However, in recent years, the subsidy  rate has approached zero. Our analysis of  HMDA data indicates that the agency could have insured from 9 to 10  percent more loans in 2005 had the higher mortgage limits been in place. The effect of lowering down-payment  requirements on demand for FHA-insured loans is also difficult to  estimate. Our analysis of how the proposed pricing structure would affect home  purchase borrowers similar to those insured by FHA in 2005 found that  approximately 43 percent of borrowers would have paid the same or less  while 37 percent would have paid more. Absent any program changes, FHA  estimates that the Fund would require an appropriation of credit subsidy  budget authority of approximately $143 million. If the major legislative proposals were passed, FHA  estimates that the Fund would generate $342 million in negative  subsidies. As discussed more fully later in this  report, FHA has taken some steps to improve its subsidy estimates. FHA Has Enhanced Tools and Resources Important to Implementing Proposals but Does Not Intend to Mitigate Risks by Piloting New Products

FHA has enhanced the tools and resources it uses that would be important  to implementing the legislative proposals, but has not always used  industry practices that could help the agency manage the risks associated  with program changes. FHA also has identified changes  in information systems needed to implement the legislative proposals and  requested additional staff to help promote new FHA products but faces  long-term challenges in these areas. However, the legislative proposals  would introduce new risks and challenges such as the difficulty of pricing  loans with very low or no down payments whose risks may not be well  understood. While other mortgage institutions use pilot programs to  manage the risks associated with changing or expanding their product  lines, FHA has indicated that it does not plan to pilot any no-down- payment product it is authorized to offer. We have previously indicated  that, if Congress authorizes FHA to insure new products, it should  consider a number of means, including limiting their initial availability, to  mitigate the additional risks these loans may pose. Congress and FHA Could Consider Other Administrative and Legislative Changes to Help FHA Adapt to Changes in the Mortgage Market

Mortgage industry participants and researchers have suggested additional  options that Congress and FHA could consider to help FHA adapt to  changes in the mortgage market, but some changes could have budget and  oversight implications. Congress also  could consider alternative approaches to the provision of federal mortgage  insurance such as converting FHA to a government corporation or  implementing risk-sharing arrangements with private partners. Also, using the Fund’s  current resources would increase the federal budget deficit unless  accompanied by corresponding reductions in other government spending  or an increase in receipts. However, FHA has not sought this authority. To adapt to market changes, FHA has implemented  new administrative procedures and proposed legislation designed to  modernize its mortgage insurance processes, introduce product changes,  and provide additional risk-management tools. Specifically, we examined (1) the likely program and  budgetary impacts of FHA’s modernization efforts, (2) the tools, resources,  and risk-management practices important to FHA’s implementation of the  legislative proposals, if passed, and (3) other options that FHA and  Congress could consider to help FHA adapt to changes in the mortgage  market and the pros and cons of these options. In evaluating the likely program impacts of FHA’s proposed legislative  changes, we focused on the proposals to raise FHA loan limits, institute  risk-based pricing of mortgage insurance premiums, and lower down- payment requirements. Finally, we estimated the  percentage of the newly-eligible loans in each CBSA that FHA would have  insured using the following range of assumptions: (1) that FHA’s market  share would have been approximately the same as it was among all loans  in that CBSA under the actual 2005 loans limits, (2) that FHA’s market  share would have been approximately the same as its share of loans with  loan amounts ranging from 70 to 100 percent of the actual 2005 loan limits  in that CBSA, (3) that FHA’s market share would have been approximately  the same as its share of loans with loan amounts ranging from 75 to 100  percent of the actual 2005 loan limits in that CBSA, and (4) that FHA’s  market share would be approximately the same as its share of loans with  loan amounts ranging from 80 to 100 percent of the actual 2005 loan limits  in that CBSA. To estimate the effects of risk-based pricing on borrowers’ eligibility for  FHA insurance and the premiums they would pay, we reviewed FHA’s  risk-based pricing proposal and interviewed FHA officials regarding their  plans to implement risk-based pricing, if authorized. We  focused on completed and planned enhancements to FHA’s SFDW data,  loan performance models, TOTAL mortgage scorecard, information  technology, human capital, and risk-management practices.
Why GAO Did This Study

In recent years, the Federal Housing Administration (FHA) has experienced a sharp decline in market share. Also, the agency has estimated that, absent program changes, its Mutual Mortgage Insurance Fund (Fund) would require appropriations in 2008. To adapt to market changes, FHA has implemented new procedures and proposed the following major legislative changes: raising FHA's loan limits, allowing risk-based pricing, and lowering down-payment requirements. GAO was asked to report on (1) the likely program and budget impacts of FHA's modernization efforts; (2) the tools, resources, and risk management practices important to FHA's implementation of the legislative proposals, if passed; and (3) other options that FHA and Congress could consider to help FHA adapt to market changes. To address these objectives, GAO analyzed FHA and Home Mortgage Disclosure Act (HMDA) data and interviewed officials from FHA and other mortgage institutions.

What GAO Found

FHA's recent changes to insurance approval and appraisal requirements have streamlined its insurance process, and FHA's major legislative proposals could affect the demand for FHA's loans, the cost and availability of insurance to borrowers, and the insurance program's budgetary costs. Based on GAO's analysis of HMDA data, the number of FHA-insured loans could have been from 9 to 10 percent greater in 2005 had the higher, proposed mortgage limits been in effect. GAO's analysis of data on 2005 FHA home purchase borrowers shows that 43 percent would have paid the same or less under the risk-based pricing proposal than they actually paid, 37 percent would have paid more, and 20 percent (those with the highest expected claim rates) would not have qualified for FHA insurance. While to be viewed with caution, FHA has made estimates indicating that the loans it expects to insure in 2008 would result in negative subsidies (i.e., net cash inflows) of $342 million if the major legislative changes were enacted, rather than requiring an appropriation of $143 million absent any program changes. FHA has taken or planned steps to enhance tools and resources and adopt risk-management practices important to implementing the legislative proposals, but does not intend to use a common industry practice, piloting, to mitigate the risks of any zero-down-payment product it is authorized to offer. In response to prior GAO recommendations, FHA has taken steps to improve the loan performance and scoring models it would use in risk-based pricing. It also has identified minor changes to its information systems and staff increases needed to implement the proposals but faces long-term challenges in these areas. Additionally, the legislative proposals would introduce new risks. The proposal to lower down-payment requirements is of particular concern given the higher default rates on these loans and the difficulty of setting prices for new products whose risks may not be well known. GAO has previously indicated that Congress may want to consider requiring FHA to limit the initial availability of any new products and also recommended that FHA itself consider piloting. However, FHA has indicated that it does not plan to pilot any no-down-payment product it might offer. Mortgage industry participants and researchers have suggested more options that Congress and FHA could consider to help FHA adapt to changes in the mortgage market, but some changes could have budget impacts and complicate oversight efforts. Some administrative changes--such as implementing a more limited form of risk-based pricing--are within FHA's existing authority. Congress also could grant FHA additional authority that would allow it to invest the Fund's current resources in information technology and human capital, but this would increase the federal government's budget deficit. Finally, Congress could contemplate other approaches to the provision of federal mortgage insurance, such as creating a government corporation. However, any fundamental changes to how the federal government provides mortgage insurance could require new oversight mechanisms and would require careful deliberation.