A new analysis of loans insured in recent years by the Federal Housing Administration is warning that the agency isn’t helping the low- and moderate-income homeowners it is designed to serve.
The study by Ed Pinto, a fellow at the conservative American Enterprise Institute, analyzed 2.4 million mortgages that the agency had backed in 40,000 ZIP Codes. It found that in 9,000 ZIP Codes with median incomes below the area median income, loans have a projected foreclosure rate of at least 10%.
“Once the expected failure rate exceeds 10%, the resulting direct and indirect costs to low- and moderate-income families and communities are a disservice to the very families and communities it is the FHA’s mission to help,” the paper said.
The New Deal-era agency, which doesn’t actually make loans but instead insures lenders against losses, has played a critical role in the housing market by backing mortgages of borrowers who make down payments of as little as 3.5%—loans that most private lenders won’t originate without a government guarantee. The FHA accounted for one third of loans used to purchase homes last year among owner occupants.
Last month, the FHA said that it had a net worth deficit of $16.3 billion, meaning that if it were to stop writing new business, under its current economic forecast, it wouldn’t have enough money in reserve to pay for expected losses. The FHA has maintained that the bulk of its losses are confined to loans insured before 2010.
At the heart of Mr. Pinto’s critique is a particularly relevant public policy question: What is the acceptable level of default for loans under such a government program?
In recent years, the FHA has taken several steps to raise the insurance premiums that it charges borrowers, but it has taken comparatively fewer steps to tighten credit. Higherpremiums—and revenue—allow the FHA to tolerate a higher default rate.
FHA officials have argued against tightening credit standards sharply in recent years, saying that doing so could make the housing downturn worse. With less access to credit, home prices in some of the hardest hit neighborhoods might tumble further, dragging more borrowers underwater.
Mr. Pinto offers a different perspective: by putting borrowers in homes where one in seven loans ends in default, communities may be worse off as they become trapped in a cycle of higher foreclosures.
Mr. Pinto’s analysis for cities including Atlanta, Chicago, Miami, and Washington, D.C., shows that the worst performing FHA-backed mortgages tend to cluster in communities that have incomes below the area median income. “They’re creating problems for these particular neighborhoods because the risks get amplified,” he says. “You get into a cycle of more delinquent loans, more foreclosures, more blight.”
Mr. Pinto concedes that the trend doesn’t hold true in all markets, including much of California, where the FHA has seen some of the most dramatic growth in recent years.
Officials at the Department of Housing and Urban Development, which oversees the FHA, said they disagreed with the report’s conclusions. “The vast majority of FHA borrowers have succeeded,” said Alex Wohl, a spokesman. “We’re giving opportunities to qualified borrowers who otherwise wouldn’t have opportunities to own homes.”
While those borrowers can be higher risks, “that’s the design of the program,” said Mr. Wohl. If those borrowers were being served by private lenders, in other words, then there would be no need for the FHA.
The FHA was created in 1934 as a lender of last resort to provide credit at a time when private lenders weren’t extending loans, and it has largely hewed to that mission through the current downturn. Unlike private lenders, it never relaxed its underwriting standards during the bubble—and that included requiring borrowers to fully document their incomes.
Some of the markets with above-average foreclosure rates likely saw a larger share of subprime lending, which meant that the FHA expanded in markets that were already witnessing some of the largest price declines. The agency’s defenders have argued that any lender that extended credit following the recent recession would have experienced above-average default rates, and that a housing recovery would be nearly impossible in those—or any—markets without having entities that make credit available.