In January 2017, the Obama administration decided to reduce the mortgage insurance premiums charged by the Federal Housing Administration.
Fortunately, after taking office later that month, the Trump administration immediately decided to reverse this decision in order to restore some semblance of financial sanity to the agency’s single-family housing mortgage insurance fund.
Under the leadership of Housing and Urban Development Secretary Ben Carson, this reversal has remained in place, which has bolstered the solvency of the capital reserve fund managed by the Federal Housing Administration. The capital reserves in the agency’s single-family housing mortgage insurance portfolio now exceed the statutorily required level of 2 percent.
This is good news for taxpayers, and a significant change from several years ago when the agency required a special bailout from Congress totaling several billion dollars.
While this is a welcome improvement for American taxpayers, the Federal Housing Administration still faces significant risks of further bailouts should the economy and housing market experience a downturn.
Indeed, based on estimates by economists at the American Enterprise Institute, the Federal Housing Administration currently faces a stressed default rate of roughly 25 percent.
Put differently, about 1 of every 4 single-family home purchase mortgages insured by the Federal Housing Administration would likely fail if the economy and housing market experienced any significant decline.
Numerous factors contribute to the high level of risk in the agency’s single-family housing mortgage insurance portfolio, including the fact that most of these insured home loans originate with borrowers who have little or no skin in the game. Indeed, home purchase loans insured by the Federal Housing Administration average down payments of less than 5 percent.
Making matters worse, the little amount of initial collateral (i.e. down payment) made on these insured mortgages are often financed by third parties—whether through down payment assistance payments made by relatives, non-profit groups, or government subsidy programs.
Fannie Mae and Freddie Mac, the behemoth government-sponsored enterprises still under federal conservatorship since the 2008 housing market collapse, also face similar risks—a problem the Federal Housing Finance Agency needs to fix.
According to the latest quarterly congressional report, about 40 percent of home purchase mortgages that the Federal Housing Administration insures receive some form of down payment assistance.
While this may seem harmless, numerous research reports confirm that mortgages with down payment assistance have higher rates of default, thereby increasing risks to taxpayers who are left to cover the costs of loan failure, as well as to homeowners should they ultimately lose their home.
To add insult to injury, such down payment assistance also puts upward pressure on home sale prices. One estimate suggests these concessions increase the appraised value on home sales by approximately two percentage points, thus increasing the concerns over affordability facing many across the housing market today.
In order to encourage more durable and sustainable home ownership experiences—and to protect both American homeowners and taxpayers—the Federal Housing Administration should take necessary steps to ensure that borrowers rely less on third-party assistance for down payments and have more of their own “skin in the game.”
Such reform measures would further build upon the success that the Federal Housing Administration, under the leadership of Carson, has already made to increase the solvency of the agency’s single-family housing mortgage insurance portfolio.
