The Public Should Not Be a Mortgage Insurance Backstop

Mortgage Insurance is a guarantee that a mortgage lender will be repaid.  Without this guarantee, most lenders would be reluctant to loan money for 15 or 30 years to anyone lacking high income, high down payment and high credit rating.  Their reluctance would show up as refusal to loan or as an uncomfortably high interest rate.  Without mortgage insurance, many who want to buy a home might find nothing affordable with less than a 20% down payment.

The Federal Housing Administration’s (FHA) role is to provide access to the mortgage market for poor and underserved communities.  Inexplicably, FHA also underwrites mortgage insurance for mortgages above $625,000 – which poor or underserved community can afford those?   

FHA insures 20% of low down payment mortgages in the new-home market.  Private sector mortgage insurers serve the remainder.  Private insurers in the mortgage insurance market include; GE Capital, Radian, CMG and others who survived the recent financial crisis. 

FHA notes that during 2008 and 2009, an excess of mortgage defaults was caused by unqualified borrowers and seller-financed down payments from earlier years.  

While the housing market has not fully recovered to its earlier vitality, conditions are no longer dreadful. FHA reached financial settlement with servicers and originators who violated FHA performance standards in earlier years.  In 2009, FHA placed 804,000 mortgage guarantees but that increased to 1,045,000 guarantees in fiscal 2012.  FHA has reduced credit risk among those it insures and hiked premiums by $5 per month for newly insured cases, boosting FHA’s reserve to $2 billion. 

The risk of mortgage default varies with personal income, prevailing interest rates, the pace of household formations, the housing stock, and underwriting standards imposed by insurers.  While one of these risk factors is under FHA’s control, the rest are not.  FHA’s exposure to defaults has been estimated by actuaries at up to $115 billion over the next 30 years, much higher than FHA’s reserve.   

If FHA fails because its reserves are inadequate for the next bump in the housing market, then taxpayers will be conscripted to pay the shortfall.  That is unnecessary, when there are many private mortgage insurers who can collectively serve the mortgage lender marketplace.  And, if it were truly in the public’s interest to subsidize mortgage insurance for a class of home buyers whose financial wherewithal cannot qualify for mortgages, then government can arrange subsidies through private insurers. 

If FHA were to exit the insurance market, the private insurers would be free from government competition with its peculiar focus and quirky subsidies.  While FHA took a baby step toward aligning rates and risks, private insurers are routinely more aggressive – adjusting rates both up and down in sync with risk and competition. 

When Congress more thoroughly probes the need for FHA, it will see that the public should not be treated as the FHA’s deep pockets. 

Alan Daley is a retired businessman who lives in Florida and who writes for The American Consumer Institute Center for Citizen Research

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