Tag Archives: FHA

Qualified Mortgages and The Community Reinvestment Act

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Regulators issued an Interagency Statement on Supervisory Approach for Qualified and Non-Qualified Mortgage Loans relating to the interaction between the QM rules and Community Reinvestment Act enforcement. This statement complements a similar rule issued in October that addressed the interaction between the QM rules and fair lending enforcement.

The statement acknowledges that lenders are still trying to figure out their way around the new mortgage rules (QM & ATR) that will go into effect in January. The agencies state that “the requirements of the Bureau’s Ability-to-Repay Rule and CRA are compatible. Accordingly, the agencies that conduct CRA evaluations do not anticipate that institutions’ decision to originate only QMs, absent other factors, would adversely affect their CRA evaluations.” (2)

This is important for lenders who intend to only originate plain vanilla QMs. There have been concerns that doing so may result in comparatively few mortgages being CRA-eligible. It seems eminently reasonable that lenders not find themselves between a CRA rock and a QM hard place if they decide to go the QM-only route. That being said, it will be important to continue to monitor whether low- and moderate-income neighborhoods are receiving sufficient amounts of mortgage credit. Given that major lenders are likely to originate non-QM products, this may not be a problem. But we will have to see how the non-QM sector develops next year before we can know for sure.

Reiss on New Mortgage Rules

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The Redding Record Searchlight interviewed me in Experts Worry New Loan Standards, Lending Limits Could Hurt Housing Market. It reads in part,

New mortgage qualification rules and lower FHA lending limits that take effect next year threaten to slow the housing market’s recovery.

*     *     *

David Reiss, a law professor at Brooklyn Law School in New York, said there is nothing wrong with tying the price of a loan to the risk.

“There is some talk that if it’s not a Qualified Mortgage loan, the cost for the creditor or lender will be higher and the cost will be passed on to the homeowner. That will probably be true,” Reiss said.

But Lawrence of Silverado Mortgage said just because one in five loans written today wouldn’t pass Qualifying Mortgage muster doesn’t necessarily suggest the loan would not be approved and closed under the new standards.

“Making a minor adjustment such as using a different interest rate and closing cost combination may allow a loan to meet the standard that it wouldn’t otherwise,” Lawrence said.

Lawrence knows there will be some loans for which an alternative can be found to resolve a Qualifying Mortgage issue.

“But I think most buyers start with getting pre-qualified before they find the home they’re interested in purchasing,” Lawrence said.

FHA’s Net Cost of $15 Billion

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The Congressional Budget Office posted FHA’s Single-Family Mortgage Guarantee Program: Budgetary Cost or Savings? In response to the question, “Has FHA’s Guarantee Program for Single-Family Mortgages Produced Net Savings to Taxpayers,” the CBO responds,

No. Collectively, the single-family mortgage guarantees made by FHA between 1992 and 2012 have had a net federal budgetary cost of about $15 billion, according to the most recent estimates by FHA. In contrast, FHA’s initial estimates of the budgetary impact of those guarantees sum to savings of $45 billion . . .. That swing of $60 billion from savings to cost primarily reflects higher-than-expected defaults by borrowers and lower-than-expected recoveries when the houses of defaulted borrowers have been sold—especially for loans made over the 2004-2009 period. (1)

The document contains a chart of estimates of the budgetary impact of the FHA’s single-family mortgage guarantees by year. It shows that the 2008 vintage was particularly bad, accounting for over $15 billion in losses by itself (the other years’ savings and costs would thus net out).

There are some disturbing aspects of this finding and some that are not. First, the disturbing ones. The FHA has not been transparent about its potential for losses and bailouts (see here for instance). Second, its own financial projections have been overly optimistic.

That being said, the mere fact that the FHA is expected to have losses is not in itself an indictment of the government’s strategy of using the FHA to provide liquidity to the mortgage markets during the financial crisis. If only this were done forthrightly . . . but perhaps that is too much to ask in the midst of the crisis itself.

Qualified Mortgage Fair Lending Concerns Quashed

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Federal regulators (the FRB, CFPB, FDIC, NCUA and OCC) announced that “a creditor’s decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution’s fair lending risk.” This announcement was intended to address lenders’ concerns that they could be stuck between a rock (QM regulations) and a hard place (fair lending requirements pursuant to the Equal Credit Opportunity Act and the Fair Housing Act). For instance, a lender might want to limit its risk of lawsuits relating to the mortgages it issues that could arise under a variety of state and federal consumer protection statutes by only issuing QMs only to find itself the defendant in a Fair Housing Act lawsuit that alleges that its lending practices had a disproportionate adverse impact on a protected class.

The five agencies issued an Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and Qualified Mortgage Standards Rule that gives some context for this guidance:

the Agencies recognize that some creditors’ existing business models are such that all of the loans they originate will already satisfy the requirements for Qualified Mortgages. For instance, a creditor that has decided to restrict its mortgage lending only to loans that are purchasable on the secondary market might find that — in the current market — its loans are Qualified Mortgages under the transition provision that gives Qualified Mortgage status to most loans that are eligible for purchase, guarantee, or insurance by Fannie Mae, Freddie Mac, or certain federal agency programs.

With respect to any fair lending risk, the situation here is not substantially different from what creditors have historically faced in developing product offerings or responding to regulatory or market changes. The decisions creditors will make about their product offerings in response to the Ability-to-Repay Rule are similar to the decisions that creditors have made in the past with regard to other significant regulatory changes affecting particular types of loans. Some creditors, for example, decided not to offer “higher-priced mortgage loans” after July 2008, following the adoption of various rules regulating these loans or previously decided not to offer loans subject to the Home Ownership and Equity Protection Act after regulations to implement that statute were first adopted in 1995. We are unaware of any ECOA or Regulation B challenges to those decisions. Creditors should continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems. As with any other compliance matter, individual cases will be evaluated on their own merits. (2-3)

 Lenders and their representatives have raised this issue as a significant obstacle to a vibrant residential mortgage market. This interagency statement should put this concern to rest.

Mortgage Reform Schooling on 30 Year Term

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S&P has posted U.S. Mortgage Finance Reform Efforts and the Potential Credit Implications to school us on the current state of affairs in Congress. It provides a useful lesson on three major mortgage reform bills introduced in Congress this year.  They are the Housing Finance Reform and Taxpayer Protection Act of 2013 (Corker-Warner); Protecting American Taxpayers and Homeowners ACT of 2013 (PATH); and the FHA Solvency Act.

Given the current mood in D.C., S&P somewhat optimistically states that there “seems to be a bipartisan commitment to encourage private capital support for the U.S. housing market while winding down Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that hold dominant positions in the mortgage market.” (1) S&P uses this report as an opportunity to “comment on the potential credit implications of these mortgage finance reform efforts on several market sectors.” (1)

In this post, I focus on, and criticize, S&P’s analysis of the appropriate role of the 30 year fixed-rate mortgage. S&P states that

The 30-year fixed-rate mortgage has contributed significantly to housing affordability in the U.S. And while some market players have looked at current rates on jumbo mortgages (those that exceed conforming-loan limits) and suggested that the private market could support mortgage interest rates below 5%, we think this view is distorted. Jumbo mortgage rates carrying the lowest interest rates, for the most part, are limited to a narrow set of borrowers who have FICO credit scores above 750 and equity of roughly 30% in their homes. We don’t believe that these same rates would be available to average prime borrowers, such as those with credit scores of 725 and 25% equity in a property. (3)

While I think that S&P is probably right about the limited usefulness of comparing current jumbo loans to a broad swath of conforming loans, I see no support in their analysis for the assertion that the “30-year fixed-rate mortgage has contributed significantly to housing affordability in the U.S.” First, a 30-year FRM typically carries a higher interest rate than an ARM of any length. Second, a typical American household only stays in a home for about seven years. Thus, a 30-year FRM provides an expensive insurance policy against increases in interest rates that most Americans do not end up needing.

While we may end up providing governmental support for the 30-year FRM because of its longstanding popularity, S&P’s mortgage reform school should be based on facts, not fancy.

American Dream/American Nightmare

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I will be presenting “How Low Is Too Low? The Federal Housing Administration and the Low Down Payment Mortgage” at the 2013 Meeting of the Canadian Law and Economics Association next week in Toronto. I just came back from an interesting conference at the Cleveland Fed where I was on a panel devoted to the FHA. The other two panelists presented some disturbing findings about default rates for FHA mortgages.

The two panelists were

Edward J. Pinto, Resident Fellow, American Enterprise Institute, How the FHA Hurts Working-Class Families

Joseph Tracy, Executive Vice President and Senior Advisor to the President, Federal Reserve Bank of New York, Interpreting the Recent Developments in Housing Markets

Pinto’s summary is as follows:

The Federal Housing Administration’s mission is to be a targeted provider of mortgage credit for low- and moderate-income Americans and first-time home buyers, leading to homeownership success and neighborhood stability. But is the FHA achieving this mission? This paper reports on a comprehensive study that shows the FHA is engaging in practices resulting in a high proportion of low- and moderate-income families losing their homes. Based on an analysis of the FHA’s FY 2009 and 2010 books of business, the FHA’s lending practices are inconsistent with its mission. The findings indicate: An estimated 40 percent of the FHA’s business consists of loans with either one or two subprime attributes—a FICO score below 660 or a debt ratio greater than or equal to 50 percent (based on loans insured during FY 2012). The FHA’s underwriting policies encourage low- and moderate-income families with low credit scores or high debt burdens to make risky financing decisions—combining a low credit score and/or a high debt ratio with a 30-year loan term and a low down payment. A substantial portion of these loans has an expected failure rate exceeding 10 percent. Across the country, 9,000 zip codes with a median family income below the metro area median have projected foreclosure rates equal to or greater than 10 percent. These zips have an average projected foreclosure rate of 15 percent and account for 44 percent of all FHA loans in the low- and moderate-income zips.

Tracy reported that rates of defaults by households rather than by mortgages gave a truer picture of the FHA’s success because many FHA borrowers would refinance into another FHA loan. Thus, to study defaults by mortgages covers up the real rate of default.

I believe that their studies were preliminary and have not gone through peer review, but both of them reported extraordinary default rates for certain types of FHA mortgages.

Pinto and his empirical work are very controversial so I cannot endorse his findings. But I can say that if he got it only somewhat right about predictable and ridiculously high default rates for some categories of borrowers, the FHA must immediately defend the underwriting of such loans or change its practices. It would be criminal to have predictable default rates in excess of 20% for any population. Such a rate transforms the American Dream of homeownership into an American Nightmare of foreclosure far, far too often.

Reiss on the FHA and Low Downpayment Mortgages

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I will be speaking at the Cleveland Fed’s 2013 Policy Summit on Housing, Human Capital, and Inequality on Thursday, September 19 from 2:40PM-4:10PM.  My panel is on

Affordable Housing, Mortgage Underwriting, and Default: The Case of the FHA

In the past few years FHA’s market share has increased substantially, as have its default and foreclosure rates. Recently, the White House announced that the FHA may have to make a capital call to Treasury for the first time in its history, prompting much debate over the future of the organization. In this session, a panel of experts will discuss the FHA’s financial situation, its role in providing affordable housing, and explore potential policy responses.

Moderator:

Emre Ergungor, Senior Research Economist, Federal Reserve Bank of Cleveland

Speakers:

Edward J. Pinto, Resident Fellow, American Enterprise Institute, How the FHA Hurts Working-Class Families

David Reiss, Professor, Brooklyn Law School, How Low is Too Low? The Federal Housing Administration and the Low Downpayment Loan

Joseph Tracy, Executive Vice President and Senior Advisor to the President, Federal Reserve Bank of New York
Interpreting the Recent Developments in Housing Markets

My summary and implications are below and those for the other speakers can be found at the link above.

Summary and Findings
The Federal Housing Administration (FHA) has been a flexible tool of government since it was created during the Great Depression. It succeeded wonderfully, with rapid growth during the late 1930s. The federal government repositioned it a number of times over the following decades to achieve a variety additional social goals. It achieved success with some of its goals and had a terrible record with others. Today’s FHA is suffering from many of the same unrealistic underwriting assumptions that have done in so many subprime lenders as well as Fannie and Freddie. The FHA has come under attack for its poor execution of some of its additional mandates and leading commentators have called for the federal government to stop undertaking them. This article takes the long view and demonstrates that the FHA also has a history of successfully undertaking new programs. It also identifies operational failures that should be noted to prevent them from occurring if the FHA were to undertake similar ones in the future. The article first sets forth the dominant critique of the FHA and a history of its constantly changing role. It then addresses the dominant critique of the FHA and evaluates its priorities in the context of legitimate housing policy objectives. It concludes that the FHA has focused on an unthinking “more is better” approach to housing, but that the FHA can responsibly address objectives other than the provision of liquidity to the residential mortgage market.

Implications for Policy and Practice
Leading commentators on the FHA do not fully appreciate the extent to which down payment requirements alone drive the success and failure of new FHA initiatives. Central to any analysis of the FHA’s role is an understanding of its policies relating down payment size. Much of the FHA’s performance is driven by its down payment requirements, which have trended ever downward so that homeowners were able to get loans for 100% of the value of the house in recent times. As is obvious to all, the larger the down payment, the safer the loan. What appears to have been less obvious is that very small down payments are unacceptably risky. Given that the FHA insures 100% of the losses on its mortgages, the down payment requirement is a key driver of its performance. From an underwriting perspective, 20% is clearly desirable as the risk of default is very low even in a down market. But from an opportunity perspective, a 20% down payment requirement would keep large swaths of potential first-time homeowners from entering the market. If down payments are set too high, than an important social goal may be left by the wayside. So it is important that the public discourse weighs the costs and benefits of setting a fixed down payment requirement versus taking a risk layering approach to down payments. In either case, the FHA must balance the goal of safe underwriting with the goal of making homeownership available to households who could maintain it for the long term.