers are set up for sustainable homeownership.
Instead of asking how FHA lending can be expanded, the debate should revolve around prudently making low down payment mortgages in general more affordable and accessible to ensure risk is being managed appropriately. It can be done. Secretary Carson and other regulators have outlined in their recent reform plans ways to promote private capital supporting the housing finance system where possible.
Further, the mortgage credit landscape is very different today than it was before the financial crisis, largely due to new statutory restrictions of mortgage product features and federal regulation. For example, the "qualified mortgage" rule provides the necessary safeguards for lending and underwriting. These safeguards, including measurable thresholds to assess a borrower's ability to repay, have resulted in much better and safer mortgages being originated. In fact, foreclosure rates are at a 20-year low.
As regulators assess changes to mortgage underwriting requirements, including the expiration of the GSE patch in the QM rule, these changes should be done in a coordinated manner with federal housing agencies by collaborating to create and implement a harmonized standard that can apply across the conventional and FHA mortgage markets alike to ensure a level playing field. Otherwise, the resulting regulatory patchwork could create arbitrage opportunities, lock some consumers out of the market due to higher costs, and merely shift, rather than reduce, the government’s exposure to mortgage credit risk.
Our housing regulators have a significant opportunity to strike the right balance to ensure that both access and risk are managed throughout the mortgage finance system. Private mortgage insurers understand this delicate balance and look forward to working with them to achieve sustainable levels for each.