Congress has set limits on the  size of the forward mortgages FHA may insure, which can vary by county. In 2012, FHA insured about $227 billion in single- family mortgages, and its overall insurance portfolio was about $1.1  trillion. Changes to Product Terms and Conditions Could Help Mitigate Risk and Increase Financial Viability but Could Also Limit Borrowers’ Access to Credit

Mortgage industry observers have suggested changes to FHA’s product  terms and conditions to lower its exposure to risk and improve its capital  position. FHA recently revised TOTAL to tighten its underwriting standards. In addition, borrowers also must pay for related closing costs. Pricing Changes Could Raise the Cost of Credit for Some Borrowers

FHA has raised premiums several times in recent years, but such  increases have not been risk-based. However, we and others have noted that increases in the cost of  mortgage insurance could increase the likelihood of adverse selection for   That is, low-risk  FHA if its pricing were far different from its competitors.borrowers with fewer down-payment constraints could choose less costly  loans from other sources, effectively making private mortgage insurance  more competitive with FHA insurance. Mortgage industry observers have proposed options  that would limit FHA’s market presence as a way of either reducing FHA’s  liability or better ensuring that it serves a certain market—that is, low- or  moderate-income borrowers and first-time homebuyers. These options  include changes that would have a direct effect on FHA’s market share,  such as reducing loan limits from current levels and determining borrower  eligibility based on income. Options that could have an indirect effect on  FHA’s market presence include reducing FHA’s insurance coverage to  less than 100 percent of the value of the loan and entering into risk- sharing agreements with private partners. Concerns have been raised  that options affecting FHA’s market presence might also affect its ability  to serve its traditional countercyclical role to stabilize the housing market  during times of increased stress or credit contraction. Currently, the loan limits vary by county, ranging from $271,050 to  $729,750 for one-unit properties in the contiguous United States. They note that lower loan limits would not have a significant effect  on FHA lending but would allow high-wealth buyers to be served in the  conventional market, a shift they consider appropriate at this time. In recent congressional hearings, industry observers  encouraged a system of assessing borrowers according to area median  income targets to determine program eligibility.on reforming the housing finance market that was developed by the U.S.  Department of the Treasury (Treasury) and HUD, the administration  presented one option for reform that would strictly limit FHA eligibility to   In a 2011 white paper  low- and moderate-income borrowers, leaving the risk for high-income  borrowers to the private market. Also,  for some lenders the additional exposure might prompt the purchase of  additional insurance coverage from third parties, the cost of which could  be passed on to borrowers. Another  risk-sharing arrangement between FHA and other partners could be a  model similar to FHA’s Multifamily Risk-Sharing Programs through  which the agency shares proportional risk at varying levels between  10 and 90 percent with Fannie Mae, Freddie Mac, and housing  finance agencies among others. Some argue that the federal government  would still absorb catastrophic risk regardless of how risk sharing and  premiums are structured. Some of these  authorities would bring FHA’s corporate powers more in line with other  government corporations. For example, mortgage industry observers have suggested  giving FHA enhanced enforcement powers, greater authority to make  changes to program requirements, and additional authorities to invest in  technology and staff. In its proposed budget for fiscal year 2014, FHA requested a number of  additional enforcement powers. To help make loss mitigation more effective, FHA is seeking authority  to, on a case-by-case basis, transfer servicing of loans to institutions  better equipped to reduce losses.allow FHA to require any of the following actions when a servicer  underutilized FHA’s loss-mitigation tools or the agency deemed the  action necessary to protect the interests of the Fund: (1) transfer  servicing from the current servicer to a specialty servicer designated  by FHA; (2) require a servicer to enter into a subservicing  arrangement with an entity identified by FHA; or (3) require a servicer  to engage a third-party contractor to assist in some aspect of loss  mitigation such as borrower outreach. For example, some said that  FHA needed these additional powers to more effectively manage risk and  avoid unnecessary losses. Similarly, the other observer said that FHA could make some changes through mortgagee  letters and the rulemaking process. However, some mortgage industry observers said FHA should be  provided with additional funding to enhance its information technology. However,  FHA has not met its statutory capital ratio requirement since 2009 and  using premium income for technology enhancement would further reduce  the ratio. Even with no changes to its existing organizational structure and  authorities, FHA can do more to enhance program efficiency and  effectiveness and protect taxpayers. We have made a number of  recommendations aimed at improving FHA’s information technology, loss  mitigation efforts, management of real-estate owned inventories, risk  assessment, and human capital management. Since our  report, FHA has taken several actions, including developing a plan for  conducting an inaugural risk assessment and a workforce analysis and  succession plan. Broader Housing Market Reforms Could Impact FHA’s Role

Following the collapse of the mortgage market, policymakers proposed a  number of mortgage reforms that could impact FHA’s market share and  role. These reforms could affect the willingness of the conventional  market to serve future home buyers of varying credit risk profiles and the  fees that lenders would charge for conventional loans. The administration  has put forth several options for reforming the federal role in the mortgage  market, including reforming the enterprises (Fannie Mae and Freddie  Mac). Each of these options has potential implications for FHA. Because of continuing uncertainty over the resolution of Fannie Mae and  Freddie Mac, the potential impact of their resolution on FHA, and  concerns about FHA’s financial condition, in February 2013 we included  FHA in this high-risk area, now called “modernizing the U.S. financial  regulatory system and the federal role in housing finance.”
As of March 31, 2013, over 90 percent of new mortgage volume had  federal backing, either through FHA and Ginnie Mae or the enterprises. The heightened federal role in mortgage lending and the increased  reliance on FHA insurance highlights the need for policymakers to ensure  that changes made to FHA and the enterprises recognize the  interdependence of these entities and that changes to federal regulations  governing the mortgage market consider the interaction between public  and private capital and reflect the roles and capacities of the agencies. Appendix I: Objectives, Scope, and Methodology

Our objectives were to examine options that have been proposed for  improving the long-term viability of the Federal Housing Administration  (FHA) or reducing its market presence and the implications of these  options. Specifically, we discuss the implications of options related to (1)  changing FHA’s product terms and conditions for single-family mortgage  insurance, (2) restricting FHA’s presence in the single-family housing  market, and (3) enhancing FHA’s operations and powers within its single- family program. In addition, we discuss the possible effects of broader  housing finance reform on FHA. We reviewed and summarized the  literature identifying options for change at FHA, including congressional  testimonies and other documents from mortgage market participants  (such as the Mortgage Bankers Association) and researchers (such as  the Urban Institute, Cato Institute, and others). We obtained FHA data on (1) loans originated in 2009, including credit  scores and down-payment percentages, (2) the effect of a potential  increase in the down-payment requirement on loans for which  applications were submitted in August 2010 through July 2011, (3) the  percentage of loan originations in 2009 and 2010 that had seller  concessions of more than 3 percent of the property value, (4) the  percentage of loans that FHA insured in fiscal year 2012 that were above  $450,000, by state, (5) the income distribution of FHA borrowers in fiscal  years 2000-2013 (October through April), and (6) delinquency rates for all  active loans as of October 31, 2011, by loan size.
Why GAO Did This Study

FHA has historically provided mortgage guarantees for home buyers, particularly first-time, minority, and lower-income borrowers. In 2012, FHA insured about $227 billion in single-family mortgages, and its overall insurance portfolio was about $1.1 trillion. Its market presence expanded during the recent housing crisis as the conventional market contracted and Congress increased the limit on the size of loans FHA may insure. But FHA's financial condition has weakened, and FHA has not met its 2 percent statutory minimum capital ratio since 2009. In its most recent budget, the agency stated that its capital reserve account might require an infusion of federal funds.
FHA, industry participants, and researchers have suggested a number of options for improving FHA's long-term viability or for limiting FHA's market presence. These options have potential implications for taxpayers, borrowers, and others. This report discusses the options--which fall into three broad categories: (1) changes to product terms and conditions, (2) changes that would restrict FHA's market presence, and (3) changes to FHA's operations and powers--and their implications. It also describes the possible effects of broader housing finance reform on FHA.
GAO interviewed a variety of industry stakeholders and researchers and reviewed studies and other documents to identify options for reforming FHA and their implications.

What GAO Found

GAO identified a number of proposed options for adjusting product terms and conditions to help improve the Federal Housing Administration's (FHA) long-term viability. FHA has raised the premiums that it charges borrowers several times in recent years and has taken steps to tighten its underwriting standards--for example, by setting a minimum required credit score. Some mortgage market observers have argued that further changes such as revising underwriting standards to focus on borrowers' residual income, requiring higher down payments, or reducing seller concessions (that is, funds sellers provide to buyers to help pay for closing costs) could help FHA better manage credit risk. However, such changes would entail trade-offs. For instance, some said that raising down-payment requirements would improve loan performance, but others said that this move would delay homeownership for many borrowers. Similarly, raising premiums could potentially increase revenue, but this potential would be constrained if it caused volume to decline. Further, low-risk borrowers with fewer down-payment constraints could choose less costly loans from other sources, leaving FHA with more high-risk borrowers. These changes could have a direct effect on the availability of credit for borrowers.
GAO also identified options that could either directly or indirectly change FHA's market presence, which increased after the housing crisis, or address its financial viability. Among the proposals that would have a direct effect are those limiting FHA insurance to loans below a lowered ceiling or to borrowers who met new income guidelines. Many stakeholders and FHA itself view FHA's current loan limits, which range from $271,050 to $729,750 for one-unit properties in the contiguous United States, as too high. Some note that the agency may insure larger loans than the housing enterprises Fannie Mae and Freddie Mac. The current FHA limits were put in place in response to declines in mortgage lending during the housing crisis, when the private sector's role in financing mortgages shrank. However, as the market has improved, some have noted that lowering loan limits would allow private capital to return to the market and focus FHA on low- and moderate-income and first-time home buyers, a shift that many observers consider appropriate. Other proposed changes, such as reducing insurance coverage to less than 100 percent of the loan amount or entering into risk-sharing agreements with private partners, may indirectly reduce FHA's market presence. However, applying a partial coverage model would limit availability of credit to some borrowers. For some lenders, the additional exposure might prompt the purchase of additional insurance coverage from third parties, the cost of which would be passed on to borrowers. Some argue that under a risk-sharing structure private partners would assume and better manage credit risk. But creating such a structure would require careful consideration of how risks are borne, how pricing is determined, how incentives are aligned between FHA and its partners, and how FHA's role in stabilizing mortgage markets would be impacted. Others point to the additional counterparty risk posed by risk-sharing arrangements, which would necessitate greater federal oversight. Finally, these options might also affect FHA's ability to respond to changing market conditions.
FHA and industry observers have also suggested changes to FHAs structure and powers that could enhance its flexibility and capacity to manage risk. Some of these changes would bring FHAs corporate powers more in line with those of other government corporations and increase its autonomy, providing it with enhanced enforcement powers and greater authority to change program requirements and invest in staff and technology. FHA has already requested additional enforcement authority. FHA and other observers have also argued that FHA needs greater power to change loan products or loan features without a lengthy rulemaking process and additional information technology resourcesresources for which FHA must currently compete within HUD. Expanding FHAs operational and managerial powers would give the agency more flexibility, and increasing its enforcement powers would allow it to more effectively oversee lenders. But any expansion of FHAs authority may need to be limited and transparency requirements heightened, including for the rulemaking process. Even with no changes to its existing organizational structure and authorities, FHA can do more to enhance program efficiency and effectiveness and protect taxpayers. GAO has made a number of recommendations aimed at improving FHAs loss mitigation efforts, management of real-estate owned inventories, risk assessment, human capital management, and information technology systems. In response to these recommendations, FHA has taken steps, such as developing a plan for conducting an inaugural risk assessment and a workforce analysis and succession plan.
Finally, efforts to further regulate housing finance and the continuing uncertainty over resolution of Fannie Mae and Freddie Mac present challenges to any efforts to reform FHA. Following the collapse of the mortgage market, Congress passed a number of mortgage reforms that could impact FHAs market share and role because they could affect the price at which the conventional market will be able to serve future home buyers of varying credit risk profiles. Similarly, the administration has put forth several options for reforming the federal role in the mortgage market, including reform of Fannie Mae and Freddie Mac. Each of these options could have an impact on FHAs role in the mortgage market. Partly for this reason, GAO identified modernization of the federal role in housing finance as a high-risk area in early 2013. Any changes to the federal tools that support housing finance should be made in concert and with full recognition of the interdependence among FHA, the enterprises, and federal regulation.