oversight

Homeownership: Results of and Challenges Faced by FHA's Single-Family Mortgage Insurance Program

Published by the Government Accountability Office on 1999-03-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                    United   States General   Accounting   Office

                    Testimony
GAO                 Before the Subcommittee on Housing and Transportation,
                    Committee on Banking, Housing, and Urban Affairs,
                    U.S. Senate


For Release
on Delivery
Expected at
                    HOMEOWNERSHIP
2:00 p.m. EST
Thursday
March 25,1999
                    Results of and Challenges
                    Faced by l?HAk
                    Single-Family Mortgage
                    Insurance Program
                    Statement of Stanley J. Czerwinski, Associate Director,
                    Housing and Community Development Issues,
                    Resources, Community, and Economic Development
                    Division




GAO/T-RCED-99-133
                                                                                          --
    Mr. Chairman and Members of the Subcommittee:

    We are here today to discuss the single-family mortgage insurance
    program of the Department of Housing and Urban Development’s (HUD)
    Federal Housing Administration (FHA). F’HAinsured over 1 million
    mortgages, representing over $90 billion in single-family mortgage
    insurance during fiscal year 1998-ending the fiscal year with a total of
    about $380 billion in single-family mortgage insurance outstanding. Many
    changes have occurred in the single-family housing finance system since
    FNAwas established in 1934 to insure housing loans made by private
    lenders. These changes include the advent of modern private mortgage
    insurance, the development of a secondary mortgage market, and the
    emergence of a number of public- and private-sector initiatives designed to
    expand affordable housing opportunities for homebuyers. Given these
    developments, an ongoing debate has centered on FHA’Srole in today’s
    single-family housing finance system. Critics of FXA contend that other
    housing finance players, such as private mortgage insurers, are filling the
    need once Elled exclusively by FTIA.Supporters of FXA argue that its
    single-family program, which has insured at least 24 million home
    mortgages since its inception, remains the only way for some families to
    become homeowners and should be expanded.

    My statement today is based primarily on reports we have issued over the
    last 3 years’ and will (1) discuss the activities of FXA’Shome mortgage
    insurance program, including the extent to which home buyers use FHA
    insurance, the characteristics of these home buyers-including     whether
    they were first-time home buyers-and how many of them might also
    qualify for private mortgage insurance; (2) compare the insurance terms
    available through nr~‘s principal single-family mortgage insurance
    program with private mortgage insurance and guarantees from the
    Department of Veterans’ Affairs (VA); and (3) examine the challenges FHA
    faces in ensuring the financial health of its Mutual Mortgage Insurance
    Fund-the insurance fund supporting most FHA-insured single-family
    mortgages.

    In summary:

l   FHAis a major participant in the single-family housing market--overall as
    well as for some specific market segments, particularly lower-income and

    ‘Homeownership: FHA’s Role in Helping People Obtain Home Mortgages (GAO/RCED-96123, Aug. 13,
    1996); Mortgage Financing: F’HA Has Achieved Its Home Mortgage Capital Reserve Target
    (GAO/RCED-9650, Apr. 12,1996); Homeownership: Potential Effects of Reducing FHA’s Insurance
    Coverage for Home Mortgages- (GAO/RCED-97-93, May 1,1997).



    Page   1                                                                GAOfl-BCED-99-133
                       other homebuyers who may have less cash for a down payment but are
                       otherwise able to afford the loan2
                       l  In 1997, FHAinsured over 33 percent of the loans for which lenders
                          required mortgage insurance.
                       l  In 1996, FHAinsured a greater percentage of the home loans made to
                          low-income homebuyers than did either the VA or the private market.
                          This also held true for loans to minorities-FHA insured 30 percent of
                          these loans in 1996, with private companies insuring 14 percent and VA
                          insuring 6 percent.
                       l  Two-thirds of the loans FHAinsured in 1995 probably would not have
                          qualified for private mortgage insurance on the basis of the loan-to-value
                          and qualifying ratios of the loans FHAinsured.
                     . The FHAand VA programs allow borrowers to make smaller down
                       payments and have higher total-debt-toincome ratios than do private
                       mortgage insurers. FHA’Sprogram differs from both the private mortgage
                       insurers’ and VA’S programs: Only FHAallows borrowers to Glance closing
                       costs in the mortgage. FI-IAinsures loans only up to a maximum amount of
                       $208,800,3 while VA-guaranteed loans generally cannot exceed $203,000.
                       Private mortgage insurers will insure larger loans than either FiU or VA.FuA
                       provides nearly full insurance coverage to lenders, while VA and private
                       insurers do not.
                     . While FHA’SMutual Mortgage Insurance Fund is financially healthy and has
                       surpassed the legislative target for reserves, FHAfaces challenges in
                       reducing the losses it incurs on foreclosed properties and maintaining its
                       financial self-sufficiency in the face of economic and other factors that
                       could adversely affect future program costs.

                           Before      I discuss       these issues         in greater    detail, let me briefly       explain      the
                           reasons for mortgage insurance programs like FHA’Sand how the programs
                           decide which loans they will insure.


                           Lenders typically require mortgage insurance when a homebuyer has a
FHAk Single-Family         down payment of less than 20 percent of the value of the home. In these
Mortgage Insurance         cases, the loan-to-value (LTV) ratio of the mortgage is higher than 80
Program                    percent. Most lenders require mortgage insurance for these loans because
                           they are more likely to default than are loans with lower LTV ratios. If a
                           loan with mortgage insurance defaults, the lender may foreclose on the

                           ‘“Low-income”       refers to a borrower     with an income no greater than 80 percent   of the median   income
                           in the Metropolitan       Statistical Area   where the borrower is located.

                           3Alaska, Hawaii, Guam, and the Virgin Islands may have even higher loan limits because the Congress
                           has designated   these states and territories as special high-cost areas, allowing F’HA to set its loan limits
                           there up to 50 percent higher than the limits applicable    elsewhere.



                           Page   2                                                                                  GAO/I?-WED-99-133
loan and collect all or a portion of the losses from the insurer. In 1996,
lenders required mortgage insurance for nearly 40 percent (or about
1.5 million) of the 3.8 million mortgages borrowers took out, according to
information collected by banking regulatory agencies through
requirements contained in the Home Mortgage Disclosure Act @MDA).*

Private  mortgage insurers, FWA,and VA provide virtually ah single-family
mortgage insurance. In general, private insurers operate standard
programs for typical borrowers and special affordable programs for
qualified borrowers who have fewer down payment funds and need
increased underwriting flexibility.5 FXAprovides most of its single-family
mortgage insurance through the Section 203(b) program. This program has
not required any federal funds to operate because FXA has collected
enough revenue from insurance premiums and foreclosed property sales
to cover claims and other expenses. FHAalso operates some smaller,
specialized single-family mortgage insurance programs. A primary goal of
FXA’Ssingle-family programs is to assist households that may be
under-served by the private market. VA provides insurance through its
Home Loan Guaranty Program only to U.S. veterans and their families.

FHA,VA,and private mortgage insurers provide lenders with guidelines for
deciding whether or not a mortgage is eligible for mortgage insurance. In
addition, the Federal National Mortgage Association (Fannie Mae) and the
Federal Home Loan Mortgage Corporation (Freddie Mac) establish their
own guidelines-including     requirements for mortgage insurance under
certain circumstances-for     the loans they will purchase in the secondary
mortgage market.6 A borrower’s ability to repay the mortgage is often
evaluated by computing    the ratios of the borrower’s total debt burden and
housing expenses to his/her income (known as “qualifying ratios”). The
“total-debt-to-income ratio” compares all of the borrower’s long-term
debt payments, including housing expenses, with his or her income. The
“housing-expense-to-income ratio” compares the borrower’s expected
housing expenses with his or her income.


                                                                                               --
this figure is based on mortgages reported by lenders pursuant to the HMDA requrements. However,
the number of mortgages written in 1996 is somewhat higher because HMDA collects information on
most, but not every, mortgage.

‘Underwriting   is the process of analyzing a borrower’s willingness and ability to repay a loan.

“Fannie Mae and fieddie Mac are govemment-sponsored enterprises that provide a secondary market
for many home mortgages. Because most mortgage lenders want to sell some or all of the loans they
make in the secondary market, they apply Fannie Mae’s and Freddie Mac’s underwriting standards to
the loans they issue.


Page   3                                                                           GAOR-BCED-99-133
                                                                                                                                   -
                        The HMDA database contains information on mortgages insured through
                        M’s principal single-family mortgage insurance program-the        Section
                        203(b) program-in addition to loans insured through FHA’Ssmaller
                        single-family mortgage insurance programs but does not distinguish
                        between them. Consequently, my testimony today on FWA’Smarket share,
                        the characteristics of FHAborrowers, and the borrowers who may have
                        qualified for private mortgage insurance pertain to all single-family loans
                        FRAhas insured.


                        FHAhas been a major player in single-family home financing for over 60
FHA Single-Family       years, and it remains so today-particularly   in certain market segments.
Mortgages               Between 1986 and 1990, FHAwas the largest insurer of single-family
                        mortgages. The factors contributing to F’HA’Slarge market share during
                        these years include an increase in FHA’Smaximum loan limit in 1988 and
                        the economic downturns in some areas of the country that decreased the
                        availability of private mortgage insurance. Except for FXA’Sloan limit, the
                        terms under which FHAand VA mortgage insurance are available, such as
                        the maximum LTV ratio, generally do not vary across different geographic
                        locations7 However, private mortgage insurance companies may change
                        the conditions under which they will provide new insurance in a particular
                        geographic area to reflect the increased risk of losses in an area
                        experiencing economic hardship.

                        Throughout the 1991 through 1997 period, private mortgage insurers had a
                        greater share of all insured single-family mortgages than FVA or VA. In 1997,
                        private mortgage insurers’ share was 54.2 percent, FHA’Swas 33.3 percent,
                        and VA’S was 12.5 percent. This change may be a result, in part, of the
                        increased premiums for FXAinsurance implemented pursuant to the
                        Omnibus Budget Reconciliation Act of 1990 (P.L. IOl-508). Premiums were
                        increased because a 1990 independent actuarial study of the FWAFund
                        indicated it would eventually have a negative net worth if its reserves for
                        covering future losses were not replenished.


m     Is an Important   In reporting on FHA’Srole,s we found that in 1994, FXA is a particularly
Source of’ Mortgage     important source of mortgage insurance for low-income, minority,        and
Insurance in Certain    first-time homebuyers. In addition, we estimated that 66 percent of FTU’S
                        borrowers in 1995 might not have qualified for private mortgage insurance
Markets
                        ‘FHA’s loan limit may differ among geographic areas to reflect differentials in the cost of housing.

                        *Homeownership: FHA’s Role in Helping People Obtain Home Mortgages (GAWRCED-S&123,                   Aug. 13,
                        1996).



                        Page 4                                                                            GAO/r-WED-99-133
                                 for the loans they received, based on the loan-to-value and qualifying
                                 ratios of W’S borrowers that year. However, it is important to note that,
                                 as with home buyers in general, most low-income and minority
                                 homebuyers who obtained mortgages in fiscal year 1996 did not have
                                 insured mortgages because they made down payments of 20 percent or
                                 greater. Data for 1996 from HMDA, the Mortgage Insurance Companies of
                                 America (M~A), and HUD showed that FHA-insured loans are concentrated
                                 to a greater extent on borrowers with these same characteristics than are
                                 loans insured by private mortgage insurers. Specifically, we estimate the
                                 following on the basis of HMDA, MICA, and HUD data for loans in 1996:g

                           FHAinsured a greater percentage of the home loans made to low-income
                             l


                           homebuyers than did either the VA or the private insurers. Specifically, of
                           the 964,495 home loans made to low-income homebuyers, FHAinsured
                           23 percent, VA insured 5 percent, and private companies insured
                            14 percent; the remaining loans to low-income homebuyers were not
                           insured. For just FHA, low-income homebuyers received about 39 percent
                           of FHA-insured loans.
                         . FHAinsured 30 percent of all loans made to minority homebuyers, and such
                           homebuyers represented about 31 percent of FHA-insured loans. FHA
                           insured a higher percentage of loans for minority borrowers in 1996 than
                           did private mortgage insurers (14 percent) and substantially more than did
                           the VA (6 percent).
                         . About 74 percent of m-insured loans in 1996 were made to first-time
                           homebuyers. FHAinsured a higher percentage of loans for fust-time
                           homebuyers than its overall share of the insured home purchase market.
                         l While 63 percent of FwA-insured loans made in 1996 had LTV ratios
                           exceeding 95 percent, only about 7 percent of conventional loans below
                           the maximum FHAloan limit had LTV ratios exceeding 95 percent in 1997.


                                 In our 1996 report on FHA’Srole, we reported that the FHA,private mortgage
Single-Family                    insurers, and VA mortgage insurance programs differed in terms of
Mortgage Insurance               maximum LTV ratios and mortgage amounts, the financing of closing costs,
Terms Offered by                 and the amount that each will-pay lenders to cover the losses associated
                                 with foreclosed loans. Specifically, we reported the following:
FHA, Private Insurers,
and VA Are Different .
                                 We adjusted HMDA data for our comparisons with Mortgage Insurance Companies of America data on
                                 private mortgage insurers’ loans. HMDA data include approximately 93 percent of all m-insured home
                                 purchase loans. The mortgage insurance companies’ data, however, include nearly alI loans insured by
                                 private mortgage insurers. To determine the relative share of the market of loans in the HMDA
                                 database held by FHA and private mortgage insurers, HMDA data were increased by a relevant
                                 percentage. Also, we deleted some mortgage insurance companies’ and HMDA data that were not valid
                                 or were of poor quality.


                                 Page 5                                                                       GAOfl’-ECED-99-133
                            l     While both FWAand VA could insure loans with LTV ratios that exceed
                                  100 percent (because of the fWukcmg of closing costs or other fees),
                                  private mortgage insurers did not offer insurance for loans with LTV ratios
                                  greater than 97 percent. Following our 1996 report, both Fannie Mae and
                                  Freddie Mac announced the introduction of conventional 97-percent LTV
                                  mortgage products that offer many of the advantages of FHA’Ssingle-family
                                  program. Both programs- Fannie Mae’s “Flexible 97 Mortgage” and
                                  Freddie Mac’s “Ah 97 Mortgage”-allow      down payments as low as
                                  3 percent that can be funded through gifts, unsecured loans from relatives,
                                  or grants from nonprofit organizations or local governments.
                                l FHAallows borrowers to finance most closing costs, but private mortgage
                                  insurers and VA do not. Both FWAand VA allow borrowers to finance their
                                  insurance premiums.
                                . m-u may insure loans only up to a maximum that varies depending on local
                                  housing costs, ranging from $115,200 for much of the country to $208,800
                                  for certain areas with higher housing costs. VA-guaranteed loans generally
                                  cannot exceed $203,000, while private mortgage insurers will insure larger
                                  loans than either FHAor VA.
                                . While F’HAprotects lenders against nearly 100 percent of the loss
                                  associated with a foreclosed mortgage, private mortgage insurers and VA
                                  limit their coverage to a portion of the mortgage balance. Private mortgage
                                  insurers generally cover only 20 to 35 percent, and VA covers only 25 to
                                  50 percent, of the mortgage balance plus other costs, even if a loss
                                  exceeds that amount.


                                    While FHA’SMutual Mortgage Insurance Fund is financially healthy and has
FHAk Single-Family                  surpassed the legislative target for reserves, FEIAfaces challenges today,
Mortgage Insurance                  including reducing the losses it incurs on foreclosed properties and
Fund Faces                          maintaining financial self-sufficiency in the face of economic and other
                                    factors that could adversely affect future program costs. To the extent that
Challenges                          FXAcan improve the efficiency of its lending operations, it will improve its
                                    ability to maintain financial self-sufliciency in an uncertain future and
                                    meet the needs of lower-income borrowers by either increasing the
                                    number of borrowers served or reducing the cost of their mortgage
                                    insurance.


FTIA’s Insurance Fund               One of the challenges FHA’Ssingle-family mortgage insurance program has
Exceeds Statutory Reserve           faced successfully has been restoring the financial health of the Fund-the
Targets                             insurance fund supporting 91 percent of the dollar value of FHA-insured
                                    single family mortgages outstanding at the end of fiscal year 1997. At the



                                    Page   6                                                    GAOR-BCED-99-133
                            end of fiscal year 1990, Price Waterhouse estimated that the Fund’s
                            economic value/reserves10 was a negative $2.7 billion. However, as of
                            September 30,1998, PricewaterhouseCooper’s recent actuarial study”
                            reported that the Fund’s economic value/reserves had reached
                            $11.4 billion, an improvement of about $14 billion. Over time, insurance
                            premiums and other income have more than covered costs. The recent
                            study also reported that the Fund’s capital reserve ratio (economic
                            value/reserves as a percentage of value of outstanding loans) was 2.71
                            percent, surpassing the legislative target for reserves (a 2-percent capital
                            ratio) in advance of the legislatively set target date of November 2000.
                            PricewaterhouseCoopers estimated that the Fund’s capital ratio will be
                            3.40 and its economic value/reserves about $14.6 billion by fiscal year
                            2ooo.‘2


Losses Incurred by FHA on   Each year, mortgage lenders foreclose on a portion of the ExQnsured
Foreclosed Single-Family    mortgages that go into default and file insurance claims with HUD for their
                            losses. FHAhas always received enough in premiums from borrowers and
Properties Are Large        other revenues to more than cover these losses. The F’und finances the
                            losses it sustains, thereby ultimately reducing its ability to withstand
                            economic downturns and possibly resulting in higher premiums for F+HA
                            borrowers. The impact that foreclosures can have on the financial health
                            of the F’und was demonstrated during the 1980s. LJntil that time, the Fund
                            had been relatively healthy. However, in the 1980s losses were substantial,
                            primarily because foreclosure rates were high in economically stressed
                            regions, particularly in the Rocky Mountain and Southwest regions. In
                            June 1990, HUD announced that, while the Fund was financially solvent, it
                            had been steadily eroding from a net worth in constant 1989 dollars of
                            $7.8 billion in 1980 to $2.6 billion in 1989. By the end of fiscal year 1990,
                            the fund’s economic value/reserves were estimated at about a negative
                            $2.7 billion. If the F’und is unable to finance program and administrative
                            costs, the U.S. Treasury would have to directly cover lenders’ claims and
                            administrative costs.

                            More recently, the claims FHApaid in fLscal year 1998 were higher than
                            expected. Actual claim payments for single-family insured loans totaled

                                                                                                                                 ---
                            ‘OThe current assets available to the Fund, plus the net present value of ah future cash inflows and
                            outflows expected to result from mortgages insured under the Fund.
                            “An Actuarial Review for Fiscal Year 1998 of the Federal Housing Administration’s Mutual Mortgage
                            Insurance Fund, F’inal Report, March 1,1999, PricewaterhouseCoopers LLP. As a result of a merger
                            with another firm, Price Waterhouse was renamed PricewaterhouseCoopers.

                            rZThe Omnibus Budget Reconciliation Act of 1990 (P.L. 101608) required the Secretary of Housing and
                            Urban Development to endeavor to ensure a capital ratio of 2 percent by November 2000 and maintain
                            that ratio or a higher one at all times thereafter.
                            Page   7                                                                         GAO/T-RCED-99-133
                                                                                                  -
about $5.3 billion, much higher than the $2.2 billion projected for fiscal
year 1998 in the fiscal year 1999 budget. Similarly, actual property
acquisitions, properties sold, and the end of fiscal year 1998 inventory of
nun-owned single-family properties were higher than projected. Actual
property acquisitions were about $5.3 billion, compared with the
$4.0 billion projected; properties sold were about $4.5 billion, compared
with the $4.2 billion projected; and, the September 30,1998 inventory of
properties totaled about $2.8 billion, compared with the $1.8 billion
projected. Notwithstanding these unexpected financial results, given
current economic conditions, we would expect the financial position of
FHA(ssingle-family mortgage insurance program to continue to improve.

Annual audits of FXA’Sfinancial statements have identified weaknesses in
FXA’Sability to manage the risks associated with troubled single-family
insured mortgages. I3The annual audit of FFW’Sfiscal year 1998 financial
statement.s14-the most recent available-continues        to identify a material
internal control weakness applicable, in varying degrees, to both the
single-family and multifamily programs. Specifically, the 1998 report states
that FWAmust continue to place more emphasis on early warning and loss
prevention for insured mortgages by, among other things, using loss
mitigation tools for the single-family insured portfolio before properties
are foreclosed. According to the report, FHAdoes not have adequate
systems, processes, or resources to effectively identify and manage risks
in its insured portfolios. The timely identification of troubled insured
mortgages is a key element of FHA’Sefforts to target resources on insured
high-risk mortgages because FHAmust identify its troubled insured
mortgages before it can institute loss mitigation techniques that can
reduce eventual claims. The report notes that FXA made significant
progress in this regard during fiscal year 1998, including increasing its
lender monitoring and enforcement activities, developing automated
systems to monitor insured loan performance, and expanding the use of
loss mitigation. Though the report states that these steps represent
significant progress, their benefits have not yet been fully recognized
because they are relatively new or still being developed.




‘3The Chief Financial Officers Act of 1990 and the Government Management and Reform Act of 1994
required HUD and some other agencies to annually prepare and subject to audit organizationwide
financial statements. These reports are submitted to the Congress through the Office of Management
and Budget. HUD’s Office of Inspector General contracts with a public accounting firm to conduct
annual audits of FHA’s financial statements.

“Audit of the Federal Housing Administration’s Fiscal Year 1998 Federal Basis Financial Statements,
prepared by KPMG UP for the Office of Inspector General (99-FO-131-0002, Mar. l&1999).



Page 8                                                                        GAO/T-WED-99-133
Other Factors That Could      As we have reported,15 the F’und’s ability to maintain             the target ratio
Affect the Financial Health   depends on many economic, program-related,               and other factors that will
                              affect the financial health of the Fund in the future. These factors include
of the Fund                   (1) economic conditions,      (2) uncertainty      surrounding       the projections of
                              the performance     of FFU’S streamlined      refinanced16 and adjustable rate
                              mortgage loans, and (3) risks associated with the demand for FHA’S loans.
                              We also reported in May 199717 that reducing FHA’S insurance coverage to
                              the level permitted    for VA home loans would likely reduce the Fund’s
                              exposure to financial losses, thereby improving            its financial health.

                              Estimates of economic value/reserves        of the Fund are sensitive to future
                              economic conditions,     particularly  the appreciation  rates for house prices.
                              The F’und will not perform as well if the economic conditions        that prevail
                              over the next 30 years replicate those assumed in pessimistic        economic
                              scenarios. PricewaterhouseCoopers’        estimate of the F’und’s economic
                              value/reserves  for its pessimistic   economic scenario is about $2.7 billion
                              (or 24 percent) less than its estimate of $11.4 billion as of September 30,
                              1998, which would still represent a significant turnaround       from the Fund’s
                              position in 1990.

                              Also, the substantial    refinancing     of FRA’S loans and the growth in the
                              number of FHA’S adjustable-rate         mortgages insured in recent years have
                              created a growing class of FTIA borrowers whose future behavior is more
                              difficult to predict than that of the typical FHA borrower’s         FHA’S
                              streamlined    refinanced mortgages and adjustable rate mortgages
                              accounted for about 32 percent of the dollar value of FRA’S loans
                              outstanding    at the end of fiscal year 1997: Streamlined      refinanced
                              mortgages accounted for about 15 percent of the value of the outstanding
                              loans and adjustable-rate       mortgages for about 17 percent. FHA has had little
                              experience with streamlined         refinanced mortgages and adjustable-rate
                              mortgages and the tendency for such loans to be foreclosed and/or
                              prepaid.




                              ISMortgage Financing: FHA Has Achieved Its Home Mortgage Capital Reserve Target
                              (GAO/RCED-9650, Apr. 12, 1996).

                              VHA’s streamlined refinanced mortgages are those for which an m-insured mortgage loan has been
                              repaid from the proceeds of a new m-insured loan using the same property as security. Borrowers
                              often refinance mortgage loans to lower their monthly principal and interest payments when interest
                              rates decline. FHA does not require appraisals and credit checks on these loans, and borrowers cannot
                              obtain cash from the transaction except for minor adjustments not exceeding $250 at closing.

                              L7Homeownership: Potential Effects of Reducing FIN’s Insurance Coverage for Home Mortgages
                              (GAO/RCED-97-93, May 1,1997).


                              Page   9                                                                       GAOm-RCED-99-133
.-
     Because m-insured properties whose mortgages were streamlined              -
     refinanced did not have to be appraised, the initial LTV ratio of these
     loans-a key predictor of the probability of foreclosure-is unkn~wn.‘~
     The impact of these loans on the financial health of the Fund is probably
     positive because they represent preexisting FWAbusiness whose risk has
     been reduced through lower interest rates and lower monthly payments.
     However, the lack of experience with these loans increases the
     uncertainty associated with their expected foreclosure rates. In addition,
     new developments in the private mortgage insurance and secondary
     mortgage markets may increase the average risk of future m-insured
     loans. Homebuyers’ demand for m-insured loans depends, in part, on the
     alternatives available to them. Some private mortgage insurers have begun
     offering mortgage insurance coverage on conventional mortgages with a
     97-percent LTV ratio, which brings their terms closer to W’S 97.75percent
     LTV ratio on loans for properties exceeding $50,000 in appraised value. In
     addition, Fannie Mae and Freddie Mac have announced the introduction of
     conventional 97-percent LTV mortgage products that offer many of the
     advantages of FHA’Ssingle-family loans.

     If Fannie Mae’s and Freddie Mac’s 97-percent LTV mortgages are successful
     in attracting those lower-risk borrowers who can choose between FHAand
     private insurance (because private insurers do not require an up-front
     mortgage insurance premium), they may be drawing away from FXA
     customers with better-than-average credit histories or payment-to-income
     ratios. In doing so, the remaining new FHAloans may become more risky,
     on average. If this effect is substantial, the economic value/reserves of the
     F’und may be adversely affected, and it may be more difficult for the fund
     to maintain a 2-percent capital ratio.

     Lastly, FHAinsures private lenders against nearly all losses resulting from
     foreclosures on the single-family homes it insures. However, VA, under its
     single-family mortgage guaranty program, covers only 25 to 50 percent of
     the original loan amount against losses incurred when borrowers default
     on loans, leaving lenders responsible for any remaining losses. In our
     May 1997 report,lg we concluded that reducing FHA’Sinsurance coverage to
     the level permitted for VA home loans would likely reduce the Fund’s
     exposure to financial losses, thereby improving its financial health. As a
     result, the Fund’s ability to maintain financial self-sticiency in an
     uncertain future would be enhanced. However, reducing FXA’Sinsurance

     “Also, FTIA’s data do not indicate whether second mortgages exist on these properties.

     LgHomeownership: Potential Effects of Reducing FTIA’s Insurance Coverage for Home Mortgages
     (GAO/RCED-97-93, May 1, 1.997).



     Page   10                                                                      GAOlli-RCED-99-133
           coverage does pose trade-offs that affect lenders and borrowers as well as
           the very role FXAitself plays in stabilizing markets. The most likely
           affected borrowers would be low-income, first-time, and minority
           homebuyers and those individuals purchasing older homes.

           To illustrate the financial impact of reducing FXA’Sinsurance coverage, our
           report pointed out that if insurance coverage on FHA’S1995 loans were
           reduced to VA'S levels and a 14 percent reduction in J?HA’Slending volume
           assumed, the economic values of the loans we estimate would be
           $52 million to $79 million greater than our estimate, assuming no coverage
           and volume reductions. Reducing FHA’Sinsurance coverage would likely
           improve the financial health of the F’und because the reduction in claim
           payments resulting from lowered insurance coverage would more than
           offset the decrease in premium income resulting from reduced lending
           income. The amount of savings that would be realized by reducing FHA’S
           insurance coverage would depend on future economic conditions, the
           volume of loans made, the relationship of the number of higher-risk and
           lower-risk borrowers who would leave the program, and whether some
           losses may be shifted from FHAto the Government National Mortgage
           Association.


           In closing, Mr. Chairman, FHA’Simportance in the housing
           market-particularly   for segments of the market that might not be able to
           buy homes without it-is substantial It fills a role that the private market
           might not completely cover if FXAwere not there--and it does so without
           needing federal funds. Nonetheless, we recognize, and FHAis certainly
           aware, that there is more it can do to better secure its long-term financial
           outlook.

           Mr. Chairman, this concludes my statement. We would be pleased to
           respond to any questions that you or Members of the Subcommittee may
           have.




(385798)   Page 11                                                     GAOfl’-WED-99-133
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