Has FHA Underwriting Created a “Recipe for Disaster?”

The Federal Housing Administration needs to rethink the way it layers risk on its loans, in particular for borrowers who have poor credit history and large payment burdens, says a George Washington University study released today.

The report, the third in a series of “FHA Assessment Reports” pinpoints mortgage default criteria for FHA and determines that down payment and equity are only a small component of what’s necessary in determining future losses.

“Our analysis seeks to illuminate the factors that can greatly increase a loan’s risk of default,” said Robert Van Order, professor of Real Estate and chair of GW’s Center for Real Estate and Urban Analysis. “We have found that down payment alone is not the leading cause of default; nor are low down payment loans much riskier than other loans. However, a number of factors working together—poor credit score, a high ratio of debt-to-income and other variables, such as seller-funded assistance—can create a recipe for disaster.”


Looking at FHA lending criteria versus the private sector, the study finds that with FHA guidelines permitting a 95.5 loan-to-value ratio for an individual with a 580 FICO score and debt-to-income allowance of up to 48%, FHA loans in 2008-2009 have a more than 25% chance of default. The comparable private sector loan has a 2% chance.

“For FHA, it’s a simple matter of prudent underwriting,” said Van Order. “When a portfolio includes such a high volume of high risk mortgages to borrowers with significant debt loads and poor credit history, you’re either going to collapse from defaults or be forced to try to recover losses by chasing revenue from premium increases for new borrowers.”

View the report here.

Written by Elizabeth Ecker




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  • The bigger problem is the underwriting overlays added by the lenders. I recently submitted a FHA forward loan to two different lenders. There was a huge disparity in the underwriting conditions I received from both lenders. It is very difficult these days to receive a straight answer from HUD concerning clarification of underwriting guidelines. Because of the underwriting overlays imposed by the lenders you can no longer base your approvals off FHA guidelines alone. The reverse mortgage industry, with the implementation of underwriting based on the financial assessment, is following the same path that has cause so much consternation in the forward mortgage world.  Because underwriting guidelines will vary from lender to lender the reverse mortgage originations that have access to numerous lenders will the winners in brave new reverse mortgage world 

  • Elizabeth, my recollection of that period is that private lending had more or less dried up for all but the top percentile of borrowers, so I’m not at all surprised that the FHA loans are a riskier portfolio than the private loans which very few borrowers could qualify for. The phrase, “FHA is the new sub-prime” was common among forward originators at the time, and all of us were aware that FHA’s market share of closings was growing dramatically.

    Since I’m a reverse specialist and didn’t deal with forward mortgages firsthand, I don’t know if this situation came about by a continuation of existing FHA guidelines, or whether these were tweaked in a calculated risk to try to support the housing market or somewhere in between. Does either of the other two GWU studies address this question?

  • This is the Great Housing Depression.  At no time as a nation have we faced such difficult times in this segment of the economy. 

    Last year Warren Buffett was openly voicing his optimism about housing.  Even he has reversed his position.

    If house values continue to dip on a national basis, defaults will continue to grow at historically high rates for an American economy which is supposedly recovering.  FHA is clearly having trouble.  Things are bad and show no sign of letting up.

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