A few weeks ago, I wrote about lowering the loan limits for mortgages insured by Fannie Mae and Freddie Mac. Congress, to their credit, wisely decided to restore the limits to their original, lower levels. Unfortunately, Congress decided to keep in the place the higher limits for mortgages insured by the Federal Housing Administration (FHA)—up to $729,900 in some areas.
Traditionally, the FHA has maintained a limited focus: they help first-time homeowners and low-income individuals obtain mortgages at reasonable rates from private lenders, by providing a 100% federal guarantee. Indeed, in 2005, the FHA insured only 5% of mortgages originated in the United States. Today, that number is above one third.
This large footprint in the housing market is especially concerning because, put simply, the FHA is facing a serious financial challenge. With increasing foreclosures, the FHA has been forced to pay over $37 billion in insurance claims in the last three years. Its cash buffer of 0.25% is now much lower than the 2% required by Congress.
And the FHA’s position is not improving: according to an unpublished report, delinquencies on FHA-insured loans increased in October—approximately one in six loans are in some stage of delinquency. The FHA could be on the hook for roughly $41 billion of losses based on past patterns.
I strongly believe that keeping the FHA loan limits at $730,000 was a mistake. An individual buying a $700,000 home does not need a subsidy—he or she should be able to buy a house without a mortgage guaranteed by the government. The FHA should focus on its original mission: helping low-income individuals transition into homeownership.
Even with the higher maximums on mortgage size, there are still reforms that can improve the FHA’s situation. Currently, the FHA will insure a loan with as little as 3.5% down payment—which often can be supplied by other state or federal programs. With such a minimal down payment, a slight decline in the price of their home will result in a mortgage worth more than the house itself (a situation referred to as “negative equity”). As I have argued before, negative equity is the most significant predictor of default (pdf)—because in this scenario, homeowners are incentivized to “walk away.” Given that taxpayers will be on the hook for these defaults, FHA-insured loans should require a higher down payment, such as 7% or 8% of the purchase price.
In short, Congress should not have overlooked the FHA when lowering loan limits for government-insured mortgages—the federal government should not be in the business of subsidizing high-cost homes. But now that this decision has been made, the FHA should lessen taxpayer exposure to declining housing values by requiring a higher down payment for the mortgages they insure.