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An Analysis of FHA's Single-Family Insurance Program, 1996


Report Acceptance Date: March 1996 (172 pages)

Posted Date: March 21, 1997

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Despite its unique and historic function in promoting homeownership for America's families at no cost to taxpayers, many questions have been raised about the Federal Housing Administration's (FHA's) proper role and structure in today's housing finance system. An Analysis of FHA's Single-Family Insurance Program, a new report from HUD's Office of Policy Development and Research, provides information and policy recommendations that will contribute to the continuing debate over the future of FHA and its single-family mortgage insurance program.

FHA's single-family insurance program, which began 60 years ago in an effort to stimulate new construction activity, has evolved into a vehicle for expanding access to mortgage credit for first-time homebuyers and traditionally underserved borrowers, including lower income households, minorities, and those living in neighborhoods with lower income or minority concentrations.

In recent years, conventional lenders, spurred by Community Reinvestment Act requirements, have begun to increase the flexibility of their underwriting standards and have become more active in lending to underserved populations. However, the report found no objective evidence of significant overlap between FHA borrowers and products and those of private mortgage insurance (PMI) providers -- FHA targets borrowers with a higher level of risk than private providers are willing to accommodate. FHA insures loans for 100 percent of unpaid mortgage principal balances -- instead of 30 percent like PMI -- which gives lenders the protection they require in order to serve higher risk borrowers.

A core group of borrowers will continue to be attracted to FHA because the single-family insurance program offers a package of benefits unparalleled in the conventional market:

  • Lending to borrowers with lower quality credit histories.
  • Financing up to 100 percent of up-front loan closing costs and insurance premiums.
  • Requiring lower downpayments for home mortgages.
  • Permitting higher loan-to-value (LTV) ratios on loan refinances.
  • Providing higher allowances for seller-paid closing costs.

The report therefore recommends that policymakers proceed cautiously in significantly altering the single-family mortgage insurance program.

Some critics have suggested that adverse selection -- when lower risk borrowers seek lower cost alternatives -- could become a problem for FHA in the future as advances in information technology enable private insurers to more accurately price their products. The concern is that FHA will be left with the very riskiest borrowers as lower risk borrowers take their business to ever more competitive conventional lenders, a cycle that could ultimately lead FHA toward insolvency. Although FHA currently operates on an actuarially sound basis and does not have a problem with adverse selection, the report suggests strategies that FHA can pursue to avoid adverse selection. In 1995 HUD proposed restructuring FHA into a government-owned corporation under the Department's direction, while others have proposed reducing the role of FHA or leaving its tasks to the conventional market. Proposals to constrain or privatize FHA, however, rest on the premise that conventional market institutions can supplant FHA's role without increasing costs to home purchasers -- an assumption the report shows to be unlikely. Without the cost advantage FHA derives from the Federal guaranty and from charging higher premiums, PMI providers are unlikely to be interested In insuring the types of loans currently insured by FHA. The report finds that terminating FHA would lead to a decrease in homeownership among moderate-income families and that FHA's cushioning effect for local housing markets in times of rising interest rates or downturns in the economy would be lost if the agency were privatized.

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