by Amerifirst Home Mortgage CEO and Co-founder Mark Jones (third from right, back row).
Two years ago I joined HUD Secretary Ben Carson (pictured above, center) and MBA’s leadership for an important discussion about the Federal Housing Administration (FHA). We specifically discussed why many lenders have backed away from participating in the program in recent years, and how FHA could bring those lenders back in order to better promote access to affordable mortgages for millions of Americans.
Since its founding in 1934, the mission of FHA has been to provide housing finance support to low- and moderate-income families that cannot be fulfilled through traditional underwriting. Indeed, for many families across the country – especially those who are unable to save a sizable down payment – FHA represents the only opportunity to achieve the American dream of homeownership. FHA is also the quintessential program for first-time homebuyers. In fact, first-time homebuyers represent over eighty percent of all FHA originations.
For decades, FHA has relied on partnerships with lenders to deliver this great home-buying opportunity to local markets. Over the past 35 years, Amerifirst has been proud to partner with FHA to deliver this opportunity to thousands of families each year, and we look forward to growing and strengthening this partnership in the years to come.
In recent years, however, many lenders in the marketplace, both big and small, have backed away from the FHA program. This has been due in no small part to excessive and disproportionate penalties levied under the False Claims Act for any errors in the FHA origination process, no matter how minor, harmless, or immaterial they might be. This standard of enforcement only exists because of FHA’s requirement that lenders certify and attest to the perfect execution of each loan, where any imperfections are considered tantamount to lying to the federal government as a “false claim” under the statute (a Civil War era statute intended to protect the government from fraud in the purchase of war supplies).
The resulting tremendous legal risk is precisely why institutions like JPMorgan Chase and Bank of America have all but disappeared from the FHA program, while others like Wells Fargo, US Bank, and countless community banks have significantly scaled back their participation. Ironically, the community hit hardest by this policy outcome is the same community FHA is intended to help – first-time homebuyers. A dramatic reduction in the number of FHA mortgage providers nationwide means many would-be buyers may have been left in the dust when their local bank retreated from the program.
After years of advocacy from Amerifirst and others, HUD just delivered a major win to first-time homebuyers by providing the regulatory clarity necessary for lenders to more confidently participate in the FHA program.
On October 28, 2019, HUD announced an agreement with the Department of Justice over the appropriate use of the False Claims Act – specifically, articulating a more robust and collaborative process for deciding when to properly pursue False Claims Act cases, and limiting such cases in general to errors that are material and/or made knowingly by the lender. HUD is also in the process of rolling out new certification and defect taxonomy forms that reflect this updated “materiality” standard. By providing much clearer rules of the road, HUD has paved the way for responsible lenders to grow their FHA footprint, return to the market, or enter for the first time, while maintaining important guardrails against any bad actors in our industry.
This announcement represents a major breakthrough for the FHA program and for credit access more broadly. While it is still too early to quantify the direct impact, we know that lenders are coming back to FHA, meaning FHA will make a comeback in many local markets, and families across the country will have greater optionality as they look to purchase their first home. This is great policy that strikes the right balance. It is a win for consumers, a win for lenders, and a win for FHA.
As great of news as this is, FHA shouldn’t stop there. It has many more opportunities to responsibly expand credit access to first-time homebuyers and reduce housing costs for existing FHA borrowers, without meaningfully increasing the risk borne by taxpayers.
Some of these opportunities include:
1. Encouraging Congress to Split the FHA Forward and HECM Programs
Last week, FHA announced that its Mutual Mortgage Insurance (MMI) Fund capital reserve ratio has hit its highest level since before the financial crisis, leading many in the industry to call for a reduction in FHA mortgage insurance premiums. While such an outcome is something we would welcome, and it would obviously be tremendous news for the cost of mortgage credit, a more permanent solution is possible.
For quite some time, FHA has set its forward loan insurance pricing artificially high in order to subsidize the legacy book of reverse mortgages (Home Equity Conversion Mortgages, or “HECMs”) that also weigh down the same insurance fund. By statutorily separating the FHA forward and reverse programs with two separate insurance funds, FHA could set more targeted (and presumably lower) annual and upfront insurance premiums that adequately cover the risk of the forward mortgage program (which has performed well for years) without having to account for the risks of the HECM portfolio that are both difficult to ascertain and entirely unrelated to the performance of the forward portfolio.
This action would require an Act of Congress, but there has been some interest in doing so in recent years, and there may be no better time than now, given that the combined capital position of the MMI Fund is at its highest point in over a decade. This action would be a huge win for first-time homebuyers, as it would end the practice of having those consumers pay extra to implicitly subsidize HECM risk.
2. Address Risk Layering, But Avoid the Potential Disaster of "Tiered Pricing"
In addition to the HECM risk in the forward book, the 2019 FHA Actuarial Report notes the increasing prevalence of what FHA calls “extreme risk layering” – a DTI ratio above 50%, a credit score below 640, and less than 2 months of reserves. While the overall proportion of loans with “extreme risk layering” remains quite small, it has grown significantly since 2016 and could produce sharply disproportionate claims losses. The best way to address such tails of risk is to adjust underwriting standards to eliminate excessive risk layering.
Unfortunately, HUD may be considering another alternative that could create more problems than it solves. On September 5, 2019, HUD published its Housing Finance Reform plan. Among the many reforms included in the plan was a proposal to implement “tiered pricing” for FHA loans – higher premiums for higher risk loans. Risk-based pricing raises costs on those least able to afford it. For these types of homebuyers, there are two choices: 1) their access to credit is blocked, and they’ll have no choice but to remain renters; or 2) for those who can afford it, they will face much higher costs and these loans will be even riskier as a result. In the end, risk-based/tiered pricing neither supports housing nor protects the taxpayer. The cross subsidization of risk within the FHA program is critical to its success. No insurance program can survive without it, and tiered or risk based pricing would undermine, not improve, the solvency of the MMI Fund.
HUD could immediately deliver a massive win to first-time homebuyers by opting against implementing this potential disaster for the FHA program. To the extent FHA needs to address emerging risks, they should be dealt with through targeted underwriting refinements that address risk layering, not higher pricing that would undermine the cross subsidy principle that has been the foundation of FHA’s success for more than eight decades.
3. Ending Life-of-Loan Mortgage Insurance Coverage for the FHA Program
Addressing the risk layering and HECM problems will also allow FHA to reduce the cost of FHA insurance by ending its “life of loan” monthly insurance premium. FHA is among the only programs that require mortgage insurance over the life of the loan, rather than insurance that shuts off when the outstanding principal balance reaches 78% of the original home value. As a result, FHA borrowers are stuck with higher monthly payments a few years into owning their home. An end to life-of-loan coverage would mean lower monthly housing costs for millions of families across the country, and more money that can go into home upgrades, utilities, or daily life.
FHA’s life-of-loan requirement has only been around since 2013 – a policy response to MMI Fund losses that dropped its capital ratio below statutory requirements. What we have seen since the implementation of the policy is a greater incentive for seasoned, high-quality FHA borrowers with greater equity in their homes to refinance out of FHA and into lower-cost conforming mortgages – therefore leaving a greater proportion of higher loan-to-value, higher risk loans weighing down the MMI Fund overall. It is time to return to cancellable insurance, and align FHA with other mortgage programs.
While this is an action FHA could quickly take via mortgagee letter, there is also significant support for it in Congress. In June 2019, a bill to end life-of-loan coverage advanced out of the House Financial Services Committee. Whether legislatively or by regulation, this would be a huge win for first-time homebuyers.
We commend HUD for listening to local markets and finally answering the call for clearer communication around False Claims Act liability. To the extent that FHA is looking for some more potential wins before the 2020 election season, the three opportunities above are a sensible place to start. For many Amerifirst applicants, these three reforms might be the difference-maker between remaining a renter for the foreseeable future and owning the roof over their head for the first time. Those are the ones we fight for, and the ones that we’re passionate about serving. We look forward to continuing that fight in Washington D.C. and everywhere we do business.