NCPA - National Center for Policy Analysis

How the Federal Housing Administration Hurts Working-Class Families and Communities

January 10, 2013

The Federal Housing Administration (FHA) exists to provide mortgage credit for low- and middle-income families and first-time home buyers. However, the FHA is actually participating in activities that hurt low- and middle-income families the most, says Edward J. Pinto, a resident fellow at the American Enterprise Institute.

  • An estimated 40 percent of the FHA's business consists of loans with either one or two subprime attributes -- a FICO score below 660 or a debt ratio equal to or greater than 50 percent.
  • Furthermore, the FHA's underwriting policies encourage low- and middle-income families to make risky financing decisions despite having low credit scores or pre-existing debt burdens.
  • The loans that the FHA disperses have an expected failure rate exceeding 10 percent.

Not only do individuals suffer from defaulting on their loans, so does the broader community. As people default on loans, home values decline, which denies other families the opportunity to build equity and have the down payment for their next home. Moreover, there is an increase in crimes in the broader community as city services suffer from a reduced tax base and higher costs for providing various municipal services.

There are several enablers of the FHA's risky practices:

  • First, the FHA benefits from large subsidies, assistance and mandates, which stem from the full faith and credit government guarantee.
  • As a result, Congress, investors and regulators are indifferent to the quality of the mortgages because they are backed by the government.
  • Additionally, mortgage-backed securities (MBS) investors, real estate agents, home builders and bureaucrats enable the FHA by influencing Congress to continue these unfair and unsustainable practices.

There are several reforms that can be undertaken to bring the FHA back to responsible lending:

  • Don't insure a loan with a projected failure rate greater than 10 percent, assuming no house price appreciation or depreciation.
  • Target an average 5 percent projected claim termination rate instead.
  • Stop guaranteeing lower-risk loans and high-dollar-balance borrowers, as it allows for cross-subsidization of those loans with excessive risk.
  • Price for risk to allow the borrower to know the true risk of the loan.
  • Implement underwriting that results in the extension of responsible mortgage credit.

Source: Edward J. Pinto, "How the FHA Hurts Working-Class Families and Communities," American Enterprise Institute, December 2012.


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