The FHA has historically met the needs of borrowers who may not have been able to qualify for loans in the prime, conventional market. These loans have helped first-time homebuyers, minorities, and low-income homebuyers access credit even when faced with down payment constraints or nontraditional credit histories.
Many borrowers who would traditionally be served by the FHA sector appear to have shifted to subprime loans over the past decade. In response to subprime market share growth, the FHA expanded product offerings, streamlined the appli- cation process, and reduced initial outlay requirements from borrowers. Therefore, the issues that led to subprime’s demise may also affect the FHA’s future lending patterns, possibly leading to higher increases in delinquencies in the FHA market than in prime markets.
Whether or not the FHA continues to gain and hold market share will be a function of its cost and its ability to appeal to consumers. The FHA will also benefit from the decrease of viable conventional products. Since 2007, nearly all independent mortgage company subprime lenders have ceased operations, vol- untarily or involuntarily, or sharply reduced their products offered. By mid-2008, the asset-backed securities market that provides liquidity to the mortgage market was substantially reduced, and subprime lenders found it nearly impossible to finance originations without going to FHA loans that could be pooled into Ginnie Mae securities. At the same time, the FHA has seen an increase in customers refinancing out of conventional loans into its insured mortgage programs. For the last two weeks of November 2008, total applications increased over 70 percent as compared to the same period in 2007 (U.S. Department of Housing and Urban Development 2008a). Some of that increase is due to the higher loan amounts al- lowable under the new FHA guidelines, but some of the gain represents borrowers hoping to move from subprime adjustable rate mortgage loans to fixed FHA loans.
The FHA likely also currently appeals to borrowers who do not qualify for prime mortgages. For example, some aspects of the FHA’s underwriting process may allow borrowers with nontraditional credit to obtain financing. The FHA uses a type of automated underwriting system that incorporates an applicant’s full credit history, employment, and nontraditional credit patterns such as rent and util- ities payments (U.S. Department of Housing and Urban Development 2009). FHA guidelines allow for compensating factors to justify exceeding ratio guidelines or offset other negative factors, much like similar systems used in the conventional sector. For example, FHA guidelines allow factors such as large down payments, potential for increased borrower earnings due to job training, or substantial nontax- able income to justify mortgage approval. While a nontraditional credit report can be used to supplement a traditional credit report that lacks a sufficient number of
FHA LOANS ANDPOLICYRESPONSES TOCREDITAVAILABILITY 159
reported trade items, however, it cannot enhance credit history for borrowers with a poor payment record or offset derogatory traditional credit references. Ongoing changes in its underwriting and pricing practices throughout 2009 continued to influence the share of the residential mortgage market held by the FHA.
Moreover, FHA loans may not be readily available for all types of properties.
For example, while the FHA will insure some loans in cooperative housing projects through the Section 203(n) program, only a limited number of lenders appear to participate in the program. Additionally, the FHA needs to specifically approve condominiums for a borrower to receive financing, which may add time to the purchase process or disqualify some units. The FHA recognized in 2008 that con- dominiums may be more affordable and attractive to first-time homebuyers by sim- plifying the loan underwriting process for condominium purchases and no longer subjecting properties of this type to the same complex requirements of multifamily housing loans (U.S. Department of Housing and Urban Development 2008b).
However, public policy initiatives that encourage the substitution of FHA for subprime and prime loans may prove costly. The U.S. Department of Housing and Urban Development, HUD’s, projected budget for the FHA in 2008 included a
$143 million shortfall. This was the first time in three decades HUD has made a request to Congress for a taxpayer subsidy (U.S. Department of Housing and Urban Development 2007). Even though the FHA is statutorily required to be budget neutral, the GAO projected that taxpayer-funded subsidies of half a billion dollars over three years would be necessary if no changes are made to the FHA program.
Programs such as FHASecure and H4H potentially raise additional financial concerns that may have compromised their effectiveness. For example, at the end of 2008, HUD terminated FHASecure, a temporary program designed to allow families who had been making timely payments to qualify for refinancing if they were at risk for default upon reset of the adjustable rate of their mortgage. Typical underwriting standards were imposed, but the FHASecure initiative permitted new subordinate financing that exceeded customary maximum loan limits and re- laxed loan-to-value ratios to cover any shortfall from the existing first lien, closing costs, and arrearages (FHA 2007, FHA 2008b). While HUD estimated the program would assist approximately 500,000 families by the end of 2008, fears of its dam- aging financial impact on the Mortgage Mutual Insurance fund spelled its demise (FHA 2008c).
FHA recommends the H4H program to borrowers who were delinquent on their mortgages. The H4H program allows refinancing loans into an FHA product for borrowers who cannot afford the terms of their previous mortgage. However, few borrowers have actually realized relief from the program because of onerous lender and borrower requirements, and as of January 2009, the program had gener- ated only a handful of applications and loan approvals (Inside FHA Lending 2009).
Guidelines were revised in January 2009 and revisited again in May 2009 as part of the Helping Families Save Their Homes Act, with the hope that the program will be more successful and provide greater incentives for mortgage servicers to participate in the program (FHA 2009a, FHA 2009b).
Most of the FHA’s recent huge growth has been in traditional FHA loans (Inside Mortgage Finance 2008). These gains in the FHA reflect the tightened un- derwriting standards in the prime markets, with borrowers facing increased diffi- culty in obtaining higher LTV loans requiring mortgage insurance in any markets
but the FHA. The magnitude of the continued movement of prime and subprime borrowers to the FHA partly depends on the efforts of conventional mortgage providers, including Freddie Mac and Fannie Mae, to offer viable alternatives to subprime borrowers. Notwithstanding the actions of conventional providers, the FHA could be a vehicle to provide lower-priced and more sustainable mortgage options for some at-risk borrowers holding higher-priced subprime loans. How- ever, careful assessment and management of the risks associated with serving these borrowers would be necessary to avoid exacerbating problems in the financial per- formance of the FHA’s insurance program.
NOTE
1. Shares calculated from Home Mortgage Disclosure Act (HMDA) data, various years.
We define the market to include FHA and conventional, single family, home purchase, and refinance loans below the conforming loan limit, excluding manufactured housing loans or lenders. We restrict our analysis to the conforming market so that we can also look at the market with loan amounts within the reach of FHA-eligible borrowers. This also allows us to compare secondary mortgage market effects where Fannie Mae and Freddie Mac, the government-sponsored entities (GSEs), hold significant market shares.
For our analysis, we use a panel of data obtained from Robert Avery of the Federal Reserve Board that defines subprime and prime lenders, relying on the HUD Subprime and Manufactured Home Lender List. From this, we exclude all manufactured housing lenders.
REFERENCES
Courchane, S., and P. Zorn. 2005. Subprime borrowers: Mortgage transitions and outcomes’
Journal of Real Estate Research29 (4): 365–392.
Courchane, S., R. Darolia, and P. Zorn. 2009. From FHA to subprime and back? Working paper.
Federal Housing Administration. 2007. The FHASecure initiative and guidance on appraisal practices in declining markets. Mortgagee Letter 2007-11, September 5.
Federal Housing Administration. 2008a. Temporary loan limit increase for FHA. Mortgagee Letter 2008-06, March 6.
Federal Housing Administration. 2008b. Expansion of FHASecure. Mortgagee Letter 2008- 13, May 7.
Federal Housing Administration. 2008c. Termination of FHASecure. Mortgagee Letter 2008- 41, December 19.
Federal Housing Administration. 2009a. Hope for homeowners origination and servicing guidance supplement. Mortgagee Letter 2009-03, January 6.
Federal Housing Administration. 2009b. The FHA Title II mortgagee approval hand- book 4060.1, Rev-2. www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4060.1/
40601handbookHSGH.doc. (accessed March 3, 2009).
Inside FHA Lending. January 16, 2009.
Inside Mortgage Finance. October 24, 2008, 6.
Inside Mortgage Finance. February 20, 2009, 3.
Inside Mortgage Finance. 2009.Mortgage market statistical annual, volume I: The primary market, 4.
Mortgage Bankers Association. 2009. National delinquency survey results, first quarter 2009.
U.S. Department of Housing and Urban Development. 2007. www.hud.gov/offices/
hsg/fhahistory.cfm.
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U.S. Department of Housing and Urban Development. 2008a. Single family operations, November 16–30,FHA Outlook, 2.
U.S. Department of Housing and Urban Development. 2008b.FHA annual management report, fiscal year 2008, 6.
U.S. Department of Housing and Urban Development. 2009. Mortgage credit analy- sis for mortgage insurance handbook 4155.1. www.hud.gov/offices/adm/hudclips/
handbooks/hsgh/4155.1/41551HSGH.pdf (accessed June 30, 2009).
ABOUT THE AUTHORS
Dr. Marsha Courchane,VP, leads the Financial Economics Practice at Charles River Associates (CRA). She is executive vice president of the American Real Estate and Urban Economics Association and a director of the American Real Estate Society. Her Ph.D. in economics is from Northwestern University. Dr. Courchane has published widely in the areas of consumer and mortgage credit with articles in Journal of Real Estate Research, Journal of Economics and Business, Real Estate Economics, Housing Policy Debate, Real Estate Economics,andJournal of Real Estate Finance and Economics.
Rajeev Daroliais a senior associate at CRA, currently completing a Ph.D. in public policy at George Washington University. He holds a master’s degree in economics.
Dr. Peter Zorn, VP, heads housing analysis and research at Freddie Mac. He was formerly an associate professor at Cornell. He received his Ph.D. in economics from the University of California at Davis and a B.A. in history from Marlboro College.
Dr. Zorn has published widely in the areas of consumer and mortgage credit with articles in theJournal of Real Estate Research,theJournal of Economics and Business, Real Estate Economics, Housing Policy Debate, Real Estate Economics,and theJournal of Real Estate Finance and Economics.
CHAPTER 22
The Single-Family Mortgage Industry in the Internet Era:
Technology Developments and Market Structure
FORREST PAFENBERG
Senior Policy Analyst in FHFA’s Office of Policy Analysis and Research∗
Technological innovation has had an important influence on the recent evo- lution of the single-family mortgage industry. Changes in technology have made possible improvements throughout the lending process that allowed prospective borrowers to apply for loans, and enabled lenders and investors to ser- vice, price, sell, and trade mortgages more quickly. The development of automated underwriting systems (AUS) that use scoring models to measure the credit risk of mortgages has completely changed how lenders underwrite loan applications and handle delinquent loans, while other innovations have begun to change the way the ownership of mortgages is recorded.
Since the mid-1990s, computer networks and the Internet have changed how firms in many industries operate, both internally and in the markets in which they do business. The costs of storing, transmitting, and processing information have been dropping continuously by 25 to 35 percent per year for the last 30 years. Im- provements in computing power, data storage, and data transmission bandwidth have increased business profitability in several ways. They have lowered the cost of information and, thereby, transaction costs. They have also contributed to changes in workflow processing within firms. Such changes have led firms to change how they are organized, which in turn has led to further reductions in transaction costs.
Lower information and transaction costs and greater organizational flexibility
∗This article summarizes and then updates a paper published in January 2004 that explored the impact of financial innovation and technological change on the economics and structure of mortgage lending since the 1980s. The impact was profound and significantly changed the way the participants in the mortgage industry did business. This article, however, does not attempt to explain the causes of the current financial crisis that manifested in 2007. Other articles in this volume address this in detail.
163 Copyright © 2010 John Wiley & Sons, Inc.
164 Borrowers
allow firms to reinvent the ways in which they do business, refocusing their activity on what they do best.
The goal of many mortgage lenders is to structure their business operations to be process-driven rather than business department–driven, consumer-oriented rather than firm-oriented, automated and collaborative rather than paper-based and competitive, and adaptable rather than hidebound. For many in the industry, full achievement of those goals will require moving from paper-based to electronic mortgages. Electronic mortgages will require an extensive, long-term effort to reengineer business processes as well as changes in consumer preferences.