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The Future of FHA Mortgage Lending

December 12th, 2011

Rick Grant wrote an article published by the National Mortgage News regarding the future role of FHA. In this FHA Assessment Report, Robert Van Order and Anthony Yezer of the George Washington University School of Business for the University’s Center for Real Estate and Urban Analysis considered at the future role of the FHA mortgage programs.

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In their first report, the authors concluded that since FHA had captured 56% of the market for first-time and low to moderate income home buyers by 2012, the agency was fulfilling its mission. But with home loans of more than $350,000 having 20% worse default rates, high loan limits increased the agency’s risk significantly. In their second report, the authors concluded that FHA could serve 95% of its historic target market even if loan limits were reduced by nearly 50%.

As the U.S. housing market enters its recovery phase, the co-authors focus their third report on “the factors that are determinants of mortgage risk to ensure that FHA doesn’t layer on excessive risk.” The authors considered these specific issues in their analysis, the balance between low down payments and other loan characteristics, the risk inherent in different loan types and the other factors that also impact overall risk that are not so easily observed. The FHA need not mimic the private sector, but must take care to adjust to changes that represent additional risks.

To explore the relationship between loan to value and FICO score, the authors studied data supplied by the Federal Housing Finance Agency. GSE loans were segmented into four LTV classes and four FICO buckets. The authors looked at FHA loans originated in 2003, a good year for the industry and borrowers, and 2006, well into the downturn.

Assuming that skin in the game (lower LTVs) is enough to prevent default or that high FICO guarantees continued payments leads to error. It’s the layering of risk that matters. For instance, the GSE loans with 95% or greater LTV and with credit scores between 680 and 720 had about the same rate of default as those loans below 75% LTV with low credit scores. Likewise, the economic conditions at the time had a significant impact on default for all LTV and FICO buckets.

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