I’m writing in opposition to two of the eight recently proposed changes by the Department of Housing and Urban Development on their single family insurance programs.  While most of the proposed changes will bolster the financial well being of the FHA, these two changes are misguided in their design and fail to fully contemplate their short term and long term consequences.   Most disconcerting is that they are antithetical to HUD’s articulated purpose and, in one instance, may jeopardize FHA’s long term health.

HUD is seeking congressional authority to raise annual mortgage insurance premiums from .55% of the loan amount per year to .85% (or .9% if the down payment is less than 5%).  This request is outlined on page 346 of the budget’s analytical perspectives.  On a median transaction[1] in Minneapolis, Minnesota, this translates to 35.64 dollars per month.  This may not seem like much but it means that if this same family were approved for this sample purchase with a sales price of $123,850 with the current premium costs, they’d lose $5,910 in purchasing power under the new premium costs.  Any reasonable person would conclude that this will apply downward pressure on home values and downward pressure on home ownership in the affordable housing sector.

Despite this compelling consequence of this change, a more severe consequence will happen if this change goes into effect.  FHA believes that “the return of conventional finance to the mortgage market would broaden both the options available to borrowers and the sources of capital to fund those options[2]” but we are a long, long way from the return of the conventional mortgage market and much uncertainty surrounds the future of Fannie Mae, Freddie Mac and those who would buy their mortgage backed securities after the Fed stops.  Until the future of Fannie and Freddie is safely determined and until the private mortgage backed securities market has healed, forcing the return of the conventional market by making FHA loans less affordable is nothing short of reckless.

FHA doesn’t seem to realize that changing annual premiums in this way will lead to a weaker portfolio of borrowers and this has not come up in any discussion on this matter to my knowledge.  Where interest rates are similar between FHA loans and conventional loans, mortgage insurance will be the decision making factor for consumers.  If borrowers have to pay .85% or .9% on a FHA loan in addition to an upfront premium, private market mortgage insurance will generally be cheaper[3] if the credit score of the borrower is at or over 700.  Consequently, the bulk of loans that require mortgage insurance with superior borrower profiles will be placed in the private sector while those with weaker borrower profiles will be placed with FHA.  This will lead to greater long term risk exposure for FHA.  Ironically, this step to shore up FHA’s capital base will ultimately weaken it.

HUD seeks to decrease the amount of seller concessions from 6 to 3 percent.   HUD states that “the current level exposes the FHA to excess risk by creating incentives to inflate appraised value. This change will bring FHA into conformity with industry standards on seller concessions.”  If the concern is to see appraisals are unbiased and of high quality, FHA has already addressed this in lending procedure modifications outlined in Mortgagee Letters 09-28 and 09-36 (to name a few). Similar changes have been made under HVCC[4] for Fannie Mae and Freddie Mac loans to eliminate inflated appraised values.  HUD hasn’t even let these changes play out to prove their effectiveness in eradicating inflated appraised values. 

 As for FHA being in “conformity with industry standards on seller concessions,” it’s not HUD’s place to conform to industry standards.  In April 6th of 2006, former Assistant Secretary of Housing Brian Montgomery characterized HUD’s purpose this way, “FHA was created in 1934 to serve as an innovator in the mortgage market, to meet the needs of citizens otherwise under served by the private sector, to stabilize local and regional housing markets, and to support the national economy.”  Conforming to industry standards with respect to seller concessions is not innovative, doesn’t meet the needs of citizens under served by the private sector (since there practically isn’t one), will have a destabilizing influence on the local and regional markets and won’t support that national economy.

Lastly, this is the most regressive guideline change I’ve ever seen.  This change will likely have no impact for purchases in the high 200,000 dollar range but for purchases near the median home price in Minneapolis, MN, it has devastating consequences for hopeful home buyers.  In the previously referenced median transaction, this change would increase the down payment by approximately $2744.  This represents a substantial amount of savings for a family making the median income of $37,974.

Most of the FHA claims have been due to defaults on transactions where there was seller paid down payment assistance or where the minimum down payment required was 2.25% of the sales price.  For some time now, seller paid down payment assistance has not been permissible and the down payment requirement has been 3.5%.  The FHA has not released statistical data tracking on the loan performance for loans funded under the new, tighter guidelines.  I think you’ll find that loans subject to the guidelines that have been used in the last year are performing much better and will only get better with the 6 positive changes the FHA is implementing.  With an encouraging trend line in loan performance and with recent news of FHA’s reserve fund improving slightly[5], reducing allowable seller concessions and increasing annual mortgage insurance premiums are not amongst the necessary changes to address risk and in fact, may add to it.

I encourage you to use your office to oppose these changes.

Regards,

Charles Dailey