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Home appraisal’s ugly history and uncertain future

This is Part I of a deep dive into the home appraisal industry. Today we explore the origins of the appraisal industry and its current lack of diversity.

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FHA actuarial report is a Rorschach test for Washington players

Proof of structural failure or proof it’s all hunky-dory?

The Federal Housing Administration released Monday its actuarial report on the Mutual Mortgage Insurance Fund for single-family programs, and a lot of very divergent voices have equally divergent opinions on what it means.

Monday’s report shows that the financial health of the regulating agency improved dramatically but that it still has a way to go with its finances. The FHA boasted a $21 billion improvement since late 2012, after implementing a series of financing changes.

The MMI Fund, which handles single-family programs, gained almost $6 billion in value in the past 12 months, printing now at $4.8 billion. Last year it fell short by more than $1.3 billion.

Ed Pinto, codirector and chief risk officer for the International Center on Housing Risk at the American Enterprise Institute, said that the report shows slow but steady progress, largely due to past increases in FHA premiums.  

“I applaud FHA Commissioner Carol Galante for staying on the course. However, the FHA continues to insure loans with an unacceptably high risk of default,” Pinto said. “AEI’s National Mortgage Risk Index for FHA stands at 24.19% – this means that one in four FHA homebuyers would face default under conditions of economic stress. FHA’s first-time homebuyers face a similar one-in-four risk of default (of) 24.15%.”

Since FHA’s financial future is still uncertain, Pinto argues, now is not the time to reduce premiums. It has nowhere near the level of reserves to withstand even a minor recession. 

“FHA has benefited greatly from increasing home prices due largely to the (Federal Reserve)’s quantitative easing and a recovery that is now over five years old,” Pinto said. “However, many of FHA’s loans are in areas with high concentrations of low-income and minority residents — areas which historically experience volatile home prices. As a result, if the US economy catches a cold, FHA and its highly leveraged borrowers will catch pneumonia.”

Pinto said that even if FHA’s projection proves to be correct and it reaches 2% in economic capital by the end of FY 2016 (and there is not an intervening recession), the current recovery will be quite old at nearly seven-and-half years old. 

An economic capital level of only 2% would prove to be woefully inadequate to protect the taxpayers, Pinto said.

“It would more likely need 5-7% or more. Both the House and Senate committees have reported out bills that would raise the 2% level. Given FHA’s current high-risk practices, it would be imprudent to not stay the course; it should not lower premiums,” he said.   

Pinto offers this path to lowering premiums:

  • Emulate the risk management practices of the VA. The VA charges about ¼ of the premium charged by FHA. This is in large measure due to practices like calculating ability-to-repay using the residual income method, risk sharing, and improved appraisal practices  Regarding FHA’s resistance to using residual income, it is clearly out of the mainstream of sustainable lending practices. In a recent survey of 30 large and medium sized released by Tom LaMalfa, an industry consultant, 26 said FHA should implement residual income. Taking these steps would allow the FHA to safely reduce premiums in the future, while protecting homebuyers and taxpayers. 
  • Focus more on wealth building through homeownership. The 15-year Wealth Building Home Loan is a big step in the right direction and should be considered by FHA.

None of that is what the Community Home Lenders Association would like.

The CHLA renewed its call for the FHA to reduce premiums straight up.

“The Community Home Lenders Association renews its call for a cut in FHA premiums, in the wake of today’s Actuarial Report, which shows continued financial progress,” said Scott Olson, executive director of CHLA. “Cutting premiums would improve access to credit, a step that is made possible by actions FHA has taken the last few years to strengthen the Fund and protect taxpayers.”

Since February, CHLA has called for FHA to reduce its annual premium on the mortgages it insures, to improve access to credit and strengthen the housing recovery. The release of FHA’s Actuarial Rerpot provides further evidence that FHA’s finances continue to improve, and that FHA should pivot from a goal of just improving the FHA Fund to also taking steps to make FHA loans more affordable.

The National Association of Realtors is generally pleased with the implications of the FHA actuarial report and wants the premiums reduced as well.

“Now that the MMI Fund is on a path to recovery, NAR urges FHA to lower its annual mortgage insurance premiums and eliminate the requirement that mortgage insurance be held for the life of the loan. Achieving homeownership has become more difficult with current FHA mortgage insurance premiums,” says NAR President Chris Polychron. “NAR estimates that in 2013, nearly 400,000 creditworthy borrowers were priced out of the housing market because of high FHA insurance premiums. By lowering its fees, FHA could provide greater access to homeownership for historically underserved groups. To put it in perspective, over the past four years, the percent share of first-time buyers using FHA-backed loans shrank from 56% to 39%.”

U.S. Rep. Randy Neugebauer, R-Texas, and chairman of the Financial Services Subcommittee on Housing and Insurance, said Republicans are concerned the MMI ratio is too low and the FHA needs fundamental structural reform, something NAR resists.

“While I am encouraged by the news that FHA’s Mutual Mortgage Insurance ratio moved into positive territory, I am concerned that the ratio remains well below two percent as mandated by Congress. Failure to meet this requirement leaves hardworking American taxpayers vulnerable to another government bailout. We can do better,” Neugebauer said. “As I have said before, FHA is not just broke, it is broken and in need of long-term structural reform. Despite being an insurer, FHA runs its operations contrary to the most basic principles of insurance and sound business practice. Specifically, FHA’s failure to both evaluate risk according to actuarial principles and correlate premiums to actual risk is disconcerting. I remain committed to working with my colleagues to improve FHA’s financial footing and enacting structural reforms that ensures that FHA can serve first-time homeowners and low-to-moderate income borrowers for the long-term.”

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