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View related content: Housing Finance
If you want to understand America’s foreclosure crisis, look no further than the Federal Housing Administration (FHA), the organization that insures the mortgages of nearly eight million families. Founded in 1934 in the midst of the Great Depression, the FHA was supposed to stabilize the mortgage market and generally make things better for homeowners. But something went horribly wrong.
Recently, the Federal Housing Administration (FHA) said it needs $1.7bn to cover losses, the first taxpayer-funded bailout in the organization’s 79-year history. To put that in perspective, if FHA were held to the same standards as private mortgage insurers, it would be insolvent to the tune of $25bn.
While this is bad news for the taxpayers, FHA has an even more troubling problem. For decades FHA’s underwriting practices have put families into homes they can’t afford. By financing failure, FHA has made foreclosures commonplace. One in eight families getting an FHA loan from 1975 to 2011 has already been or will end up in foreclosure. That’s over 3 million families.
This abysmal record is made worse by the fact that lower-income and minority families have suffered from disproportionately higher foreclosure rates – closer to one in five families.
How did it get this bad? In the run-up to the recent housing market collapse, the Department of Housing and Urban Development (HUD) forced Fannie Mae, Freddie Mac, and private lenders to adopt, and even go beyond, FHA’s weak underwriting practices. In 2004, HUD even took credit for bringing about looser underwriting by what it termed a “revolution in affordable lending”.
FHA continues to sell hope and deliver harm by pushing families into homes they can’t afford, saddling them with loans that barely build equity. By tolerating such a high failure rate, families are left in financial ruin and communities are left reeling.
This is in sharp contrast to FHA’s early years (1934-59) when foreclosures were uncommon. By the mid-1950s, FHA had pioneered sound underwriting principles based upon balancing down payment, loan term, and debt levels. As late as 1954, down payments and terms on FHA loans averaged about 20% and 20 years, respectively. The National Housing Act of 1934 required FHA to assure that borrowers were not taking on obligations in “excess of his reasonable ability to pay”. As a result, home buyers accumulated nearly 30% in earned equity after four years. With housing debt ratios averaging 15%, borrowers with an FHA loan had a cushion to handle adverse income shocks
The FHA began abandoning these principles in the late 1950s and, as a result, foreclosures soared. New underwriting policies encouraged many low- and moderate-income families to make a risky financing decision – one combining poor credit with a 30-year loan term, high debt, and a low down payment. This set up for failure the very families and communities FHA was charged with helping.
Today, families in low- and moderate-income zip codes have a 40% higher expected foreclosure rate than those in zip codes with a median income greater than 110% of the metro area median. Families living in metro area zip codes where the minority percentage is 80% or more have a projected foreclosure rate 60% higher than zip codes where the minority percentage is 20% or less.
A long history of cross-subsidizing high-risk loans with lower-risk loans facilitates FHA’s disproportionate impact on lower income and minority families. FHA must stop inflicting these high rates of default and foreclosure on lower income and minority borrowers. FHA should be providing responsible mortgage credit by balancing down payment, loan term, FICO credit score, and debt-to-income level. It should assure that borrowers are not taking on obligations in excess of one’s reasonable ability to pay and result in a strong probability that the debt will be paid off in accordance with its terms and should advise each consumer as to his or her foreclosure risk based on an applicant’s risk profile. It should ask Congress for authority to hold lenders more responsible by reducing its insurance coverage from 100% to 50%.
These common sense reforms will provide these families with the opportunity to achieve meaningful equity and be mutually advantageous to lenders and the FHA.
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