Provisions in the proposal relating  to its single-family insurance program would among other things authorize  FHA to change the way it sets insurance premiums, reduce down-payment  requirements, and insure larger loans. In addition, Congress has proposed  changes to FHA’s Title I Manufactured Home Loan program that would  increase loan limits and index them annually; insure each loan made  instead of capping insurance at 10 percent of the value of a lender’s  portfolio; incorporate stricter underwriting requirements; and establish up- front and annual premiums. Based on our  analysis of HMDA data, FHA’s share of the market for home purchase  mortgages (in terms of numbers of loans) declined 13 percentage points  from 1996 through 2005, while the prime share increased slightly, and the  subprime share grew 13 percentage points. FHA’s lack of process improvements and product  restrictions relative to the conventional market provided conditions that  favored conventional over FHA-insured mortgages. FHA and mortgage industry officials with whom  we spoke also cited FHA loan limits as a factor that contributed to the  decline in FHA market share. Our analysis of HMDA data indicated that the agency could have insured  from 9 to 10 percent more loans in 2005 had the higher mortgage limits  been in place. Approximately 20 percent of FHA’s 2005 borrowers  would not have qualified for FHA mortgage insurance under the  parameters of the risk-based pricing proposal we evaluated. FHA  determined that the expected claim rates of these borrowers were higher  than it found tolerable for either the borrower or the Mutual Mortgage  Insurance Fund. Absent any  program changes, FHA estimates that the fund would require an  appropriation of approximately $143 million. If the major legislative proposals were passed, FHA  estimates that the fund would generate $342 million in negative subsidies. FHA Has Enhanced Tools and Resources Important to Implementing Single- Family Proposals but Does Not Intend to Mitigate Risks by Piloting New Products

FHA has planned or taken steps to enhance the tools and resources that  would be important to implementing the legislative proposals for its  single-family insurance program. FHA is in the process of addressing a number of limitations in its mortgage  scorecard that could reduce its effectiveness for risk-based pricing. While FHA plans to take some steps, such as instituting stricter  underwriting standards, to mitigate the risks associated with lowering  down-payment requirements, it does not plan to pilot any zero-down- payment product the agency is authorized to offer. The proposal to lower  down-payment requirements is of particular concern given the greater  default risk of low-down-payment loans, housing market conditions that  could put borrowers with such loans in a negative equity position, and the  difficulty of setting prices for new products whose risks may not be well  understood. As we reported in February 2005, other mortgage institutions  limit the availability of or pilot new products to manage risks associated  with changing or expanding product lines. Our objectives are to (1) describe selected  characteristics of manufactured housing and the demographics of the  owners, (2) compare federal and state consumer and tenant protections  for owners of manufactured homes, and (3) describe the proposed  changes to the Manufactured Home Loan program and assess potential  benefits and costs to borrowers and the federal government. While our scenario analysis offers a very general illustration of how the  proposed changes could affect the General Insurance Fund, the effects of  the proposed changes are unclear because FHA has not articulated which  borrowers would be targeted if the program were expanded, specified  changes in its underwriting requirements, developed a risk-based pricing  structure for the proposed legislation, or estimated costs to the General  Insurance Fund.
Why GAO Did This Study

Fewer borrowers are using the Federal Housing Administration's (FHA) single-family and manufactured housing insurance programs. To help counter this trend, proposed changes to the single-family program would raise loan limits, allow risk-based pricing of premiums, and reduce down payments. Changes such as higher loan limits also were proposed for the manufactured housing program. To assist Congress in considering the impact of these changes, this testimony provides information from recently issued GAO reports and preliminary views from ongoing work. Specifically, GAO discusses (1) trends in FHA's share of the mortgage market, (2) likely impacts of proposed changes to the single-family program, (3) practices important to implementing the changes to the single-family program, if passed, and (4) preliminary observations from our work on the manufactured housing program. To conduct this work, GAO analyzed agency, Home Mortgage Disclosure Act, and Census data and interviewed agency and lending industry officials and other stakeholders.

What GAO Found

FHA's share of the single-family mortgage market declined 13 percentage points from 1996 through 2005, with conventional lenders gaining notably increased percentages of lower-income and minority borrowers. This decline in market share was associated with a number of factors, including FHA's product restrictions and product innovations in the conventional market. The proposed changes to the single-family program could affect borrowers as well as program costs. For example, GAO estimated that in 2005 FHA could have insured 9 to 10 percent more loans if proposed mortgage limits were in effect. But, if the risk-based pricing proposal had been in effect in 2005, 20 percent of borrowers would not have qualified for FHA insurance. FHA determined that the expected claim rates of these borrowers were higher than it found tolerable for either the borrower or the Mutual Mortgage Insurance Fund. Absent any program changes, FHA estimates that the fund would require an appropriation of approximately $143 million in fiscal year 2008. If proposed changes were passed, FHA estimates that the fund would generate $342 million in negative subsidies (i.e., net cash inflows). Although FHA is taking steps to enhance tools important to implementing the proposed changes to its single-family program, it does not plan to use a common industry practice, piloting, to mitigate the risks of any zero-downpayment product. In response to prior GAO recommendations, FHA improved its loan performance models and is refining its mortgage scorecard (which evaluates the default risk of borrowers). However, the proposals would introduce new risks and challenges. The proposal to lower down payments is of particular concern given the greater default risk of these loans and the difficulty of setting prices for new products whose risks may not be well understood. One of the ways FHA plans to mitigate new or increased risks is through stricter underwriting standards, but it does not plan to pilot any zero-down-payment product. Other mortgage institutions use pilots to manage risks associated with changing or expanding product lines. Proposals for the manufactured home loan program would increase loan limits, insure each loan made, incorporate stricter underwriting requirements, and set premium rates. While the changes could benefit borrowers, according to FHA and the Congressional Budget Office, the potential costs could expand the government's liability. However, FHA has not articulated which borrowers would be targeted if the program were expanded, specified changes in its underwriting requirements, developed a risk-based pricing structure for the proposed legislation, or estimated costs to the General Insurance Fund. As a result, the potential effects of the changes on the program and the insurance fund are unclear.