THE GSEs’ FUNDING OF AFFORDABLE LOANS: 

A 2004-05 UPDATE 

Harold L. Bunce 

December 2012 

Office of Policy 

Development 

and Research 

Housing Finance 

W O R K I N G P A P E R S E R I E S

U.S. Department of Housing and Urban Development 

Working Paper No. HF-019

THE GSEs’ FUNDING OF AFFORDABLE LOANS: 

A 2004-05 UPDATE 

Harold L. Bunce 

Office of Policy 

Development 

and Research 

Working Paper No. HF-019

THE GSEs’ FUNDING OF AFFORDABLE LOANS: 

A 2004-05 UPDATE 

Harold L. Bunce 

December 2012 

Office of Policy 

Development 

and Research 

U.S. Department of Housing and Urban Development 

Working Paper No. HF-019

The FHA Single-Family Insurance Program:

Performing a Needed Role in the

Housing Finance Market
 

Edward Szymanoski
 

William Reeder
 

Padmasini Raman
 

John Comeau
 

Housing Finance 

W O R K I N G P A P E R S E R I E S

December 2012 

U.S. Department of Housing and Urban Development | Office of Policy Development and Research 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

The FHA Single-Family Insurance Program:
 

Performing a Needed Role in the
 

Housing Finance Market
 

Office of Policy Development and Research 

Executive Summary
 

Introduction 

In laying out the Federal Housing Administration’s (FHA’s) 

mission in the single-family mortgage market and in presenting 

its historical role in meeting immediate and emerging challenges over its history, this paper serves as a useful foundation 

for considering FHA’s future role in housing finance as both 

institutional and regulatory reforms are debated. The paper 

focuses on the historical and ongoing role of FHA mortgage 

insurance in sustaining access to mortgage credit, stabilizing 

housing markets, and expanding sustainable homeownership 

opportunities. In so doing, it provides useful facts, descriptions 

of policies undertaken, and information that can inform debates about FHA’s appropriate role going forward. In performing its historical role, FHA has insured more than 41 million 

mortgages since its inception in 1934. 

The paper is organized into four sections and an appendix. 

The first section provides a historical overview of FHA’s role in 

stabilizing housing markets, setting market standards, providing information, and addressing market failures such as credit 

rationing. The second section shows how this role provides 

improved opportunities for low-wealth (often newly formed) 

households to access affordable, sustainable homeownership. 

The third section describes some significant challenges that 

FHA has faced over the years and the steps it has taken to meet 

these challenges. Throughout the current crisis, FHA has borrowed from lessons it learned in the past. The fourth section 

examines FHA’s response to the current housing crisis: FHA has 

stabilized declining markets by maintaining access to federally 

guaranteed mortgage credit in the face of a severe curtailment 

of private capital in the market, and it has assisted distressed 

homeowners to keep their homes. Finally, the appendix reviews 

key questions and policies that will inform the future role of 

FHA, including questions related to the costs and benefits of 

FHA’s countercyclical role, pending regulatory and institutional 

reforms that could affect underwriting standards in the conventional mortgage market. 

Historical Overview of FHA’s Role 

Before the government’s involvement in the 1930s, the recorded 

homeownership rate was never higher than 48 percent. Financial 

markets were highly volatile with financial panics every 10 to 

20 years and frequent depressions. Mortgage loans were difficult 

to obtain. Substantial downpayments for first-lien mortgages 

were in the neighborhood of 50 percent, and second- and thirdlien financing at high interest rates were commonplace. In 1934, 

with new mortgage credit frozen, residential construction stalled, 

and a serious nationwide decline in construction employment, 

Congress authorized FHA mortgage insurance with the aim of 

getting the building trades and private credit back to work. 

Initially, FHA was intended to revitalize the housing industry 

and make home financing attainable for a much larger share of 

American families in the face of national recession. It has since 

extended this role to help soften the effects of local or regional 

downturns and increase homeownership opportunities for lower 

wealth, minority, and first-time buyers. Studies show that profitmaximizing conventional lenders do not raise prices just when 

lending becomes riskier in areas experiencing economic downturns; instead, they tighten underwriting to ration the number 

of mortgages made in such an area. FHA, on the other hand, 

maintains its presence in all markets, providing stability and 

liquidity in markets experiencing recession. By addressing the 

tendency of the private marketplace to ration credit, FHA has 

always brought a great deal more stability to mortgage markets 

and extended the opportunity for homeownership to a much 

broader segment of the population. 

It should be noted that mortgage loan limits rather than borrower income limits have been the principal method of targeting FHA’s insurance activities over its history. This has the 

effect of focusing FHA insurance activity on specific segments 

of the housing market, and it helps maintain stability in credit 

flow to these market segments. Temporary expansion of FHA’s 

loan limits in the current housing crisis has extended FHA 

Housing Finance Working Paper Series 1 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

access to a broader segment of the housing market, thereby 

leveraging FHA’s ability to provide stability to the distressed 

housing market. 

In its early days, FHA also took on the task of developing and 

building the national infrastructure to operate an economically 

sound insurance program across the United States. FHA redefined mortgage underwriting standards to allow a much broader 

segment the population to qualify for mortgage finance, and it 

created new uniform construction and appraisal standards in 

the building and finance industries so that the FHA mortgage 

contract was readily tradable across the country. Another important role of FHA was to make information available to the 

market on the performance of relatively high loan-to-value 

ratio (LTV) mortgage lending (compared with the low LTV 

loans before the Great Depression). By the mid-1950s FHA had 

demonstrated the feasibility of such lending, given the sound 

underwriting and appraisal standards it pioneered. The upshot 

of this was a rebirth in the 1950s of the private mortgage insurance (PMI) industry, which originally operated for a time before 

the Great Depression wiped it out. By 1970, the system of thrifts, 

commercial banks, FHA-insured lending, PMI-insured conventional lending, and access to private capital via secondary market 

support from Ginnie Mae (a government agency) and Fannie 

Mae (a government-sponsored enterprise [GSE]) had helped to 

raise the national homeownership rate from its 1930 measure 

of 46 percent to 63 percent. 

FHA Offers Opportunities for LowWealth Families 

To a large extent, FHA does not compete with conventional 

lenders. FHA focuses on homebuyers who, in comparison 

with those typically served in the conventional market, have 

lower wealth and pose moderately higher risks, yet are deemed 

creditworthy. FHA addresses the credit market imperfections 

that prevent households from accessing the type and level of 

housing consumption best suiting their needs and budget. As 

a result, and as an ancillary benefit to addressing these market 

imperfections, FHA provides opportunities for newly formed 

lower wealth households that wish to buy a home that meets 

their family’s needs at a time when their children are young and 

can still experience the full range of benefits from homeownership. 

To illustrate the above, the Office of Policy Development and 

Research at the U.S. Department of Housing and Urban Development (HUD) has compared characteristics of FHA and GSE 

(Fannie Mae and Freddie Mac combined) first-time homebuyer 

loans (the latter restricted to those falling below FHA loan limits) 

for selected origination years to gain understanding of how 

FHA has been used by first-time homebuyers in relation to the 

(prime) conventional market. The vast majority of FHA home 

purchase loans over the past 15 years have been made to firsttime homebuyers. Except for the peak housing boom years, 

first-time homebuyers tended to rely more heavily on FHA 

financing—by two to three times as much—than on GSE conventional financing, and that reliance has grown dramatically in 

the past 2 years. For younger homebuyers using FHA—those 

under age 35—FHA’s first-time buyer percentage has been consistently 80 to 90 percent; for those over age 35, 60 to 80 percent; and, overall, nearly 80 percent. Among FHA’s first-time 

buyers, nearly 70 percent have been below age 35—consistent 

with the notion that FHA provides greater opportunities than 

the conventional market to families starting out. 

FHA has also long been known to serve a disproportionately 

larger number and share of minority homebuyers, particularly 

African-American and Hispanic buyers. For example, in 2001, 

FHA served more than twice as many minority first-time buyers 

(about 220,000) than Fannie Mae and Freddie Mac combined 

(about 100,000). During the peak boom years, when many 

minority homebuyers chose subprime or other nontraditional 

conventional loans, the FHA minority first-time buyer counts 

dipped below those of the GSEs; however, since the crisis began, FHA has returned to serving a disproportionate number of 

minority first-time buyers. 

FHA Has Overcome Challenges in Its 

History 

Over its history, FHA has faced challenges regarding its financial 

condition or its relegation to small niche status in the marketplace. Three such challenges and FHA’s responses are discussed: 

(1) in 1989, FHA faced a severe financial crisis and a large portfolio of unsound legacy business insured over many prior years; 

(2) large market shifts between 2001 and 2006 during the 

runup of the housing bubble called into question the continuing relevance of FHA in the market; and (3) poor performance 

during the 2000s from home purchase mortgages with downpayment gifts provided by nonprofit organizations in which the 

gift funds were contributed by the homesellers involved in the 

specific transactions, and possibly financed by inflated house 

values. 

Housing Finance Working Paper Series 2 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

1. It may not be widely known, but FHA faced a severe financial 

crisis once before in its history during the administration of 

George H.W. Bush. The accounting firm of Price Waterhouse 

was commissioned in 1989 to conduct an independent actuarial review (the first of many such annual reports) of FHA’s 

Mutual Mortgage Insurance (MMI) Fund, the principal 

ac-counting fund used by FHA to insure its home mortgages. The Price Waterhouse analysis found that FHA was 

underpricing its mortgage insurance and had been doing so 

for a decade. Price Waterhouse attributed a sharp decline 

in the MMI Fund’s net worth during the 1980s, primarily 

to the lower rates of inflation and house price appreciation 

in the 1980s compared with the 1970s. The 1980-to-1982 

recession years and the economic problems in the energyproducing states generated particularly large losses; losses 

due to lax management also were a contributing factor, but 

the underlying trend in house price appreciation was cited 

as the fundamental problem. 

During 1990, Congress and the Bush administration considered various policy proposals to shore up the MMI Fund. 

The policy debate in 1990 centered on how best to balance 

the public purposes of FHA with policies designed to improve 

its financial soundness. The Cranston-Gonzales National 

Affordable Housing Act (NAHA) of 1990 was ultimately enacted to restore the MMI Fund to actuarial soundness (along 

with other legislation enacted in 1989 to improve management effectiveness). The NAHA established a new actuarial 

soundness standard for FHA—a target level of capital of at 

least 2.0 percent of insurance-in-force (aggregate balance on 

insured loans in FHA’s portfolio). But it was understood at 

the time that this target was designed only to enable FHA to 

withstand a moderate recession—not a severe downturn as 

has occurred since 2007. The law requires FHA to operate in 

an actuarially sound manner, but it does not require FHA to 

hold reserves that would make it able to withstand a severe 

economic event. 

Two years after the initial Price Waterhouse study and after 

the implementation of NAHA and other reforms, the fiscal 

year (FY) 1991 actuarial review of the MMI Fund found 

that the capital ratio of the fund had continued to fall. Price 

Waterhouse estimated the FY 1991 capital ratio to have 

declined to negative 0.2 percent (-0.2 percent) of insurancein-force. NAHA and other reform measures adopted to reduce 

MMI Fund risks and to raise premiums were too new to offset 

the factors causing losses from the legacy business. That 

finding, however, did not mean that FHA needed a bailout. 

Rather, the 1991 actuarial review itself predicted future 

capital ratios would rebound, because the reforms would 

improve the performance of newly insured loans and the 

economy would recover. Price Waterhouse predicted the 

MMI Fund would meet its long-run capital ratio target of 

2.0 percent by year 2000, and history shows that the fund 

actually achieved the 2.0 percent goal in FY 1995. 

2. Large market share fluctuations during the decade of the 

2000s also posed a challenge for FHA. Unlike a profitmotivated private insurer or lender, FHA does not actively 

seek to maximize market share. The extreme fluctuations 

observed in FHA’s market share since 2000, however, have 

given rise to questions regarding FHA’s appropriate role in 

the market. In particular, FHA had gone for more than a 

decade from capturing about 10 to 15 percent of the home 

purchase market—the approximate share it had for many 

years leading up to the new millennium—to less than 

5 percent of the market during the boom years immediately 

preceding 2007 and rebounding to around 30 percent from 

mid-2008 forward. Although many believe the current 30 

percent home purchase share represents too large a footprint 

for the FHA in the long term, there is less clarity about 

whether the very low (below 5 percent) precrisis share is 

the appropriate level for FHA going forward. The low FHA 

shares during the boom years occurred at a time when 

predatory and subprime lenders offering high-risk or highcost alternative mortgage products attracted large numbers 

of homebuyers who might otherwise have chosen more 

sustainable FHA financing. 

Subprime underwriting criteria were “liberal to nonexistent” 

back then, and the high cost of these loans was often masked 

by short-run mortgage payments (before teaser rates adjusted) 

that were lower, giving borrowers the perception that the 

loan was affordable. A disproportionate share taking these 

products were minority homebuyers; thus, the declines in 

FHA market share were greatest for African American and 

Hispanic homebuyers. After the crisis hit, minority homebuyers were disproportionately affected by the dramatic 

tightening of conventional mortgage credit, and FHA’s share 

of minority homebuyers has increased above the levels 

observed at the start of the decade. 

FHA did not follow the market’s lead into teaser rate adjustablerate mortgages (ARMs), low-documentation loans, or “piggyback” second liens. If FHA were to have extended itself into 

these products, it would likely have incurred large losses once 

home prices began to fall that could have undermined FHA’s 

ability use its institutional capacity to assume a countercyclical 

Housing Finance Working Paper Series 3 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

 

 

role during the crisis. Although FHA is likely to sustain large 

losses on the loans it did insure during the precrisis boom 

years of 2005 to 2007—in part, because it may have been 

adversely selected during those years when the GSEs, in response to HUD affordable housing goals, were also extending 

credit to borrowers not typically served by the prime conventional market—FHA did avert even greater losses by staying 

principally with its traditional line of business. 

3. Although FHA did not follow the market’s lead into the nontraditional loan products, it did insure a group of loans that 

proved to be high risk: loans with downpayment gifts from 

nonprofit or charitable organizations in which the gift funds 

were ultimately replenished from a donation to the organization by the seller of the home. Often the borrowers who received the seller-funded downpayment gifts had weak credit 

histories as well. The combination of low or zero equity in 

a property often sold at an inflated sale price (sellers would 

recoup their donations through raising asking prices) to a 

buyer with weak credit history resulted in a group of loans 

that, on average, had a frequency of mortgage insurance 

claims that was two to three times the average for other 

comparable FHA loans. 

In 1996, FHA published guidance for mortgagees on the 

acceptable sources of the homebuyer’s required investment 

(downpayment) beyond the homebuyer’s own cash savings. 

Nowhere did FHA extend permission to obtain downpayment 

funds from the seller of the property—a practice expressly 

prohibited by conventional lenders. In the 1990s, however, 

some charitable organizations, which are permissible sources 

of downpayment gifts, began to circumvent the FHA restriction on gifts from sellers in various ways, including the establishment of a fund that provides the “gift” to the homebuyer 

that is replenished by the homeseller through a “charitable 

donation” to the organization after the sale is completed. 

As early as 1999, FHA took steps to prohibit the funding of 

downpayment gifts in which the source of the funds directly 

or indirectly comes from the seller of the property. Ultimately, 

the elimination of the seller-funded downpayment gifts 

would be accomplished through statutory prohibition of 

the practice. The passage of the Housing and Economic 

Recovery Act (HERA) on July 30, 2008, finally terminated 

seller-funded downpayment assistance effective for loans 

underwritten on or after October 1, 2008. The practice, 

however, did result in large losses for FHA, as documented 

in FHA’s MMI Fund actuarial reviews. 

FHA Response to the Crisis 

Beginning in 2007, FHA began to focus on its countercyclical 

role as conventional credit dramatically tightened in response 

to the rise in delinquencies and foreclosures among subprime 

mortgages and the drop in home prices. Home prices continued 

falling for 33 consecutive months through early 2009, and the 

FHA played a major part in the government’s efforts to slow 

this trend and stabilize prices. Mark Zandi, chief economist at 

Moody’s Analytics, offered this assessment of FHA’s role during 

the crisis: 

The FHA had been virtually dormant during the housing 

bubble, but it made about one-third of all U.S. mortgage 

loans in the period after the bust. Without such credit, 

the housing market would have completely shut down, 

taking the economy with it. The effort took a toll on the 

agency’s finances, but so far the FHA has avoided turning 

to taxpayers for help, making it one of the few housingrelated enterprises—public or private—that have not. 

As home prices peaked and began to decline, and as delinquencies and foreclosures increased, lenders withdrew credit from 

the conventional mortgage market. The sheer volume of delinquent mortgages and foreclosure filings, along with numerous 

failures of mortgage lenders beginning in 2007, created a situation in which markets were in a self-perpetuating spiral with 

declining home prices and rising mortgage defaults; that is, 

defaults and foreclosures in the subprime sector led to falling 

home prices and tighter underwriting by conventional lenders, 

which, in turn, affected the prime sector and caused further 

home price declines. Arguably, FHA’s response to the crisis was 

one of many actions taken by the federal government to help 

break the home price downward spiral. FHA’s response consisted of (1) enabling home purchases, (2) enabling mortgage 

refinances, and (3) helping homeowners keep their homes. 

The increase in FHA’s home purchase market share starting in 

2008 is due to three principal factors: (1) the tightening of private credit, (2) FHA keeping its underwriting standards fairly 

constant, and (3) the temporary increases in FHA’s loan limits 

enacted by Congress. In 2006, FHA was authorized to insure 

loans of up to $200,160 in all markets and up to $363,790 in 

high-cost markets. In 2008, the Emergency Economic Stabilization Act (EESA) and, later, HERA granted FHA temporary 

authorization to insure mortgage loans of up to $271,050 in 

all markets and up to $729,750 in high-cost areas. The result 

was that, during FY 2006, as the crisis was about to begin, FHA 

insured 314,000 home purchase loans, but, by FY 2009, it had 

Housing Finance Working Paper Series 4 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

increased it volume of home purchase loans to 996,000 during 

a year in which the overall home purchase market was considerably smaller. 

Not widely known is the fact that FHA also provided support 

for the refinance segment of the housing market during the crisis. 

Beginning in 2007, FHA stepped in to enable growing numbers 

of homeowners facing interest rate resets from expiring teaser 

rates on conventional ARMs to avoid large payment shocks. These 

conventional-to-FHA “product refinances” helped hundreds of 

thousands of borrowers who met FHA’s standard underwriting 

criteria to convert conventional mortgages facing (or that already 

had received) monthly payment increases into far more sustainable FHA loans. In addition to providing help to homeowners 

with unsustainable conventional loans, FHA also enabled borrowers with existing FHA loans to refinance through its streamlined FHA-to-FHA refinance programs. Because FHA already 

holds the default risk on the loan, it is not taking on new risk 

with a streamlined rate or term refinance of the loan (with no 

cash out other than to cover closing costs), even if the loan 

were to be under water, or if the borrower’s credit history had 

deteriorated. 

The exhibit from the paper shown below illustrates FHA’s 

response to the crisis in terms of market shares by loan type 

(purchase or refinance). 

Although FHA’s expansion of mortgage credit has been and 

continues to be critical to housing markets, the FHA’s support 

for the market during the crisis also includes help for distressed 

homeowners. Although not as widely recognized as the U.S. 

Department of the Treasury’s Home Affordable Modification 

Program for conventional loans, FHA has actually extended loss 

mitigation aid to more than 1.4 million distressed homeowners 

with existing FHA loans since the second quarter of 2009. 

Finally, any discussion of FHA’s countercyclical role during 

the current crisis should consider the costs incurred by FHA in 

performing this role. Loans FHA insured during the 2005-to2009 period are likely to suffer the most (in terms of lifetime 

performance) from the recent national housing recession. These 

loan vintages contained high shares of seller-funded downpayment gifts, which historically have performed much worse than 

other FHA loans. These vintages also were underwritten when 

home prices were near or at their peak in mid-2006, which was 

followed by 33 consecutive months of decline in national price 

levels, creating the greatest potential for significant negative 

equity. FHA’s relatively low market shares during these boom 

years with high-loss potential, helped mitigate the impact of 

these loan vintages on FHA itself, however. Also, in certain 

states such as California, for which falling home prices were 

especially severe, FHA had even more limited exposure due 

FHA Is Known To Have Ramped Up Its Support for Home Purchases; Less Well Known Is Its Support for Refinances 

During Crisis 

FHA as Share of Quarterly Mortgage Originations by Type (percent) 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

Purchase 

2003 Q12003 Q32004 Q12004 Q32005 Q12005 Q32006 Q12006 Q32007 Q12007 Q32008 Q12008 Q32009 Q12009 Q32010 Q12010 Q32011 Q12011 Q32012 Q1 

Refinance Combined 

Sources: Mortgage Bankers Association and the U.S. Department of Housing and Urban Development 

Housing Finance Working Paper Series 5 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

to precrisis loan limits that restricted origination volumes. As 

a result of FHA’s countercyclical activity, however, the high 

origination volumes insured between 2009 and 2012 now constitute about 78 percent of FHA’s insured loan portfolio, and 

although the bulk of these loans have better risk characteristics 

than is typical for FHA, they will nevertheless be entering their 

peak default periods during 2013 through 2017. 

Appendix 

The authors hope that this paper serves as a useful foundation 

for considering FHA’s future role in housing finance as both 

institutional and regulatory reforms are debated. FHA’s history 

has shown that the public policy debate after FHA’s financial 

crisis of the 1980s was driven by balancing the dual objectives 

of carrying out FHA’s purpose and mission with maintaining 

and improving its financial soundness. In the current environment, FHA is still helping to mend the ailing housing market. 

Looking forward to a time when that objective will have been 

substantially accomplished, there are numerous policy questions 

to be addressed. Some questions involve balancing the costs 

and benefits of FHA assuming a countercyclical role when 

future market distress may occur at the same time that it is 

meeting the other aspects of its mission. This and other questions about FHA’s institutional role are integral to the policy 

debate framed by the White Paper on Reforming America’s 

Housing Finance Market that was jointly released by the Department of the Treasury and HUD in February 2011. 

In addition, there are questions related to regulatory reforms 

now under consideration that are likely to impact FHA’s role 

going forward. These are the Qualified Mortgage rule, the Qualified Residential Mortgage rule, and Basel III capital rules for 

financial institutions. If, in the context of these reforms, FHA 

continues its tradition of serving creditworthy, lower wealth 

households not well served by the conventional market, its relative size and role could depend significantly on how the rules 

are interpreted and implemented. 

Other considerations may also affect the future size of the FHA 

market. Specifically, demographic trends, which recently have 

shown a decline in the rate at which individuals form households 

and a sharp drop in immigration, may suppress the number of 

FHA’s major historical client group, first-time homebuyers. 

The appendix provides background information on these issues 

to help frame the discussion of the relevant policy questions to 

be addressed regarding the future role of FHA. 

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The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Introduction
 

Since the advent of the Great Depression, government has been 

involved in fine tuning the balance between public and private 

support for the system of home mortgage finance in the United 

States. Today, government guaranties or support are in evidence 

at every important link between sources of capital and mortgage lending. Commercial bank and thrift mortgage lenders are 

linked with loanable funds through federal deposit insurance. 

Many banks and thrifts are eligible for membership in the 

Federal Home Loan Bank system, through which they can 

access below-market-rate loans for financing housing. Other 

mortgage lenders, such as mortgage companies, banks, and 

thrifts, are linked to capital markets with either Ginnie Mae’s 

federally guaranteed securities or Fannie Mae’s and Freddie 

Mac’s (government-sponsored enterprise [GSE]) agency status. 

The Federal Housing Administration’s (FHA’s) home mortgage 

insurance program, however, is the only generally accessible 

federal government guaranty linking mortgage borrowers with 

mortgage lenders (Bunce et al., 1995).1, 2 

FHA is a government agency housed in the U. S. Department 

of Housing and Urban Development (HUD). FHA insures 

private lenders against loss on mortgage loans that meet FHA 

underwriting standards, enabling those lenders to provide 

mortgages to creditworthy borrowers who are unable to meet 

more stringent conventional lending standards and might 

otherwise be denied access to the capital markets. The various 

FHA portfolios include mortgages on single-family residential 

properties, multifamily apartments, hospitals, assisted-living 

facilities, and nursing homes. 

In laying out FHA’s mission in the single-family mortgage market and its historical role in meeting immediate and emerging 

challenges during its history, the authors’ hope that this paper 

serves as a useful foundation for considering FHA’s future role 

in housing finance as both institutional and regulatory reforms 

are debated. To that end, the paper provides useful facts on 

FHA’s historical and ongoing role, descriptions of policies undertaken, and information that can inform debates about FHA’s 

future. In performing its historical role, FHA has insured more 

than 41 million such mortgages since its inception in 1934. 

The paper is organized into four sections and an appendix. The 

first section provides an historical overview of FHA’s role in 

stabilizing housing markets, setting market standards, providing information, and addressing market failures such as credit 

rationing. The second section shows how this role provides 

improved opportunities for low-wealth (often newly formed) 

households to access affordable, sustainable homeownership. 

The third section features some significant challenges that 

FHA has faced over the years and the steps it has taken to 

meet these challenges. Throughout the current crisis, FHA has 

borrowed from lessons it learned in the past. Its response to 

the current housing crisis is described in the fourth section: 

FHA has stabilized declining markets by maintaining access 

to federally guaranteed mortgage credit in the face of a severe 

curtailment of private capital in the market, and has assisted 

distressed homeowners to keep their homes. Finally, the appendix reviews key questions and policies that will inform the 

future role of FHA, including questions related to the costs and 

benefits of FHA’s countercyclical role, pending regulatory and 

institutional reforms that could affect underwriting standards in 

the conventional mortgage market.3 

1

 This and subsequent paragraphs, where noted, closely follow Bunce et al. (1995: 9-2, 9-3). 

2

 Other government-guaranteed mortgage programs like those of the U.S. Department of Veterans Affairs or the Rural Housing Service are limited to veterans or 

households meeting specific income and geographic location criteria. 

3

 The FHA Mutual Mortgage Insurance (MMI) Fund Actuarial Review for fiscal year 2012 was released on November 16, 2012, and showed that the capital reserve 

ratio of the MMI Fund had fallen below zero to negative 1.44 percent. Because this paper was written before the release of the Review, however, it does not discuss 

these results. 

Housing Finance Working Paper Series 7 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Section I. Historical Overview of FHA’s Role
 

Before the government’s involvement in the 1930s, the recorded homeownership rate was never higher than 48 percent.4 

Financial markets were highly volatile with financial panics 

every 10 to 20 years and frequent depressions.5 Mortgage 

loans were difficult to obtain, and homebuyers had to provide 

their own mortgage default “insurance” for lenders in the 

form of substantial downpayments in the neighborhood of 50 

percent or second and third loan financing at interest on the 

order of 18 to 20 percent (see Semer et al., 1976a: 10–11). 

In addition, homebuyers had to bear most of the interest rate 

risk with short-term, high-interest balloon mortgages. Even 

with the limited development of private mortgage insurance 

(PMI), primarily in New York State, homebuyers were unable 

to reduce downpayments below 33 percent and this insurance 

proved worthless when difficult economic times came (Rapkin 

et al., 1967: 23–27). The purely private system of mortgage 

finance, under which lenders and investors bore the full weight 

of default losses and faced variable economic conditions, 

limited consumer access to mortgage credit and sustainable 

homeownership (Bunce et al., 1995: 9-2). 

The complete and extended collapse of the housing economy, 

including both its home financing and home building sectors 

through the early years of the Great Depression, provided 

a dramatic and incontrovertible demonstration of just how 

ineffectual private sector institutions unaided by government 

were at mitigating the effects and rebounding from economic 

disaster (Semer et al., 1976a: 3). In an effort to restore the 

supply of credit to mortgage lending and employment in the 

housing industry, President Hoover convened the President’s 

Conference on Home Building and Home Ownership to bring 

about a system of Home Loan Discount Banks. These institutions were created with passage of the Federal Home Loan Bank 

Act of 1932. The Home Owner’s Loan Act of 1933 quickly 

followed and established the Home Owner’s Loan Corporation, 

created to refinance home mortgages in default or foreclosure 

or to help owners to recover homes lost through foreclosure or 

forced sale (see Semer et al., 1976a: 4–6). 

In 1934, however, with new mortgage credit still frozen, residential construction stalled at less than one-tenth of the units 

built in 1925, and a decline in construction employment to 

fewer than 150,000 people nationwide with an equivalent loss 

in employment in the production of materials and equipment 

for home construction (Semer et al., 1976a: 8–9), Congress 

authorized the Federal Housing Administration (FHA) mortgage 

insurance with the aim of getting the building trades and private 

credit back to work. Speaking in support of the legislation, Federal Emergency Relief Administrator, Harry L. Hopkins, stated: 

The building trades in America represent by all odds 

the largest single unit of our unemployment. Probably 

more than one-third of all the unemployed are identified, 

directly and indirectly, with the building trades.... Now, 

a purpose of this bill, a fundamental purpose of this bill, 

is an effort to get these people back to work.... There 

has been no repair work done on housing since 1929.... 

And, finally, we believe it is essential that we unloose 

private credit rather than public funds in the repairing of 

those houses and the building of new houses ... (Semer 

et al., 1976a: 9). 

FHA mortgage insurance served as a credit enhancement that 

could be used by borrowers to access lender financing and actuate the borrower’s demand for newly constructed or existing 

homes. Whereas other financing institutions, such as Federal 

Home Loan Banks, federal deposit insurance, or subsequent 

government sponsored entities, such as the Federal National 

Mortgage Association (Fannie Mae), connected lenders to loanable funds, FHA mortgage insurance connected borrowers to 

lenders facilitating the borrower’s demand for and connection 

to those funds. 

Initially, FHA insurance was intended to revitalize the housing 

industry and make home financing attainable for a much larger 

share of American families in the face of national recession. It 

has since assumed the same role helping to soften the effects of 

local or regional downturns or negative effects on less advantaged groups to restore healthy housing market activity. 

Studies have shown that lenders can more easily vary conventional underwriting standards (whereas the FHA has relatively 

fixed underwriting standards), which leads to nonprice rationing by conventional lenders in response to local differences 

4

 By comparison, the U.S. Census Bureau reported the 2011 homeownership rate for the nation at 66.1 percent. 

5

 See figures 30-2 and 34-1 in Lipsey and Steiner (1975: 586–587; 662). 

Housing Finance Working Paper Series 8 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

 

in economic conditions or other perceived risks. That is, 

profit-maximizing lenders do not only raise prices when lending becomes riskier in areas experiencing economic downturns, 

instead, they tighten underwriting to ration the number of mortgages made in such an area. FHA, on the other hand, maintains 

its presence in all markets, providing stability and liquidity in 

markets experiencing recession. Credit rationing in the conventional lending market is considered a market failure in the parlance of economists, and FHA’s ability to address this failure is 

the key justification for FHA’s historical and current role in the 

market. That is to say, the FHA, by addressing the tendency of 

the private marketplace to ration credit, has always brought a 

great deal more stability to mortgage markets and extended the 

opportunity for homeownership to a much broader segment of 

the population than was or would have been true in its absence. 

The FHA, by addressing the tendency of the private marketplace to ration credit, has always brought a great deal 

more stability to mortgage markets and extended the opportunity for homeownership to a much broader segment 

of the population. 

FHA is able to extend credit to those creditworthy borrowers 

who are not adequately served by conventional lenders and 

do so in an actuarially sound manner (which is a statutory 

requirement for FHA) because FHA has a lower cost of capital 

than conventional lenders. According to Bunce et al. (1995) 

“FHA’s federal guaranty is the principal reason it can serve a 

more risky clientele” (Bunce et al., 1995: 9-6). Private lenders 

or insurers must earn a profit sufficiently large to attract the 

capital necessary to satisfy their shareholders. Because serving 

riskier borrowers involves a greater risk of failure, private 

lenders/insurers would have to maintain both larger reserves 

of capital and a larger profit margin to secure the capital in 

that riskier use. They go on to say “the freedom from having 

to earn a private risk-adjusted profit is FHA’s principal cost 

advantage....” In addition FHA can make mortgage finance 

available to some borrowers by cross-subsidizing their losses 

with surplus premium income from lower risk FHA borrowers, 

who are themselves too risky for private lenders and insurers” 

(Bunce et al., 1995: 9-6). 

The original FHA mortgage insurance contracts enabled borrowers to obtain financing with a minimum 20-percent downpayment. The maximum mortgage was limited to $16,000, 

which enabled families to purchase a $20,000 home with a 

minimum downpayment. Thus FHA originally served a large 

portion of the market as the typical home’s price at the time 

was about $5,300. By charging borrowers a small premium 

and insuring the full mortgage amount, thereby protecting 

lenders from default losses, the FHA encouraged acceptance 

of long-term, lower downpayment, self-amortizing (all interest 

and principal repaid over the life of the loan), level-payment 

mortgages, bringing homeownership within the reach of many 

more families with lower upfront and monthly payments 

(Reeder et al., 1987: 2). 

Note that mortgage loan limits rather than borrower income 

limits have been the principal method of targeting FHA’s insurance activities during its history. This eligibility requirement 

has the effect of focusing FHA insurance activity on specific 

segments of the housing market, and helps maintain stability in 

credit flow to these market segments. Introducing the idea of 

federally backed mortgage insurance was only the beginning. 

Next came the nuts and bolts issues of developing and building 

the national infrastructure to operate an actuarially sound 

insurance program across the United States. In addition to 

redefining mortgage underwriting standards to allow for a 

much broader segment of American households to qualify for 

mortgage finance, FHA created new uniform construction and 

appraisal standards to be used by private sector practitioners in 

the building and finance industries so that the FHA mortgage 

contract was readily traded across the country ensuring that 

homebuyers would have access to the lowest cost funds available nationally rather than locally (Semer et al., 1976a: 11–12). 

In addition to redefining mortgage underwriting standards to allow for a much broader segment of American 

households to qualify for mortgage finance, FHA created 

new uniform construction and appraisal standards to be 

used by private sector practitioners. 

Over time, the mortgage terms were gradually liberalized on 

lower value homes with an increase to a 90-percent maximum 

loan-to-value ratio (LTV) and 25-year repayment term for 

newly constructed homes mortgaged for less than $5,400 or up 

to $8,600 if the mortgage did not exceed the sum of 90 percent 

of the first $6,000 in value and 80 percent of the value between 

$6,000 and $10,000 (Semer et al., 1976a: 21). 

Early on (as has been the continued practice), race was not 

explicitly regarded as a factor in FHA’s mortgage insurance 

operations. Although as noted in section III, lenders of the time 

generally held the belief that it was unwise to invest mortgage 

funds in certain areas of cities (characterized by blight, low income, and minority residents), and FHA’s earliest underwriting 

Housing Finance Working Paper Series 9 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

manuals reflected similar policies for evaluating older urban 

neighborhoods. By administrative decision in 1950, however, 

FHA actively took steps to address existing explicit racial 

discrimination in the market as the agency ceased insuring 

any more mortgages on real estate subject to covenants against 

ownership or occupancy by members of certain races. In 1962, 

President Kennedy issued Executive Order 11063 making 

FHA- and U.S. Department of Veterans Affairs-insured housing 

and related properties subject to Equal Opportunity in Housing 

requirements despite industry reaction that such action would 

lead lenders and homebuyers alike to shun FHA financing in 

favor of conventional financing which was not yet subject to 

equal opportunity requirements. No significant shift away from 

FHA materialized and in 1968 all housing and related transactions became subject to Fair Housing law under Title VIII of the 

Civil Rights Act (Semer et al., 1976a: 15). By 1970, the system 

of thrifts, commercial banks, FHA-insured lending, and Fannie 

Mae had helped to raise the homeownership rate from its 1930 

measure of 46 to 63 percent (Semer et al., 1976a: 26). 

More recently, FHA introduced major underwriting changes in 

1995 designed to expand the shares of first-time and minority 

homebuyers that it served. For example, it recognized more 

sources of income (for example overtime or part-time employment income if certain conditions were met) in qualifying a 

borrower, enabled borrowers to use rent and utility payments 

to establish their credit quality, and permitted debt-to-income 

and payment-to-income ratios above FHA’s limits if the lender 

could identify factors that compensated for the additional risk 

assumed.6

 As a result of these changes, first-time homebuyers 

increased from about 60 to 80 percent of FHA’s home purchase 

business, and its share of minority homebuyers increased from 

about 25 to 35 percent. Homeownership rates for the nation 

as a whole and for racial and ethnic minority households, for 

which the rates have historically lagged behind those of White 

households, rose each year thereafter through 2002, achieving 

a nationwide peak of 69.0 percent by 2004. 

Another important role of FHA was to make information 

available to the market on the performance of relatively high 

LTV mortgage lending (as compared with the low LTV loans 

before the Great Depression). By the mid-1950s FHA had 

demonstrated the feasibility of such lending given the sound 

underwriting and appraisal standards it pioneered. The upshot 

of this demonstration was a rebirth of the PMI industry in the 

late 1950s. 

Another important role of FHA was to make information 

available to the market on the performance of relatively 

high LTV mortgage lending. 

The PMI industry grew so that by the mid-1990s it, together 

with other conventional market institutions, was serving an 

annual volume of homeowners that was approximately equal 

to that served by FHA (Bunce et al., 1995: 9-2). As the PMI 

industry grew in size and strength, however, so did efforts to 

legislatively limit access to FHA. Between 1970 and 1995, no 

fewer than five major efforts were made to reassess FHA’s role 

(and in some cases other government support) in the mortgage 

finance system, with a focus on the extent to which it could 

shift its business to conventional mortgage lending with private 

insurers (HUD PD&R, 1987, 1977; McKenna and Hills, 1982; 

President’s Private Sector Survey on Cost Control, 1983; United 

States and Linowes, 1988).7 Each effort argued that FHA was 

serving borrowers that conventional-market providers could 

have served as well or better—that is, substantial “overlap” 

existed between conventional and FHA borrowers. None of 

these efforts ever empirically established significant overlap 

between FHA and conventional lending, however, and each 

ultimately concluded that FHA had a continuing role so long as 

it complemented rather than competed with the conventional 

market. 

Some of the calls to limit FHA also included proposals to 

replace its full insurance coverage with partial or limited 

insurance, or to remove its full faith and credit backing of 

the United States’ government, or for its privatization (that is, 

outright elimination). These calls have often been accompanied 

by claims that FHA was incapable of keeping up with the 

technological changes in mortgage finance and the efficiencies 

of private market delivery systems. 

FHA and Ginnie Mae have led the way in demonstrating 

the viability of many technical innovations. 

Such claims, however, often fail to recognize that FHA uses the 

same private lender and servicer delivery system that conventional mortgage providers use. FHA and/or Ginnie Mae (the 

government-owned analog to the government-sponsored enterprises [GSEs]) have in many cases led the way in demonstrating 

the viability of technical innovations. Early on FHA demonstrated 

6

 See mortgagee letter 95-7 at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/letters/mortgagee. 

7

 This and the following discussion closely follow Bunce et al. (1995: 9-2 to 9-4). 

Housing Finance Working Paper Series 10 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

the value of the long-term, fixed-rate, self-amortizing mortgage 

and paved the way for the modern mortgage lending industry 

with development of minimum property construction and 

appraisal standards. Indeed, FHA demonstrated the viability 

of mortgage insurance, and Ginnie Mae pioneered the use of 

mortgage-backed securities, which were quickly adopted by 

the conventional market. Moreover, FHA pioneered lower 

downpayments, higher payment-to-income ratios, graduated 

payment mortgages, the 1- to 5-year adjustable-rate mortgage, 

underwriting guidelines for borrowers with nontraditional 

credit histories, and Home Equity Conversion Mortgages (reverse 

mortgages) for elderly homeowners (Bunce et al., 1995: 9-3). 

In addition, FHA has worked with industry to develop an 

automated credit underwriting capacity for FHA lending and 

continues to provide publically available data on which government, industry, and academe rely for analysis and understanding of mortgage credit markets inclusive of prepayment 

and default.8

 Looking forward, FHA may continue to play a 

significant role in developing standards and guidelines in the 

industry to address unique or specific challenges. 

Claims that the conventional mortgage market is fully capable 

of assuming FHA’s role and delivering equal or better service 

on at least the same scale depends on the ability of the conventional market to make similar loans to similar borrowers—that 

is to say, the existence of overlap between conventional and 

FHA-insured loan products and borrowers. Bunce et al. (1995) 

developed a comparative analysis of 1993 FHA and GSE loanlevel data that revealed that, in fact, GSE and FHA products 

or borrowers overlapped very little and that FHA continued 

to offer homeownership opportunities to a large, creditworthy 

segment of households that was not otherwise available.9 

Subsequent academic papers analyzing data from later periods 

have found a modest degree of overlap but nevertheless confirm distinct populations. Rodda et al. (2005) found that only 

about 10 percent of FHA-insured loans have risk characteristics 

similar to GSE-purchased loans and that, when compared with 

GSE-purchased loans, FHA-insured loans are characterized by 

lower borrower credit scores and higher LTVs (that is, lower 

downpayments), and they are more targeted to lower income 

and minority borrowers.10 

Nonetheless, analysts have argued that some continuing overlap may be essential for maintaining FHA’s ability to carry out a 

market stabilization role, maintaining its institutional capacity 

to expand if necessary. Pennington-Cross and Yezer concluded 

that, for FHA to continue its important purposes of regional 

stabilization, information production, and insuring equal credit 

opportunity, it must maintain “a substantial FHA presence in 

national mortgage markets ... even if that means substantial 

competition between FHA and conventional mortgage lending” (Pennington-Cross and Yezer, 2000: 370). As discussed 

in section IV, FHA’s countercyclical role during the housing 

crisis from 2007 forward relied on its institutional capacity to 

expand, and many of the loans FHA has insured in this role 

would have qualified for conventional financing in the precrisis 

environment, although given the tightening of conventional 

underwriting, postcrisis overlap between FHA and the conventional market has likely remained small. 

8

 FHA is in the process of updating its internal technology systems, which are admittedly antiquated. As described previously, FHA relies on private lender and 


servicer systems for underwriting and servicing its portfolio with additional information stored on internal technology systems.
 

9

 This section closely follows Bunce et al. (1995: 6-8 to 6-26 and 7-1 to 7-23).
 

10 See Pennington-Cross and Nichols (2000: 2; 307–336), Pennington-Cross and Yezer (2000: 2; 357–372), and Rodda et al. (2005: 1–108).
 

Housing Finance Working Paper Series 11 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Section II. FHA Offers Opportunities for Creditworthy Low-


Wealth Families 

To a large extent, the Federal Housing Administration (FHA) 

does not compete with conventional lenders. FHA focuses its 

home purchase business on a lower wealth, moderately higher 

risk, yet creditworthy clientele than is served by conventional 

lenders. FHA also is more accepting of compensating factors 

that demonstrate a borrowers’ ability and willingness to make 

timely mortgage payments to offset risk characteristics that 

might be unacceptable to conventional lenders. FHA’s insur

ance products and underwriting are designed to accommodate 

creditworthy households that present higher risk characteristics 

related to economic climate and/or their location, asset and 

income circumstances, or other demographic characteristics. As 

a result, FHA serves a much higher fraction of households that 

are first-time buyers, and may also have minority status, live 

in neighborhoods characterized by lower incomes, minority 

concentrations, or center-city locations. 

Under the credit-rationing paradigm, households not 

meeting conventional underwriting standards are more 

apt to use FHA. 

As discussed in section I, the conventional mortgage lending 

industry has traditionally tightened underwriting standards to 

ration the number of mortgages and limit exposure in areas 

or to groups in locations where lending is perceived to have 

become riskier, whereas FHA as a matter of policy has not. As 

a result of the nonprice credit-rationing policy, households that 

at one time may have qualified for a conventional mortgage 

loan of a given size might later fail to qualify for that loan, 

making FHA the only viable alternative. Credit rationing in 

the conventional mortgage market has been widely recognized 

in academic literature. A paper by Ambrose et al. is one of the 

more recent studies to have examined the effects of locationspecific variation in credit risk on FHA market share. These 

authors conclude that strong evidence shows that the conven

tional mortgage lenders employ a nonprice credit-rationing 

paradigm (Ambrose, Pennington-Cross, and Yezer, 2002: 2; 

1–28). Thus, households not meeting conventional underwrit

ing standards are more apt to use FHA because the range of 

service provided by FHA extends well beyond that available 

from these lenders. FHA insures lenders against loss up to 

100 percent, and this deep coverage gives lenders the level of 

comfort they need to make loans to homebuyers in higher risk 

­

­

­

neighborhoods and localities. Without that level of comfort, 

lenders do not merely charge more; rather, they limit access to 

credit through more stringent underwriting and/or substantially 

higher downpayments. The credit-rationing model was widely 

used by the industry before the recent house price boom when 

significant segments of the conventional market adopted riskbased pricing, especially in the subprime sector where loosened 

(or outright abandoned) underwriting standards prevailed and 

risks were priced (albeit mispriced in many instances). Since 

the crisis, the industry has returned to prudent underwriting 

and, arguably, to credit rationing, to the extent that credit tight

ening might be considered excessive (Goodman et al., 2012). 

In addition, FHA has traditionally offered more lenient 

underwriting thresholds than the prime conventional market, 

making it possible for borrowers purchasing modest homes 

(below area median price) to obtain a larger mortgage and bet

ter house for a given income, asset level, and/or credit rating. 

Bunce et al. (1995) calculated that a 1993 homebuyer could, 

under FHA downpayment rules, purchase a given home with 

approximately 30 percent less cash than would be required 

with private mortgage insurance (PMI). Put another way, were 

the homebuyer with given cash assets required to use PMI, he/ 

she would be limited to a home priced 30 percent below the 

one available with FHA. FHA has also been more flexible than 

conventional lenders with its income-qualification rules, al

lowing for variations in the qualifying ratios when appropriate 

compensating factors were identified. Stretching payment to 

income ratios from 28 to 33 percent is equivalent to reducing 

the income required to finance a home by 15 percent below 

what would be required by conventional lenders at the standard 

28-percent ratio or increasing the value of the home available 

to a homebuyer of given income by an equivalent 15 percent. 

Finally, FHA is substantially more tolerant of past borrower 

credit history problems or lack of established credit history. 

Pennington-Cross and Nichols (2000: 318) found that FHA 

FICO credit scores in 1996 were on average substantially below 

that for conventional loans, 665.7 versus 716.6. FHA is also 

more apt to insure mortgages in areas with greater uncertainty 

about the stability of borrower credit or collateral values. 

Again, FHA’s greater acceptance of compensating factors that 

demonstrate a borrower’s willingness to repay helps to offset 

some of these risks. 

­

­

­

Housing Finance Working Paper Series 12 
30

20

10

0

40

50

60

70

80

90

100

1995

Share (percent)

0

200

400

600

800

1,000

1,200

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

199519971999

2001

20032007200820092010

Ratio (FHA to GSE)

Number (thousands)

Ratio of FHA to GSE first-time buyers

Number of FHA FTHB Number of GSE FTHB

The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

An ancillary benefit of the above underwriting differences between FHA and conventional lenders is the greater opportunity 

that FHA extends to families to move into better homeownership situations and begin to build a middle class life at roughly 

similar times in the family lifecycle as more advantaged households. Some argue that FHA does not really increase homeownership, it merely accelerates it by an estimated 5 years or 

so (Goodman and Nichols, 1997: 184–202). That, however, 

is an important benefit that FHA provides as a corollary to its 

primary mission to address the credit market imperfections 

from credit rationing. In other words, for newly formed households that wish to buy a home that meets their needs at a time 

when their children are young and can still experience the 

full range of benefits from homeownership, FHA provides the 

opportunity to access credit earlier. 

For newly formed households that wish to buy a home at 

a time when their children are young and most able to 

benefit from owning a home, FHA provides the opportunity to access credit earlier. 

The Office of Policy Development and Research has examined 

characteristics of FHA and government-sponsored enterprise 

(GSE) first-time homebuyer loans (the latter being restricted to 

those falling below FHA loan limits for purposes of comparison) 

for selected origination years from 1995 through 2010 to 

gain understanding of how FHA has been used by first-time 

homebuyers in relation to the (prime) conventional market.11 

Most FHA purchase loans made during the past 15 years were 

to first-time homebuyers. For younger homebuyers—those 

younger than 35 years old—FHA’s first-time buyer percentage 

has consistently been 80 to 90 percent; for those older than 35, 

60 to 80 percent; and overall 70 to 80 percent. Exhibit II-1A 

shows both the number of FHA and GSE first-time homebuyers by selected year and the ratio of FHA first-time buyers to 

GSE first-time buyers. It shows that except for the time of the 

housing boom and right up to the housing and financial crisis, 

first-time homebuyers tended to rely more heavily on FHA 

financing—by 2 to 3 times as much—as compared with GSE 

conventional financing. That reliance has grown dramatically 

during the crisis years. Exhibit II-1B shows the consistently 

high percentage of FHA buyers—approximately 70 to 80 

percent—who are first-time buyers. In contrast, since 2006, a 

much lower percentage—approximately 35 to 40 percent—of 

GSE homebuyers have been first-time buyers. 

Exhibit II-2A shows that the distribution of FHA first-time 

buyers grouped by age of borrower is fairly consistent across 

Exhibit II-1A. First-Time Homebuyers Rely More on 

FHA Than on Conventional Market 

Number of FHA and GSE First-Time Buyers by Year and 

Ratio of FHA to GSE First-Time Buyer Mortgages for 

Selected Years 

111

222222

995 997 999 

001 003 007 008 009 010 

3.5 1,200 

3.0 1,000 

2.5 800 

2.0 

600 

Ratio (FHA to GSE)

Number (thousands)

1.5 

400 1.0 

200 0.5 

0.0 0 

Ratio of FHA to GSE first-time buyers 

Number of FHA FTHB Number of GSE FTHB 

Note: Analysis restriced to GSE loans within FHA loan limits.
 

Sources: U.S. Department of Housing and Urban Development and Federal 


Housing Finance Agency (government-sponsored enterprise public-use 


database)
 

Exhibit II-1B. FHA Home Purchase Loans Are 

Predominately to First-Time Buyers 

Percentage Share of First-Time Homebuyers and Total 

Count of FHA Purchase Loans 

111222222

995 997 999 001 003 007 008 009 010 

Count (thousands) 

100 1,200 

90 

80 1,000 

70 800 

60

Share (percent) 50 600

40 

400 30 

20 200 

10 

0 0 

FTHB percentage among FHA purchase loans 

Total FHA purchase loans (right scale) 

Source: U.S. Department of Housing and Urban Development 

11 The definition of a first-time homebuyer includes individuals who have had no ownership in a principal residence during the 3-year period before purchase of the 

property. For a complete definition, see http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/ref/sfhp3-02. FHA data are from the U.S. Department 

of Housing and Urban Development (HUD); GSE data come from the Federal Housing Finance Agency and HUD public use databases. GSE public use data for 2005 

were not available at the time this paper was written. 

Housing Finance Working Paper Series 13 
1997 2001 2007 2008 2009 2010

< 21 21–25 25–30 30–35

Borrower age

35–40 40–55 55–99

0

5

10

15

20

25

30

Percent of total first-time buyers

0

5 55–99

The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

the selected years and stable since the start of the housing 

crisis. Between 60 and 70 percent of FHA first-time buyers are 

below age 35—which is consistent with the notion that FHA 

provides greater opportunities than the conventional market 

to families starting out. The conventional market, as shown in 

related exhibit II-2B and as measured by GSE first-time buyer 

loans within FHA loan limits, has consistently fewer first-time 

buyers younger than age 35 (only 50 to 60 percent) with the 

Exhibit II-2A. 60 to 70 Percent of FHA First-Time 

Buyers Under Age 35; Post-Crisis Age Trend Stable 

First-Time Homebuyers by Age Group and Selected Year Percent of total first-time buyers30 

25 

20 

15 

10 

5 

0 

< 21 

1997 

21–25 

2001 2007 2008 2009 2010 

25–30 30–35 

Borrower age 

35–40 40–55 55–99 

Source: U.S. Department of Housing and Urban Development 

Exhibit II-2B. 50 to 60 Percent of GSE First-Time Buyers 

Under Age 35; Post-Crisis Average Age Rising 

First-Time Homebuyers by Age Group and Selected Year 

0 

5 

10 

15 

20 

25 

30

Percent of total first-time buyers

< 21 21–25 25–30 30–35 35–40 40–55 55–99 

Borrower age 

1997 2001 2007 2008 2009 2010 

Note: Analysis restricted to GSE loans within FHA loan limits. 

Sources: U.S. Department of Housing and Urban Development and Federal 

Housing Finance Agency (government-sponsored enterprise public-use 

database) 

trend since the start of the housing crisis being toward older 

first-time buyers, as underwriting has tightened in the conventional sector. 

Exhibit II-3 compares the incomes of FHA first-time homebuyers with those in the conventional (GSE) market. The chart 

displays the means of FHA and GSE first-time buyer incomes 

as a percentage of area median income for selected origination 

years. The chart shows that relative incomes of FHA first-time 

buyers are approximately 10 to 20 percent below the relative 

incomes of conventional first-time buyers for every year except 

2007 and 2008 when the difference narrowed to less than 10 

percent below conventional first-time buyer incomes. 

Exhibit II-4 shows the income qualifying advantage FHA has 

offered these lower income first-time buyers. The exhibit plots 

the mean ratio of the individual buyer’s loan amount divided 

by the buyer’s income for FHA first-time buyers and the similar 

ratio for conventional GSE first-time buyers. One can see that 

in the preboom years FHA first-time buyers had greater purchasing power than GSE first-time buyers. That is, the FHA 

buyers qualified for and got mortgage loans that were 10 to 15 

percent larger relative to income than the conventional buyers 

and this advantage was eroding through the boom years and 

was gone in the post-crisis years.12 

Exhibit II-3. First-Time Buyers Served by FHA Have 

Lower Incomes Than Those Served in Conventional 

Market 

First-Time Homebuyer Incomes as Percent of Area Median 

Income for Selected Loan Origination Years 

1995 1997 1999 2001 2003 2007 2008 2009 2010 

120 

110 

100 

90 

80 

70 

60

FHA FTHB income to AMI GSE FTHB income to AMI

Note: Analysis restricted to GSE loans within FHA loan lImits. 

Sources: U.S. Department of Housing and Urban Development and Federal 

Housing Finance Agency (government-sponsored enterprise public-use 

database)

12 One partial explanation for the perceived erosion of the FHA buyer’s purchasing power advantage is that the distributions of FHA and GSE first-time buyers were 

becoming more similar as traditional FHA buyers shifted to the GSE conventional market financing during the boom period (because it was easier to income-qualify 

for a conventional loan in that period and possibly because of GSE affordable housing goals), followed by a shift of traditional GSE conventional buyers to FHA as 

the GSEs tightened credit, and FHA loan limits were temporarily raised. 

Housing Finance Working Paper Series 14 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

FHA has long been known to serve a disproportionately larger 

number and share of minority African-American and Hispanic 

homebuyers. Exhibit II-5 shows that before the financial and 

housing crisis, FHA served far more minority (African-American 

or Hispanic) buyers than did the conventional GSE market. During 

the peak boom years, when many minority homebuyers chose 

subprime or other nontraditional conventional loans, the FHA 

minority first-time buyer counts dipped below those of the GSEs. 

Exhibit II-4. FHA Provided First-Time Homebuyers With 

Greater Purchasing Power Than GSE Conventional 

Market Before Crisis; Not So After Crisis 

Ratio of Original Unpaid Principal Balance to Borrower 

Income for Selected Years 

1995 1997 1999 2001 2003 2007 2008 2009 2010 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

FHA FTHB UPB to income GSE FTHB UPB to income 

 

250 

Sources: U.S. Department of Housing and Urban Development and Federal 

Housing Finance Agency (government-sponsored enterprise public-use 

database) 

Exhibit II-5. FHA Serves More Minority First-Time 

Buyers Than Conventional (GSE) Market; Peak Boom 

Years Exception 

First-Time Buyers by Selected Year 

1995 1997 1999 2001 2003 2007 2008 2009 2010 

Number (thousands) 200 

150 

100 

50 

FHA FTHB minority count GSE FTHB minority count 

0 

Sources: U.S. Department of Housing and Urban Development and Federal 

Housing Finance Agency (government-sponsored enterprise public-use 

database) 

Finally, FHA has long served a higher proportion of firsttime buyers purchasing homes in underserved areas because 

(1) FHA has traditionally served more first-time homebuyers 

(see exhibit II-1A), and (2) a higher proportion of its first-time 

buyers purchase homes in underserved areas. Exhibit II-6 

shows that FHA has consistently helped 43 percent or more of 

its first-time homebuyers to purchase homes in underserved 

areas, by contrast to the GSE conventional market where firsttime purchases in underserved areas accounted for approxi

mately 32 percent of their first-time homebuyer business. More 

recently, the proportions of first-time FHA homebuyers in 

underserved areas have both increased modestly and continued 

to exceed the comparable proportions for GSE conventional 

first-time buyers; however, the gap between the relative shares 

has narrowed considerably—falling from an average 11 percentage points to roughly 5 percentage points. 

Thus, FHA’s mission of providing increased opportunities for 

less advantaged, creditworthy families, although tested during 

the boom years, proved to be critical to stabilizing the market 

after the crisis began. The differences between FHA and prime 

conventional homebuyers have narrowed somewhat since 2003 

because of easier income qualification of conventional buyers 

in the boom period, and possibly to the GSE affordable housing 

goals.13 Differences also narrowed as formerly conventional 

Exhibit II-6. Higher Percentage of FHA’s First-Time 

Buyer Homes in Underserved Areas Than GSE FirstTime Buyer Homes; Post-Crisis Differential Has 

Narrowed 

First-Time Buyers in Underserved Areas as Percent of Total 

First-Time Buyers by Year 

­

1995 

1997 1999 2001 2003 2007 2008 

2009 

60 

50 

40 

30 

20 

10 

0 

FHA FTHB underserved area GSE FTHB underserved area 

Note: Underserved areas are defined as census tracts characterized by high 

proportions of low- and moderate-income and minority households or high 

proportions of very low-income residents. 

Sources: U.S. Department of Housing and Urban Development and Federal 

Housing Finance Agency (government-sponsored enterprise public-use 

database) 

13 More detail on the GSE housing goals is provided in section III. 

Housing Finance Working Paper Series 15 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

buyers shifted to FHA as conventional credit standards tightened 

after 2006 and FHA loan limits were temporarily raised. The 

narrowing differences notwithstanding, FHA’s home purchase 

business continues to be more focused on less-advantaged homebuyers than the conventional market. FHA has served and continues to serve a much higher fraction of households that are 

first-time buyers, have lower incomes and/or minority status, 

or live in lower income, minority, center-city, or underserved 

areas. Both its level and proportion of first-time business relative 

to GSE conventional first-time business has grown dramatically 

in the years after 2007 helping to stem the most negative effects 

of the credit crunch across the country. More on FHA’s role in 

addressing the housing crisis will be presented in section IV. 

Housing Finance Working Paper Series 16 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Section III. FHA Has Overcome Challenges in Its History
 

During its history, the Federal Housing Administration (FHA) 

has faced challenges that could have affected its financial insolvency or potentially relegated it to small market niche status 

in the market place. FHA has repeatedly met these challenges 

and has righted itself financially and reaffirmed its traditional 

mission. This section discusses three such challenges: (1) in 

1989, FHA faced a severe financial crisis and a large portfolio 

of unsound legacy business insured over many previous years; 

(2) large market shifts between 2001 and 2006, during the 

runup of the housing bubble, called into question the continuing relevance of FHA in the market; and (3) poor performance 

during the 2000s from home purchase mortgages with downpayment gifts provided by nonprofit organizations, wherein the 

gift funds were contributed by the homesellers involved in the 

specific transactions, and possibly financed by inflated house 

values. The manner in which FHA overcame each of these challenges is addressed in this section. 

III-1. Through Improved Risk Management and Other Reforms, FHA 

Emerged From a Financial Crisis 

During the 1990s 

Brief History of the FHA Financial Crisis in 1990 

It may not be widely known, but FHA was faced with a severe 

financial crisis during the administration of President George 

H.W. Bush. The accounting firm of Price Waterhouse was commissioned by the General Accounting Office (GAO) in 1989 

to conduct an independent actuarial review (the first of many 

such annual reports by Price Waterhouse and other independent firms) of FHA’s Mutual Mortgage Insurance (MMI) Fund, 

which is the principal fund used by FHA to insure its home 

mortgages. Before 1989, FHA had conducted internal actuarial 

analyses, but this was the first independent audit of FHA’s 

financial strength undertaken in a comprehensive manner, 

including construction of statistical models to predict future 

claims and prepayments. Price Waterhouse’s fiscal year (FY) 

1989 study stated that the FHA was still solvent, but not 

The public policy debate in 1990 centered on how best 

to balance the public purposes of FHA with policies 

designed to improve FHA’s financial soundness. 

actuarially sound, which meant that new business coming 

through the door would ultimately pay out more in insurance 

claims than the premium revenues it would collect, further 

eroding FHA’s finances. During 1990, Congress and the Bush 

administration considered various policy proposals to shore 

up the MMI Fund. The Cranston-Gonzales National Affordable 

Housing Act (NAHA) was ultimately enacted to restore the 

MMI Fund to actuarial soundness. 

The public policy debate in 1990 centered on how best to 

balance the public purposes of FHA with policies designed to 

improve FHA’s financial soundness (Weicher, 1992). 

How did this situation come about? As discussed previously 

in this paper, FHA originally helped supply mortgage credit 

to a broad segment of the housing market, thereby increasing 

demand for housing. FHA accomplished this objective through 

a statutory nationwide limit on the principal mortgage amount 

with no upper limit placed on the homebuyer’s income. The 

original FHA mortgage limit in 1934 was $16,000 nationwide—well above the $5,300 median home price at the time 

according to Jaffee and Quigley (2010). FHA also insured what 

was then an unusual form of mortgage instrument: a fixed-rate 

self-amortizing mortgage over a long term (20 years at the 

time) to maturity.14 Insurance was funded by the proceeds of a 

fixed premium (0.5 percent) charged annually on unpaid loan 

balances. These revenues were deposited in Treasury securities 

and managed as a mutual insurance fund. Of significance, 

default insurance was offered on what were dubbed “economically sound” self-amortizing mortgages with terms as long as 20 

years and with loan-to-value ratios (LTVs) of up to 80 percent. 

Over time, the terms of FHA mortgages were gradually liberalized as experience provided evidence of the soundness of the 

long-term, fixed-rate mortgage. By the time FHA got into financial trouble in 1989, it was insuring 30-year mortgages with 

downpayments as low as 3 percent on mortgages of $50,000 

14 Before the Great Depression, the typical home mortgage took the form of a balloon rollover with a short term, typically 5 to 10 years. Longer term loans were 

considered too risky by lenders, especially for nonamortizing loans for which the balance owed does not decline. 

Housing Finance Working Paper Series 17 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

or less (although loans above $50,000 required downpayments of 3 percent of the first $25,000, and 5 percent on the 

remainder.) FHA’s mortgage ceiling was raised and restructured 

to be set by market area (county or metropolitan area) with 

a statutory minimum of at least $67,500, and higher levels 

permitted for high-cost areas up to 95 percent of the area’s 

median-priced home, with a legislated maximum of $90,000 

in 1980, which remained at that level until raised to $101,250 

in 1987.15 Despite these loan-limit increases from the original 

level established in 1934, home price inflation outpaced 

FHA’s loan limits, and FHA became increasingly focused on 

the lower value segment of the market. At the time, FHA also 

permitted homebuyers to finance their closing costs as part of 

the mortgage, a practice that was unique in the industry, and 

which also increased FHA’s risk profile.16 Finally, the long-time 

FHA premium of 0.5 percent annually on the outstanding loan 

balance was replaced in 1983 by a one-time upfront payment 

of 3.8 percent of the original loan balance, and this amount 

could be financed in the mortgage and partially refunded if the 

borrower prepaid the loan without an insurance claim. This 

premium structure, although designed to be revenue neutral, 

actually increased FHA’s risk because it raised effective LTVs 

and required large sums to be refunded during periods of high 

refinance activity. 

Laws enacted during the 1950s and 1960s changed FHA’s 

original underwriting standard of insuring only “economically 

sound” loans to a more flexible “reasonable risk standard.” The 

more flexible standard was needed to extend FHA insurance 

authority to special purpose and subsidized home mortgage 

insurance programs targeted to lower income households, 

declining areas, and other special groups (see Vandell, 1995). 

Economic soundness was a requirement of the original Housing 

Act. From its inception, FHA was influenced by the existing 

customs and practices of the mortgage-lending industry, which 

likely spilled over into its early interpretation of the requirement (Semer et al., 1976b: 175). Conventional lenders of the 

time likely gave tacit, if not explicit, agreement to the notion 

that it was unwise to invest mortgage funds in certain areas of 

cities (especially transitional neighborhoods characterized by 

blight, low income and minority residents). Thus FHA’s early 

policy may have inadvertently promoted redlining practices 

and may have accelerated post-World War II (WWII) suburban 

sprawl.17 As discussed in section I, however, in the 1950s and 

1960s, FHA, and later the U.S. Department of Housing and 

Urban Development (HUD), which became the parent agency 

of FHA in 1965, moved strongly to turn this situation around. 

Redlining was prohibited. Also, as noted previously, Congress 

had directed FHA and HUD to implement a series of special 

purpose and subsidized home mortgage insurance programs 

targeted to lower income households, declining areas, and 

other special groups. 

According to Semer et al. (1976b: 177), the programs to serve 

lower income households and those in declining areas were not 

implemented with as much care and management oversight 

as they should have been. As a result, some cities (such as 

Detroit in the early 1970s) experienced high FHA default and 

foreclosure rates soon afterward (Semer et al., 1976b; Vandell, 

1995). As noted by Weicher (1992: 136) when GAO released 

the findings of its 1989 study of FHA, HUD had been “frontpage news for months, with revelations of influence peddling 

and favoritism in awarding contracts in certain programs, fraud 

in others, and substantial losses in several relatively small FHA 

insurance programs in other funds.” 

Although these changes increased the inherent risk of FHA’s 

business, and large losses had occurred for a time in the 1960s 

and early 1970s, the post WWII era was generally a period of 

expansion, and as a result the MMI Fund’s reserves continued 

to grow. This situation began to change during the 1980s. 

The initial Price Waterhouse analysis found that the net present value of FHA’s entire book of business plus cash reserves 

through 1989 was $3.1 billion, about 1 percent of its insurance 

15 The nationwide high-cost conforming loan limit for Fannie Mae and Freddie Mac was set at a higher amount than the high-cost market area ceiling for FHA. 

Specifically, the conforming loan limit was established at $93,750 in 1980 and going forward was indexed to the annual house price change in the conventional 

market. FHA’s minimum and high-cost ceiling were not similarly indexed and required statutory authority to change. 

16 Typical closing costs averaged 2.5 to 3.0 percent of the sales price for FHA buyers in 1989, which meant that a homebuyer making the minimum downpayment 

on a typical $65,000 home could have only $900 equity in the home—about 1.4 percent and far lower than even today’s FHA downpayment requirements permit. 

To calculate: assume 3 percent closing costs, making the sum of purchase price plus closing cost $66,950; compute borrower downpayment as 3 percent of first 

$25,000 ($750), plus 5 percent of the remainder (.05 x $41,950 = $2,098) for a total of $2,848; subtract this downpayment from 66,950 and the homeowner may 

finance a mortgage of $64,100 (to the nearest $100)—effectively leaving the buyer with only $900 equity. 

17 Excerpts from FHA (1938) established criteria for rating economic viability of property locations and neighborhoods, including those that assessed lower viability 

to older neighborhoods with low growth as “accelerating the transition to lower class occupancy,” and required an assessment of the quality of development near the 

property location “to determine whether incompatible racial and social groups are present, for the purpose of making a prediction regarding the probability of the 

location being invaded by such groups.” See FHA (1938: ¶ 909 and 937). 

Housing Finance Working Paper Series 18 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

 

in force (aggregate loan balances).18 This decline was significant 

in the course of a decade—Price Waterhouse calculated that 

in 1979 the MMI Fund had an economic value of $3.4 billion, 

which was 5.3 percent of the insurance in force at the time. The 

MMI Fund was projected to lose money on each year’s book of 

business (loan vintage) from 1980 through 1989. In short, FHA 

was underpricing its mortgage insurance, and had been doing 

so for a decade (Weicher, 1992). 

Price Waterhouse attributed the sharp decline in the MMI Fund’s 

net worth during the 1980s primarily to the lower rates of infla

tion and house price appreciation in the 1980s compared with 

that of the 1970s. The 1980–1982 recession years and the economic problems in the energy producing states in the late 1980s 

generated particularly large losses, but the underlying trend 

in house price appreciation was the fundamental problem. In 

addition, the fund was insuring an increasingly risky book of 

business, and a contributing factor was “past poor management 

practices and lax monitoring” (Weicher, 1992: 138). 

Considerable policy debate existed over how to restore the 

financial strength of FHA, to make administrative reforms to 

reduce fraud and abuse, and to improve management practices. 

Changes addressing these issues were enacted in several key 

pieces of legislation in 1989 and 1990. 

•	 Administrative reforms were enacted by the Housing and 

Urban Development Reform Act of 1989,19 which included 

establishment of (1) a Mortgagee Review Board, to enforce 

lender compliance with FHA rules and standards; (2) the 

Offices of the Chief Financial Officer and FHA Comptroller, 

to improve agency financial accountability; (3) improved 

management practices such as annual audited financial state

ments; and (4) elimination of private investor-owners from 

the FHA single-family program. (Investor loans had been a 

key source of abuse leading to high losses by FHA.) 

•	 Reforms directly addressing FHA’s MMI Fund soundness 

were enacted by the NAHA of 199020 and included (1) the 

development of an actuarial standard of financial soundness; 

(2) modification of minimum equity requirements; (3) changes 

in the pricing of insurance premiums; and (4) revisions to 

­

­

policies regarding distributive shares, which were a form of 

dividends FHA paid to some borrowers whose loan cohorts 

had experienced low losses. 

•	 Governmentwide reforms were enacted by the Federal 

Credit Reform Act of 1990,21 which instituted a more 

realistic picture of the cost of U.S. government direct loans 

and loan guarantees. The credit subsidy cost of direct loans 

and loan guarantees is the net present value of the estimated 

long-term cost to the government for these credit activities. 

Beginning in FY 1992, this calculation of credit subsidy 

cost for loan guarantees such as FHA mortgage insurance 

occurs at the time a new loan guarantee is made and when 

the previous-year loan guarantees are annually re-estimated 

to reflect any changes in the cost of the subsidy. This law 

ended previous practices of cash accounting that tended to 

make the budget effect of loan guarantees appear positive 

in the early years when premium revenues were high and 

losses were low, but had adverse budget effects in later years 

when the opposite situation prevailed. 

Through these legislative changes, FHA took the following 

steps to shore up its finances: (1) shed high-risk loans (by 

eliminating investor loans, a major source of fraud and abuse); 

(2) raise the mortgage insurance premium (to raise revenues) 

while simultaneously restructuring it (to reduce effective LTVs), 

and stop distributive share refund payments; (3) implement 

systematic risk management and better monitoring practices; 

and (4) tighten underwriting through limits on the financing of 

closing costs (to reduce effective LTVs). 

The steps that FHA took in the 1990s are very similar to steps 

that FHA has taken to shore up its finances during the current 

crisis. Clearly FHA’s current capital reserves have eroded as a 

result of the housing crisis beginning in 2007, which is well 

documented in its recent MMI Fund actuarial reviews. The risk 

management steps FHA has taken since 2007 include (1) shedding its riskiest loans (banning high-risk downpayment gifts); 

(2) raising mortgage insurance premiums; (3) instituting better 

management practices (including establishment of Office of Risk 

Management, more frequent reporting to Congress on MMI 

Fund condition, and expanding loss mitigation interventions 

18 This net present value calculation is defined as the economic value or economic net worth of the Fund. It is a net asset position, after booking a liability for loan 

loss reserves. Those loan loss reserves are to be sufficient for paying all projected future insurance claims, after accounting for expected future premium revenues. 

The projection of loan loss reserves assumes no new business is booked to provide any additional resources. 

19 P. L. 101–235. 

20 P. L. 101–625. 

21 P. L. 101-508. 

Housing Finance Working Paper Series 19 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

 

for defaulted borrowers); and (4) modest tightening of underwriting requirements (including minimum consumer credit 

scores and higher downpayments on low-credit-score loans). 

Again, similar to the 1990s experience, FHA took these post2007 steps while balancing the goals of financial stability and 

public mission to maintain mortgage liquidity in all markets 

and provide service to creditworthy borrowers who would 

otherwise not be served in a period of severe credit tightening 

by the conventional market. 

Pre-1991 Legacy Business Gradually Replaced by 

Better Performing Loans and Improved Economic 

Forecasts 

Two years after the initial Price Waterhouse study, and after 

the implementation of NAHA and other reforms, the FY 1991 

actuarial review of the MMI Fund22 found that the capital ratio 

of the Fund had continued to fall. Price Waterhouse estimated 

the FY 1991 capital ratio to have declined to negative 0.2 

percent (-0.2 percent) of insurance in force as improved econometric models predicted higher losses among FHA’s legacy 

(pre-NAHA) business compounded by slightly less favorable 

economic forecasts. NAHA and other reform measures adopted 

to reduce MMI Fund risks and to raise premiums were too 

new to offset the factors that were reducing the economic value 

of the legacy business. That finding, however, did not mean 

that FHA needed a public bailout. Rather, the 1991 actuarial 

review predicted future capital ratios would rebound as both 

the reforms and the economy would recover, and that the MMI 

Fund would meet its long-run capital ratio target of 2.0 percent 

by year 2000. That is precisely what occurred, as exhibits III-1 

and III-2 show, although the 2.0-percent capital target was 

achieved much sooner than predicted in 1995. 

NAHA Target Ratio: Designed To Withstand a 

Moderate (Not Severe) Housing Downturn 

The 1990 policy debate over the appropriate level of capital 

for FHA resulted in a long-term target of at least 2.0 percent 

of insurance in force. It was understood at the time, however, 

that this target was designed only to enable FHA to maintain 

positive capital during a moderate recession—not a severe 

downturn as has occurred since 2007. Again, a review of the 

historical record sheds light on the thinking behind this target. 

The law requires FHA to operate in an actuarially sound 

manner, but it does not require FHA to hold reserves that 

would make it able to maintain positive capital during a 

severe economic event. 

The NAHA legislation actually established two target capital 

ratios for FHA during its recovery: a 2-year target of 1.25 percent, and a more conservative long-term target of 2.0 percent 

for the year 2000 forward. Price Waterhouse’s FY 1990 actuarial 

review of the MMI Fund concluded that the fund’s net worth 

should be at least 1.25 percent of its insurance in force: “The 

Exhibit III-1. FHA Quickly Recovered After 1991 Reforms 

FHA MMI Fund Economic Values and Capital Ratios by Fiscal Year of Actuarial Review, FY 1989–2004 

Fiscal Year of Insurance-In-Force Economic Value Capital Ratio NAHA Target Capital Ratio 

Actuarial Review (millions of dollars) (millions of dollars) (percent) (percent) 

1989 263,963 3,133 1.19 — 

1990 304,216 (2,674) – 0.88 — 

1991 327,811 (669) – 0.20 — 

1992 325,912 1,405 0.43 1.25 

1993 316,527 4,554 1.44 1.25 

1994 335,073 6,682 1.99 1.25 

1995 345,278 7,086 2.05 1.25 

1996 370,484 9,397 2.54 1.25 

1997 400,850 11,258 2.81 1.25 

1998 419,575 11,360 2.71 1.25 

1999 454,184 16,637 3.66 1.25 

2000 482,732 16,962 3.51 2.00 

Note: Capital ratio is economic value as a percentage of insurance-in-force. 

Source: U.S. Department of Housing and Urban Development 

22 This report was submitted to FHA on December 31, 1992. 

Housing Finance Working Paper Series 20 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit III-2. FHA Exceeded 1991 Projections for 

Captial Ratio, Meeting 2.0 Percent Statutory Target for 

FY 2000 in FY 1995 

FHA MMI Fund Capital Ratio Projections From the 1991 

Actuarial Review Compared With Actual Capital Ratios 

From Subsequent Reviews 

1991 1992 1993 1994 1995 

1996 1997 1998 

1999 2000 

4.0 

3.0 

2.0 

1.0 

0.0 

– 1.0 

1997 projected capital ratio Actual capital ratio 

Source: U.S. Department of Housing and Urban Development 

1.25 percent is not a desired ratio, but a minimum ratio.... 

As we saw in the 1980’s when the capital ratio declined from 

5.3 percent to one percent, far more than 1.25 percent capital 

could be needed.” 

This minimum capital percentage was derived from Price 

Waterhouse’s simulation of FHA’s legacy book of business 

under adverse (moderate recession) economics, and represents 

the capital level the MMI fund would needed to stay solvent in 

a hypothetical situation in which no new business is written.23 

The report goes on to say, “Any analysis of the MMI Fund 

must recognize that FHA’s public purpose can be, and often is, 

at odds with its statutory requirement to be sound.... While 

reliance on the Treasury to cover catastrophic conditions might 

be appropriate in the most severe circumstances, we believe 

that, given current statutory requirements, MMI must (at a 

minimum) maintain enough equity to withstand, on its own, 

moderately severe economic conditions.” 

The law requires FHA to operate in an actuarially sound 

manner, but it does not require FHA to hold reserves that 

would make it able to maintain positive capital during a severe 

economic event. 

III-2. FHA Met the Challenge Posed by 

Market Shifts From 2001 to 2006 

FHA’s Market Share Fluctuations Before and After 

Crisis 

Large market share fluctuations during the decade of the 2000s 

also posed a challenge for FHA. Unlike a profit motivated 

private insurer or lender, FHA does not actively seek to maximize market share—that is not consistent with FHA’s mission. 

The extreme fluctuations observed in FHA’s market share 

since 2000, however, have given rise to questions as to FHA’s 

appropriate role in the market. In particular, FHA had gone 

more than a decade from capturing about 10 to 15 percent of 

the home purchase market—the approximate share it had for 

many years leading up to the new millennium—down to below 

5 percent during the boom years immediately preceding 2007, 

and rebounding to about 30 percent from mid-2008 forward.24 

See exhibit III-3, which illustrates quarterly FHA market shares 

leading up to the crisis and in response.25 

Although many policy analysts believe the current 30-percent 

share represents too large a footprint for the FHA in the long 

term, less clarity exists about whether the very low (below 

23 The moderate recession scenario that Price Waterhouse modeled to reach its conclusion was (1) lower house-price appreciation (than consensus scenario) by 

2 percentage points, (2) lower interest rates by 1.5 percentage points, and (3) higher unemployment rates by 3 percentage points. These adverse conditions were 

assumed to occur during the first 2 years in the forecast and are gradually phased out by the 5th year, after which the assumptions return to the consensus forecast. 

In contrast, the post-2006 housing downturn was far more severe. 

24 These shares are in terms of loan counts, not aggregate principal balance. Because FHA average loan sizes are typically smaller than those in the conventional 

market, FHA shares by loan balance would be lower. 

25 Immergluck (2009), Vandell (1995), and others provide a historical summary of FHA’s market shares going back to the agency’s inception. Some estimates refer to 

FHA’s share of all mortgage originations and others refer to shares of home purchase loans or even home sales, so caution is warranted in making intertemporal comparisons. We summarize some of the findings here to give a longer historical perspective on FHA market shares. From 1935 to 1939, FHA-insured loans accounted 

for 23 percent of all single-family mortgage lending, growing to 45 percent during the years 1940 to 1944. When the Veterans Administration loan guaranty program 

was introduced after WWII to serve returning veterans, the FHA share dropped significantly. During the 1950s the private mortgage insurance (PMI) industry reemerged after its demise in the Great Depression, which gradually reduced FHA’s shares further. In 1970, FHA loans still accounted for nearly 30 percent of singlefamily loans. With the increase in PMI activity along with the increasing presence of Fannie Mae (1968) and Freddie Mac (1972)—which by their founding charters 

required a credit enhancement such as PMI for loans with LTVs above 80 percent—FHA’s market share had fallen to the 5- to 10-percent range during the 1980s 

(except for a few years after 1985, when FHA shares spiked as private insurers retreated from the market in response to the recession in the energy-producing states). 

FHA’s share rebounded in the 1990s to between 10 and 15 percent, partly in response to underwriting changes in the mid-1990s intended to increase homeownership rates for low- and moderate-income borrowers and minorities. It remained in this range until the advent of the boom preceding the 2007 crisis. 

Housing Finance Working Paper Series 21 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit III-3. FHA Shares of the Home Purchase Market Hit Record Lows in 2005, Followed by a Dramatic Turnaround 

FHA as Share of Quarterly Home Purchase Mortgage Originations (percent) 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0

2003 Q1 2003 Q3 2004 Q1 2004 Q3 2005 Q1 2005 Q3 2006 Q1 2006 Q3 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3 2011 Q1 2011 Q3 2012 Q1 

Sources: Mortgage Bankers Association and U.S. Department of Housing and Urban Development 

5 percent) precrisis share is the appropriate level for FHA going 

forward, or if FHA would more appropriately return to the 

pre-2002 share in the 10- to 15-percent range to adequately 

perform its mission. That is, the low FHA shares during the 

boom years may also be an anomaly because those shares occurred at a time when predatory and subprime lenders offering 

high-risk or high-cost alternative mortgage products attracted 

large numbers of homebuyers who might otherwise have 

chosen more sustainable FHA financing. In 2008, Bloomberg 

Business Week noted the following: 

For much of the real estate boom, the Federal Housing 

Authority [sic] sat frustrated on the sidelines. Handcuffed by congressional limits on the cost and size of its 

loans, the original government buyer of mortgage loans 

couldn’t compete with private firms in the subprime 

game. As a result, the agency’s share of the loan market 

dwindled from its long-term average of 18 percent to 

less than 2 percent by 2007. “We were marginalized,” 

FHA Commissioner Brian Montgomery said in July (der 

Hovanesian, 2008). 

FHA growth during the boom years was also constrained, as 

noted by Bloomberg, by congressional limits on the maximum 

loan size FHA could insure. For example, house-price growth 

across the United States outpaced the growth of the FHA loanlimit ceiling leading into the crisis. From 1999 to mid-2005, 

the national median existing house price rose by 62 percent. 

By contrast, the FHA national loan-limit ceiling and floor 

rose by only 50 percent. In high-growth, high-cost states like 

California, the constraint was especially binding. According to 

the California Association of Realtors, the median-priced home 

in California increased by 252 percent during the 1999-to2005 period. With house prices growing faster than the FHA 

loan-limit ceiling, the portion of the housing market that FHA 

was even eligible to serve declined rapidly in high-cost areas. 

This decline is clearly illustrated by the fact that FHA mortgage 

endorsements in California declined from 127,000 in FY1999 

to less than 5,000 in FY2005. After the bust in 2007, loan ceilings for both FHA and the government-sponsored enterprises 

(GSEs) were raised temporarily in several pieces of legislation 

designed to broaden the ability of these agencies to provide a 

backstop to the market which was experiencing severe credit 

tightening. These loan-limit increases, which will be discussed 

further in the next section, leveraged the subsequent rebound 

in FHA’s market share. 

In addition to the loan-limit constraints FHA faced going into 

the crisis, and subsequent statutory expansions to these limits, 

the shifting market shares observed during this decade were 

also highly affected by underwriting standards. As noted in section I, lenders can more easily vary conventional underwriting 

standards, whereas the FHA has relatively fixed underwriting 

standards, which leads to nonprice rationing by conventional 

lenders in response to local differences in economic conditions 

Housing Finance Working Paper Series 22 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

(Ambrose, Pennington-Cross, and Yezer, 2002). That is, lend

ers do not only raise prices when lending becomes riskier in 

areas experiencing economic downturns, instead, they tighten 

underwriting to ration the number of mortgages made in such 

an area. FHA, on the other hand, maintains its presence in all 

markets, providing stability and liquidity in markets experienc

ing recession. 

Because FHA charges a mortgage insurance premium, many 

homebuyers who can qualify for conventional lending without 

mortgage insurance or with less costly private mortgage insur

ance choose conventional mortgages when the local economy is 

robust. When the local or national economy is weak, however, 

conventional lenders or private insurers tighten underwriting 

and reduce their exposures in these markets, and FHA home 

purchase mortgage market shares increase as FHA continues to 

provide liquidity. 

Thus, in good times, FHA home purchase mortgage market 

shares often decline as lenders loosen underwriting standards. 

This tendency was especially evident during the boom years 

­

­

­

(2002–2006) preceding the 2007 downturn as FHA home 

purchase mortgage market shares, especially those for racial 

and ethnic minority borrowers, fell dramatically. 

During the boom years, conventional lenders also competed 

with FHA on product type variations in addition to price.26 

Many offered a range of nontraditional (often high-risk and 

high-cost subprime) loan products along with expedited under

writing decisions. These subprime loan products increasingly 

appealed to homebuyers who were facing ever-increasing home 

sales prices. 

A disproportionate share of homebuyers taking these products 

were racial or ethnic minorities. Exhibit III-4, which uses data 

reported by lenders under the Home Mortgage Disclosure Act 

(HMDA) because that is the only readily available source of 

racial and ethnic composition of conventional mortgage originations, shows how the shifts in market share were greatest for 

African American and Hispanic homebuyers.27 After the crisis 

hit, minority homebuyers were disproportionately affected by 

the dramatic tightening of conventional mortgage credit. 

­

Exhibit III-4. Changes in FHA Shares for Minority Home Purchase Market Were More Pronounced Than for Other 

Groups 

FHA as Share HMDA Reported Home Purchase Mortgage Originations by Race/Ethicity of Borrrower (percent) 

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 

60 

50 

40 

30 

20 

10 

0 

Year of loan origination 

All loans White alone Black or African American alone Hispanic or Latino

Note: One- to four-unit (single-family) home purchase loan originations: first-lien, owner- and nonowner-occupant borrowers, including manufactured housing. The data 

are not adjusted for different coverage of FHA loans relative to convential loans; hence, FHA shares may be slightly overstated. For more details about coverage HMDA 

levels, see “A Look at the FHA’s Evolving Market Shares by Race and Ethnicity,” U.S. Housing Market Conditions, Q1 2011. 

Source: Home Mortgage Disclosure Act 

26 FHA was also restricted in many markets by low loan limits. 

27 When selecting HMDA data records for exhibit III-4, the criteria were to include only reported one- to four-unit (single-family) home purchase loan originations 

that were secured by first-lien mortgages, representing both owner- and nonowner-occupant borrowers, and including purchases of manufactured housing. 

Housing Finance Working Paper Series 23 
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Jaffee and Quigley (2010) attribute the decline in FHA loans 

during the boom years to subprime lending, predatory lending, and the failure of the FHA to keep up with the lending 

industry technology. They point to advances in underwriting 

technology, contract (mortgage product) innovation, and 

growth in private mortgage securitization, in addition to GSE 

competition. 

Thus to some, it appeared that FHA had been relegated to a 

small niche role by a nonprime conventional market that used 

new technologies to (1) design products that would appeal to 

FHA’s traditional borrowers, (2) render faster credit underwriting and pricing decisions, and (3) pass along the risk through 

complex securitization structures. It also appeared that the 

prime conventional market contributed to the decline in FHA 

market share because of increased efforts by the GSE to lend to 

FHA’s former clientele in part attributable to HUD’s affordable 

housing goals for the GSEs. 

Shift Toward the Nonprime Sector. The observations by 

Jaffe and Quigley with regard to the shift toward the nonprime 

sector was shared by the Government Accountability Office in 

a 2007 report on FHA market share (GAO, 2007). The GAO 

report also suggested this shift to nonprime resulted in a deterioration in FHA’s risk profile. Specifically, the GAO noted— 

The decline in FHA’s market share was associated with 

a number of factors and has been accompanied by 

higher ultimate costs for certain conventional borrowers 

and a worsening in indicators of credit risk among FHA 

borrowers. More specifically, (1) FHA’s product restrictions and lack of process improvements relative to the 

conventional market and (2) product innovations and 

expanded loan origination and funding channels in the 

conventional market—coupled with interest rate and 

house price changes—provided conditions that favored 

conventional over FHA-insured mortgages. In contrast to 

FHA-insured loans, the majority of conventional subprime 

loans had higher ultimate costs to borrowers, partly because their initial low interest rates could increase substantially in a short period of time. (GAO, 2007a:5) 

In comments to Jaffee and Quigley, Wachter (2011) notes that 

subprime mortgages are designed for borrowers with impaired 

credit records. Unlike FHA insured (and GSE guaranteed) 

mortgages, subprime mortgages “price” the risk. For borrowers who meet the risk thresholds of the FHA (and similarly 

the GSE portion of the conventional market), a more or less 

uniform mortgage rate is charged for accepted loans. That is, 

FHA’s risk-based pricing is limited, and lower risk borrowers 

(who, as noted by Bunce et al., 1995, are relatively lower risk 

among all FHA borrowers, but are generally too risky for the 

prime conventional market) cross-subsidize higher risk borrowers. That has been FHA’s business model over its history. 

For much of its history, the conventional market did not price 

risk either—rather it generally followed a credit-rationing 

paradigm to manage risks—until the advent of the past decade. 

With new risk-based pricing and product development technologies available in the market, FHA’s continued reliance on 

cross-subsidies would arguably drive FHA’s better risks (based 

on a combination of borrower and loan characteristics) to the 

portion of the conventional market where risks are “priced” 

at the loan level, leaving FHA with a dwindling book of ever 

riskier loans. The key question sparked by FHA’s huge drop 

in market share in mid-decade was whether FHA’s insurance 

model of cross-subsidization had been rendered obsolete. 

Alternatively, would FHA’s full embrace of the new market 

paradigm based on the new technologies and product mix contribute to pro-cyclical swings, in effect negating one of FHA’s 

main missions of promoting market stability? 

During the boom, subprime underwriting criteria were “liberal 

to nonexistent” and the high cost of these loans was often 

masked by short-run mortgage payments (before teaser rates 

adjusted) that were lower, giving borrowers the perception 

that the loan was affordable (Wachter, 2011). The reality was 

that the subprime loans being made both lacked suitability 

for borrowers, and at the same time were not fully pricing the 

high level of risk the products entailed. According to Wachter 

(2011) subprime loans were much higher risk than FHA loans 

without bearing sufficiently higher return (to investors) to 

cover the risk. Thus the experience in the nonprime market 

during the boom years preceding 2007 does not make the case 

that FHA’s model of cross-subsidization is obsolete. 

Shift Toward the Prime Sector. To better understand the 

shift toward the prime conventional sector that FHA may have 

experienced up until the housing crisis began in 2007, it is 

helpful to present a brief history of the affordable housing goals 

that HUD had established for the GSEs. Until 2009 HUD had 

been the mission regulator for Fannie Mae and Freddie Mac, 

and a major aspect of this regulation involved setting minimum 

percentage-of-business goals for the GSEs’ mortgage purchases. 

These housing goals measured the enterprises’ respective levels 

of support for very low-income and low- and moderate-income 

lending and lending in underserved geographic areas. The 

main objective of the housing goals was to increase GSE investment in underserved areas and GSE financing of underserved 

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borrowers in return for the many cost advantages afforded the 

enterprises through their public charters. The housing goals 

also intended to encourage Fannie Mae and Freddie Mac to 

introduce new affordable lending programs in underserved 

areas and to make prudent adjustments in their mortgage 

purchase standards that recognize the special circumstances of 

low-income families and others who have found it difficult to 

access credit in the conventional mortgage market. Through 

a rulemaking process, HUD periodically established specific 

targets for these goals since the passage of the Federal Housing 

Enterprises Financial Safety and Soundness Act (FHEFSSA) of 

1992 and until the passage of the Housing and Economic Recovery Act (HERA) in 2008, which transferred the housing goal 

function to the newly formed Federal Housing Finance Agency. 

As noted by Weicher (2010), a major policy issue regarding the 

setting of GSE goals was whether these enterprises should “lead 

the market” or continue to “lag the market” as had historically 

been the case. Leading the market means the fraction of an 

enterprise’s mortgage purchases for a given year that qualify 

for one of the goals would be greater than the corresponding 

fraction for the entire conventional mortgage market (including 

GSE loan purchases plus loans originated by portfolio lenders, 

community-based lenders, and FHA/U.S. Department of Veterans 

Affairs, but excluding subprime loans classified as “B and C”). 

The housing goals set by HUD during 1993 through 2004 

required the GSEs to raise their share of business for each goal 

category relative to past performance, but these goals could be 

met while the enterprises continued to lag the market. In its 

November 2004 GSE Rule, however, HUD increased the goal 

percentages for 2005 to 2008 to levels that were designed to 

bring the GSEs’ performance to the upper end of HUD’s market 

range estimates for each goal, consistent with the FHEFSSA 

requirement that HUD should consider the GSEs’ ability to 

lead the market. Because HUD had to project the size of goal 

qualifying shares in the market to set the goals, actual market 

goal-qualifying percentages would vary from the ex-ante HUD 

projections. Weicher (2010) shows that in 2005 and 2006, it 

was still possible for the GSEs to meet the goals and lag the 

market (as ex-post actual market goal-qualifying shares came in 

above the HUD projections) but in 2007 and 2008, for two of 

the three main goals (low- and moderate-income, and special 

affordable) the goal targets exceeded the actual market levels. 

Both Fannie Mae and Freddie Mac responded to the higher 

housing goals over the years by expanding their suites of mortgage products targeting low- and moderate-income buyers. As 

noted by GAO (2007b), 

These products, in combination with the historically 

low interest rates, made it easier for homebuyers to 

purchase homes in a period of strong house price appreciation. For example, to serve the lower-income 

and minority populations targeted by their affordable 

housing goals, the GSEs developed products featuring 

underwriting criteria that allowed for higher risks, such 

as Freddie Mac’s Home Possible® Mortgage, which allows qualified borrowers to make no down payment. As 

the GSEs worked to meet their goals, their market share 

among lower-income and minority borrowers grew 

over much of the 10-year period we examined [1996 to 

2005], while FHA’s fell (GAO, 2007a: 11). 

Consistent with these observations, research by An and Bostic 

(2008) found a significant negative relationship between the 

change in the GSE and FHA shares of the overall mortgage 

market using data at the census tract level over a period spanning 1996 through 2000, and these authors attribute the shift 

to the HUD affordable housing goals. Unfortunately similar 

research covering the period of 2005 to 2008 is not available. 

This key period corresponds to a dramatic loss of FHA market 

share to the nonprime market and the previously mentioned 

HUD policy decision to raise the housing goals to levels corresponding to meeting or leading the market. The market shares 

for both FHA and the GSEs ultimately declined after 2002, 

however, which suggests that the main driver of FHA market 

share declines may have been to the nonprime sector. 

FHA’s Response to the Changing Market 

FHA did not participate in exotic mortgages with low initial 

teaser rates used to qualify borrowers who might not be able 

to afford the fully indexed rate after the expiration of the 

initial rate period. FHA also did not loosen its underwriting to 

permit less than full documentation loans, nor did it permit 

“piggy-back” structures that use second mortgages to fund 

downpayments, nor did it permit prepayment penalties.28 

To compete successfully in the boom years leading up to the 

crisis, FHA might have offered the teaser rate adjustable-rate 

28 The one truly high-risk product that FHA permitted until it was prohibited by law by HERA were loans with downpayment gifts from nonprofit organizations that 

were funded by the sellers of the property. 

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mortgages (ARMs) that were at the center of the subprime crisis 

and arguably a major source of the growth in subprime and 

resulting loss of FHA market share. Alternatively, it may have 

extended mortgage insurance to mortgages that contained other 

exotic features. It may be that the growth of teaser rate ARMs, 

in particular, enabled the subprime sector to outcompete the 

FHA, because these loans were initially more affordable (while 

the teaser rate was in effect) in a period of rising housing 

prices, when other loans were not. Of course, FHA would not 

likely have offered such loans because they would not likely 

meet a standard of suitability (and may not have been permitted under existing statutory or regulatory authorities of FHA), 

but if the FHA were to have extended itself into these products, 

Wachter (2010) suggests it would likely have required immediate taxpayer support for FHA and a bailout after the boom 

ended, undermining the ability for FHA to assist the struggling 

mortgage market and borrowers in distress during the crisis.29 

FHA ... did not change course from [its] fundamental 

mission in response to shifting market shares. 

Thus, FHA met the challenge posed by the market shifts that 

caused its market share to decline by continuing to offer its 

traditional line of business. To the extent advances in technology 

were a causative factor, note that FHA embraces technological 

advances where appropriate to better serve the public through 

more efficiently meeting its basic mission with soundly underwritten mortgages, but it did not change course from that fundamental mission in response to shifting market shares in a period 

in which the capital markets had a high appetite for mortgage 

product with little regard for its underlying credit risk. 

Although both Jaffee and Quigley (2010) and GAO (2007a) 

have suggested that the loss of FHA market share during the 

precrisis boom years may have resulted in adverse selection and 

a higher overall risk profile for FHA, the decision by FHA to 

maintain relatively consistent underwriting ultimately put the 

agency in a better position to respond to the severe tightening 

of credit after 2006, and the result was a dramatic shift of 

market share back to FHA starting in 2008. Furthermore, a 

review of FHA’s MMI Fund actuarial review for FY 2007 does 

not indicate a dramatic increase in FHA’s portfolio risk characteristics in the10 years preceding 2008.30 

III-3. FHA Eliminated High-Risk SellerFunded Downpayment Gift Mortgages 

Although FHA did not follow the market’s lead into teaser rate 

ARMs, low documentation loans, or piggy back second liens, it 

did offer one loan product which proved to be high risk: loans 

with downpayment gifts from nonprofit or charitable organizations where the gift funds were ultimately replenished to the 

organization by the seller of the home. 

Starting in 2000, the share of loans with gift letters from 

nonprofit, religious, or community entities increased rapidly. 

Most of these gifts from nonprofit organizations involved funds 

which were supplied by contributions from the homesellers 

involved in the specific transactions, and possibly financed 

by inflated house values, as noted in a 2007 report by GAO.31 

This concentration reached about 10 percent by FY 2003 and 

increased dramatically to more than 20 percent in FY 2005. As 

a share of home purchase loans, the concentrations peaked at 

more than 30 percent between 2005 and 2007. 

Often the borrowers who received the seller-funded downpayment gift had weak credit histories as well. The combination 

of low or zero equity in a property often sold at an inflated sale 

price to a buyer with weak credit history resulted in a group of 

loans that on average had a frequency of mortgage insurance 

claims that was two to three times the average for other comparable FHA loans. 

29 For further discussion of how FHA resisted the temptation to preserve market share by relaxing underwriting as other providers raced to the bottom, see Van 

Order and Yezer (2011) and Reeder and Comeau (2008: 9–11). 

30 Specifically, the 2007 actuarial report noted the distribution among FHA’s initial LTV categories shifted after 1998, with increased percentages of FHA’s business 

comprising loans with LTV of 97 percent or higher. For example, the percentages of FHA’s loans endorsed during FY 2005–2007 falling in the 97-percent-or-above 

category were 55.5, 49.3, and 42.3, respectively, compared with 22.9 in 1998. (One explanation for the post 1998 jump is that FHA instituted downpayment 

simplification guidance in 1998 that replaced a cumbersome formula for maximum LTV. The formula change resulted in maximum LTVs for some loans that 

formerly would have fallen in the 95- to 97-percent category rising to 97 percent. See FHA Mortgagee Letter 98-29. Partially offsetting this increase in the highest 

LTV category, however, the years following 1999 also showed a corresponding decrease in loans with LTVs between 95 and 97 percent, with the overall effect being 

that roughly equal percentages of FHA’s loans (42 percent) had LTVs less than 95 percent in 2007 and in 1998, with somewhat lower percentages in this lower risk 

category during the intervening years. 

31 The seller made a donation to the nonprofit or charitable organization in an amount equal to the downpayment gift plus a small additional amount that would be 

retained by the organization. The downpayment gift often came from a fund operated by the organization, and this fund would be replenished by the donation from 

the seller after the sale had been completed. Often, sellers would recoup their donations through raising asking prices for the home by an equal amount. The GAO 

did an analysis and found that seller-funded downpayment contributions may have inflated selling prices by about 2 to 3 percent. See GAO (2007b). 

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The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

FHA Never Intended To Permit Seller-Funded 

Downpayments 

Back in the mid-1990s, the National Housing Act required 

homebuyers to pay a minimum contribution (generally at 

least 3 percent) of the cost of acquisition of a property for 

the mortgage to be eligible for insurance by FHA. The statute 

and the implementing regulations were originally silent about 

permissible and/or impermissible sources of the mortgagor’s 

investment. Then legislation was enacted in 1996 to permit 

family members to provide gifts and loans to other family members. FHA followed with guidance published in handbooks and 

mortgagee letters a broad range of other permissible sources 

of the mortgagor’s investment beyond the homebuyer’s own 

cash savings. These sources included the aforementioned gifts 

and loans from family members, but also extended permissible 

sources to include the borrower’s employer, government agencies, and charitable organizations. Nowhere did FHA extend 

permission to obtain downpayment funds from the seller of the 

property. 

Nowhere did FHA extend permission to obtain downpayment funds from the seller of the property. 

The prohibition of seller provision of downpayment funds is 

widely accepted in the conventional lending sector as well. 

FHA permitted limited amounts of seller contribution for 

other borrower charges such as closing costs, with instructions 

for appraisers to adjust the property value downward dollarfor-dollar for excess seller contributions (see FHA Mortgagee 

Letter 2005-2).32 The statutory minimum contribution by the 

borrower, however, clearly was never intended to be permitted 

to come from the seller. Downpayment gifts from relatives, 

employers, government, or most charitable organizations were 

considered to come from parties not participating directly in 

the sales transaction. 

In the 1990s, however, some charitable organizations began to 

circumvent the FHA restrictions in various ways, including the 

establishment of a fund that provides the “gift” to the homebuyer. 

As noted previously, the fund is immediately replenished by 

the seller providing through a “charitable donation” or a “service fee” to the nonprofit from the proceeds of the sale of the 

home, and the seller does so only if the homebuyer is using 

the charitable organization’s downpayment assistance program. 

In September 1999, FHA published a proposed rule to establish standards regarding the use of gifts by charitable or other 

nonprofit organizations as a source of an FHA’s mortgagor’s 

investment in the mortgaged property.33 Specifically, the 

standards would provide that gifts could not be made from 

funds that the organization received, directly or indirectly, 

from the seller of the property. Arguments were made that the 

seller donation to the charitable or nonprofit organization after 

the consummation of the sale did not constitute a gift from 

the seller, however, and therefore the gift was to be treated 

as coming from the organization. FHA eventually withdrew 

the proposal in January 2001 as HUD received 1,871 public 

comments of which only 21 favored the rule, and especially 

after litigation opposing the ban was successful. Thus, FHA was 

thwarted in its initial attempt to prohibit this type of downpayment gift, which was known to contribute to elevated mortgage 

insurance claim rates. 

In 2006, FHA approached the problem from a different 

perspective. By this time the share of FHA home purchase 

loans with seller-funded downpayment gifts was exceeding 30 

percent and these loans were experiencing cumulative claim 

rates that were two to three times the rate for other comparable 

FHA loans. FHA consulted with the Internal Revenue Service to 

obtain clarification from the tax authorities on the eligibility of 

organizations offering this type of downpayment gift to qualify 

for nonprofit status under section 501(c)(3) of the IRS code. 

FHA issued Mortgagee Letter 2006-13 to clarify that eligible 

sources of the borrower’s contribution included gifts from 

charitable organizations and nonprofits, but only those that 

were “exempt from income taxation under section 501(a) of 

the Internal Revenue Service Code (IRC) of 1986 pursuant to 

section 501(c)(3) of the IRC.”34 

At the same time, IRS issued its Bulletin 2006-21, which stated 

that the manner in which an organization receives funding for 

its downpayment gifts matters regarding the organization’s 

eligibility for tax-exempt status under section 501(c)(3). The 

IRS bulletin states that in cases in which the organization relies 

on sellers and other real estate-related businesses that stand to 

32 http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/letters/mortgagee. 

33 Docket No. FR-4469-P-01, published September 14, 1999. 

34 http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/letters/mortgagee. 

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benefit from the transactions, that organization would not qualify under 501(c)(3). Although it appeared that the combined 

effects of Mortgagee Letter 2006-13 and IRS Bulletin 2006-21 

would be to curtail the practice of seller-funded downpayment 

gifts, the result was that high volumes of these loans were still 

being endorsed following the IRS announcement. It appeared 

that removal of 501(c)(3) status from the organizations involved was not easily accomplished and that the organizations 

likely revised their business models sufficiently to argue that 

they remained in compliance with section 501(c)(3) as clarified 

by Bulletin 2006-21. 

FHA Received Statutory Relief in 2008 

Ultimately the elimination of the seller-funded downpayment 

gifts would be accomplished through statutory prohibition of 

the practice. The passage of HERA on July 30, 2008 finally 

terminated seller-funded downpayment assistance for loans 

underwritten on or after October 1, 2008. Specifically section 

2103 of HERA stated in no case shall the funds required for 

the borrower’s minimum cash contribution consist, in whole 

or in part, of funds “provided by the seller or any other person 

or entity who stands to benefit from the transaction” and that 

the prohibition applies to funds that may have been provided 

“during or after closing of the property sale.” 

Although a surge of these loans was observed immediately 

before the effective date of the HERA prohibition which spilled 

over as cases endorsed for FHA insurance immediately after 

that date, the endorsement of seller-funded downpayment assistance loans decreased rapidly soon thereafter. By the second 

quarter of FY 2009, these loans accounted for less than 1 percent of total endorsements. The steep decline in seller-financed 

downpayment assistance in FY 2009 and later years will have a 

significant effect in reducing losses on future FHA loans. 

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Section IV. Response to the Crisis: FHA Keeps Credit Flowing 

and Helps Distressed Homeowners 

The years since 2000 have been very challenging for the 

Federal Housing Administration (FHA), requiring it to make 

and implement policy decisions in response to rapidly changing market conditions, and more recently to assume a major 

countercyclical role. In the previous section, we saw how FHA 

did not succumb to pressures to compete with the subprime 

sector on product types in a “race to the bottom” that would 

have proved to be very risky for FHA, despite its market share 

dropping to historic lows in the years just before the start of 

the crisis in 2007. Beginning in 2007, FHA began to focus 

on its countercyclical role as conventional credit dramatically 

tightened in response to the rise in delinquencies and foreclosures among subprime mortgages and the drop in home prices. 

Home prices continued falling for 33 consecutive months 

through early 2009, and the FHA played a major part in the 

government’s efforts to slow this trend and stabilize prices (see 

exhibit IV-1). Mark Zandi, chief economist at Moody’s Analytics, offered this assessment of FHA’s role during the crisis. 

The FHA had been virtually dormant during the housing 

bubble, but it made about one-third of all U.S. mortgage 

loans in the period after the bust. Without such credit, 

the housing market would have completely shut down, 

taking the economy with it. The effort took a toll on 

the agency’s finances, but so far the FHA has avoided 

turning to taxpayers for help, making it one of the few 

housing-related enterprises—public or private—that 

have not (Zandi, 2012). 

An important component of FHA’s mission is “...to stabilize 

credit markets in times of economic disruption” (HUD, 2012a). 

During the years leading up to the housing bubble (roughly 

2000–2006), FHA continued to keep its underwriting standards 

and product mix roughly constant. As detailed in this section, 

however, the rest of the market was fueled during this time by 

rising house prices, loose underwriting standards and exotic 

mortgages that proved ultimately to be unsustainable. As a 

result, FHA’s market share and loan volumes declined during 

this period. After the bursting of the housing bubble and the 

collapse of the private-label securities (PLS) sector through which 

many of the exotic mortgages were financed, FHA focused on 

its stabilization role in the credit and housing markets in many 

ways. FHA enabled homeowners with unsustainable conventional 

loans to refinance into more suitable FHA loans, and offered 

sustainable financing for new home purchases. It helped FHA 

borrowers reduce monthly payments with streamlined refinances. 

Exhibit IV-1. Home Prices Peaked in Mid-2006 and Began a 33-Consecutive-Month Decline Through April 2009 

Index Value (Jan 2000 = 100) 

Jan-03

Apr-03

Jul-03

Oct-03Jan-04

Apr-04

Jul-04

Oct-04Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jul-06

Oct-06Jan-07

Apr-07

Jul-07

Oct-07Jan-08

Apr-08

Jul-08

Oct-08Jan-09

Apr-09

Jul-09

Oct-09Jan-10

Apr-10

Jul-10

Oct-10Jan-11

Apr-11

Jul-11

Oct-11Jan-12

Apr-12

Jul-12

210

200

190

180

170

160

150

140

130

S&P/Case-Shiller

Index

Source: Standard & Poor’s 

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FHA also enhanced its loss-mitigation strategies and its retention and nonretention alternatives for distressed borrowers 

facing foreclosures. 

IV-1. Rising Home Prices Minimized 

FHA’s Role 

In the 1990s nonbank mortgage lenders emerged to operate 

without many of the regulations governing traditional banks. 

Many of the new lenders specialized in loans to borrowers 

who could not qualify for traditional mortgages because of 

poor credit or low incomes and supplied/sold the mortgages to 

mortgage-backed security (MBS) issuers.35 The issuers passed 

the risk on to investors around the world who at the time were 

eager to buy MBS carrying higher yields than those offered by 

safer investments such as U.S. Treasury bonds (Knowledge@ 

Wharton, 2007). Following the burst of the dot-com stock 

market bubble in early 2000, U.S. GDP growth began to slow 

and the Federal Reserve began cutting interest rates to stimulate 

the economy. After the terrorist attacks on September 11, 

2001, the Federal Reserve cut interest rates six more times 

between 2001 and 2003 (Federal Reserve Bank of New York, 

2012). Mortgage lending peaked in 2003, driven by a surge in 

refinancing as the Federal Reserve cut interest rates to exceptionally low levels. 

After 2003, home prices rose and private sector underwriting 

standards declined. Exceptionally low rates of returns on savings accounts and stock market decline led many households 

and investors to turn to housing attracted by higher returns 

and low borrowing costs (Zandi, 2012). Low Treasury bond 

yields attracted both domestic and foreign investors to the 

higher yielding agency MBS and PLS. PLS traditionally played 

a very minor role in funding home mortgages, with a market 

share of just more than 2 percent in 1990, yet, at the home 

price peak in 2006, PLS issuers accounted for more than 20 

percent of the home mortgage market (Federal Reserve Board, 

2012a). As demand for mortgaged backed securities grew, 

traditional mortgage originators evolved from underwriters of 

portfolio mortgages to financial intermediaries in an originateto-distribute business model. Without a vested stake in the 

performance of the mortgages the underwriters originated, 

prudent underwriting was subordinated to increasing volume 

and generation of loan processing fees. Similarly, PLS securitizers, driven by fees associated with the securitization and sale of 

PLS put little emphasis on prudent underwriting, which made 

FHA underwriting requirements less attractive and reduced the 

demand for FHA insured loans. 

FHA’s reluctance to relax its underwriting standards and 

expand its product mix resulted in a decline in market 

share at the peak of the housing bubble. FHA’s institutional capacity enabled it to step in when private capital 

withdrew after the bursting of the bubble, however. 

Rising home prices obscured the riskiness of the mortgages 

pooled in PLS or being purchased by the government-sponsored 

enterprises (GSEs) as borrowers extracted equity gains with 

more highly levered affordable payment refinancing (often with 

new introductory teaser rates) or purchased new, second, or 

investment homes (Reeder and Comeau, 2008: 9–11). 

During this period, FHA kept its underwriting standards fairly 

constant which led to a sharp decline in market share of originations as borrowers were attracted to subprime and Alt-A 

mortgage loans with their minimal qualifying requirements and 

documentation standards.36 As underwriting standards continued to be relaxed, exotic mortgages products such as 3-27 and 

2-28 hybrid adjustable-rate mortgages (ARMs), interest-only (IO) 

mortgages, and payment option ARMs with negative amortization features permeated the market posing risks that were 

often poorly understood by borrowers and investors alike.37 

FHA’s reluctance to relax underwriting standards resulted in 

endorsements contracting as housing prices peaked, but FHA 

35 Asset-backed securities vary in type of financial assets that back the securities. ABS differed from agency (Ginnie Mae, Fannie Mae, Freddie Mac) mortgage-backed 

securities in that the types of mortgage collateral backing them were often subprime or low-documentation mortgages that did not conform to agency underwriting 

standards. 

36 At the peak of the bubble in 2004–2006, some private sector underwriters issued SISA (stated-income, stated assets), NINA (no income, no assets), and NINJA 

(no income, no job or assets) mortgages where borrowers did not have to show any proof of the income, assets, or employment that would be used to make their 

monthly mortgage payments. 

37 Alt-A mortgages and payment option-ARMs were originally designed for borrowers who were self-employed and thus were unable to document income from an 

outside employer or who had income that was variable and thus variable payments would enable them to adjust mortgage payments to match seasonal income. The 

products may be useful in such specialized situations, however, during the relaxed underwriting of the past crisis these mortgage products were often used to qualify 

borrowers for a larger, more expensive home than their income could support, an untenable situation that overextended borrowers and put them at risk of losing 

their home. 

Housing Finance Working Paper Series 30 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

retained the institutional capacity necessary to expand and 

provide countercyclical support when private capital withdrew 

from the market. 

At the start of the first decade of the 2000s, FHA originations 

counted for more than 14 percent of mortgaged home purchases; 

by the middle of the decade FHA’s share had fallen to less than 

5 percent before growing to more than 30 percent of mortgaged home purchase originations by the end of the decade.38 

IV-2. The Housing/Economic Contraction: FHA Helps Stop the Downward 

Spiral 

As home prices peaked and began to decline, delinquencies 

increased and lenders withdrew credit from the conventional 

mortgage market in two ways: by lenders tightening underwriting standards and by the closure or bankruptcy of mortgage 

lenders. 

Tightening of underwriting standards by lenders is discussed 

further in this section (see exhibit IV-11, showing the sharp 

increase in the net share of senior loan officers reporting tighter 

underwriting conditions after late 2006). 

Between 2007 and 2010, the Federal Deposit Insurance Corporation was appointed the receiver of 325 failed banks, a 

huge increase from their receivership count of 24 failed banks 

between 2000 and 2004. Fear in financial and housing markets 

reached a crescendo in September 2008 with the bankruptcy 

of Lehman Brothers, the fourth largest U.S. investment bank 

at the time, and the conservatorship of the GSEs, Fannie Mae 

and Freddie Mac, which were precipitated by rising losses on 

mortgage loans as defaults and foreclosures rose to historically 

high levels. Market turmoil and stress were very high as shown 

by the sharp increases in the delinquency and foreclosure levels 

in exhibit IV-2. 

In other words, housing and mortgage markets were in a 

self-perpetuating downward home-price and rising default 

Exhibit IV-2. Market Stress Levels Evidenced by Rapid Rise in Delinquency and Foreclosure 

U.S. First-Lien Mortgage Performance, Percent of Active Loans 

199519961997199819992000200120022003200420052006200720082009201020112012

In foreclosure 

Delinquent 

0

2

4

6

8

10

12

Source: LPS Applied Analytics 

38 Calendar year home purchases by loan count. Source: FHA 

Housing Finance Working Paper Series 31 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

spiral (summarized by exhibit IV-3), which provided the 

impetus for federal actions and policies that were intended 

to break this self-perpetuating spiral. FHA’s countercyclical 

role providing increased mortgage credit flows to counteract 

the overtightening of underwriting standards is a crucial 

component of these federal actions. FHA (and GSE) loan limits 

were temporarily increased by the passage of several pieces of 

legislation during 2008 and 2009 intended to support housing 

and economic recovery (specifically the Emergency Economic 

Stabilization Act [EESA] of 2008, the Housing and Economic 

Recovery Act [HERA] of 2008, and the American Recovery 

and Reinvestment Act [ARRA] of 2009) which extended FHA 

access to more homebuyers and enabled more borrowers in the 

conventional market to use FHA to refinance into lower interest 

rates, reducing monthly payments. In addition to extending 

access to more homebuyers and existing homeowners seeking 

to refinance, FHA was also key in the successful temporary 

surge in homebuying and associated temporary price increase 

(which helped stem the free fall of prices) from the First-Time 

Homebuyer Tax Credit program in 2009 and 2010. Furthermore, FHA improved its loss mitigation policies and strategies 

to assist about 1.4 million distressed homeowners with existing 

FHA mortgages to retain their homes. Finally, FHA took steps 

to shore up its finances and risk management process so that 

it could balance its mission objectives with its requirement to 

operate in an actuarially sound manner. 

Exhibit IV-3: Self-Perpetuating Home Price and Default 

Spiral 

Falling home prices 

Defaults increase 

Fewer new 

homebuyers gain 

approval 

Lower housing demand 

Falling home prices 

Overextended 

homeowners unable 

to refinance 

Defaults increase 

Reduced mortgage credit and 

tightening of underwriting standards 

IV-3. FHA Maintained Access to Credit 

During the Crisis 

The boom and bust in home prices and the ensuing mortgage 

credit crunch highlighted the importance of maintaining access 

to credit for not only homebuyers, but also homesellers. Support for falling home prices requires that sellers be able to find 

buyers who can access credit under reasonable terms. 

The bust also stressed the need to maintain credit with sound, 

but not overly restrictive, underwriting standards. By not 

loosening underwriting standards and by not originating 

unsustainable mortgages such as option ARMs and loans with 

less than full documentation during the runup of the housing 

bubble, FHA played an important role as a standard bearer of 

sound underwriting. Yet, unlike the conventional market, FHA 

did not subsequently severely tighten its underwriting standards after the bubble burst, which could have exacerbated the 

downward spiral in home prices and defaults and reinforced 

the market instability shown in exhibit IV-3. Indeed even as 

credit standards tightened significantly in the conventional 

market each quarter from the first quarter of 2007 through 

the second quarter of 2010, FHA, with modest tightening of 

underwriting requirements was able to play a countercyclical 

role, increasing originations from 528 thousand in 2007 to 

1.98 million in 2009 (Federal Reserve Board, 2012b). 

As noted above, to balance its countercyclical role during the 

crisis with its requirements to remain actuarially sound, FHA 

did take deliberate steps to adjust underwriting standards and 

pricing to reduce its highest risk loans and bolster the adequacy 

of FHA’s Mutual Mortgage Insurance (MMI) Fund and capital 

reserves. The actions taken by FHA to shore up its financial 

condition include the following: 

1. Eliminated high-risk seller-funded downpayment gift loans. 

2. Raised mortgage insurance premiums. 

3. Raised minimum cash contribution from homebuyers from 

3 to 3.5 percent as required by HERA. 

4. Instituted better management practices, including establishment of the Office of Risk Management and more frequent 

reporting to Congress on MMI Fund condition. 

5. Expanded loss mitigation interventions for defaulted borrowers, which in addition to helping borrowers retain their 

homes, also mitigates FHA losses. 

Housing Finance Working Paper Series 32 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

6. Modest tightening of underwriting requirements, including 

establishment of a minimum consumer credit score, 

increased downpayment requirements on certain higher 

risk loans (those with low credit scores), and limiting seller 

contributions to closing costs.39 

Although FHA did take the above steps to improve its financial 

condition, the agency also resisted pressure from critics to 

make substantial increases to downpayment requirements, 

thereby maintaining access to low-downpayment loans when 

others were exiting this segment. 

Exhibit IV-5 (which appears later in this section) provides 

a detailed breakout of the types of loans FHA was insuring 

leading up to the crisis (during fiscal years [FY] 2004 through 

2006) and their cumulative claim (foreclosure) rates, which provide a partial measure of the relative performance of each group 

of loans insured. Exhibit IV-6 (which follows exhibit IV-5) 

shows a detailed breakout similar to that in exhibit IV-5 but 

showing FHA’s response to the crisis in FY 2007 through 2009. 

The tables clearly show the volumes of poor-performing loans 

with high-risk downpayment gifts that FHA had been trying 

to end declined rapidly after the legislative relief of 2008, and 

volume of new home purchase business, conventional-to-FHA 

refinances, and FHA-to-FHA refinances rose rapidly after 2006. 

FHA Enabled Refinances 

Not widely known is the fact that FHA provided support for 

the refinance segment of the housing market during the crisis. 

Beginning in 2007, FHA stepped in to enable growing numbers 

of homeowners facing large interest rate resets from expiring 

teaser rates on conventional ARMs to avoid large payment shocks. 

These conventional-to-FHA “product refinances” helped 

hundreds of thousands of borrowers who met FHA’s standard 

underwriting criteria to convert conventional mortgages facing 

(or which already had received) monthly payment increases 

into far more sustainable FHA loans. Cagan (2007), who 

examined more than 8 million conventional ARMs originated 

between 2004 and 2006, found that given interest rate levels 

prevailing as of the time of his analysis, 39 percent would face a 

payment increase of between 25 and 50 percent on initial reset, 

10 percent would face a payment increase of 51 to 99 percent, 

and 15 percent would face a payment increase of 100 percent 

or more (Cagan, 2007). If the borrower had sufficient equity 

and credit quality to qualify for an FHA loan, he/she could have 

refinanced into a fixed-rate FHA loan at a much lower payment 

than the fully indexed ARM rate. This advantage was somewhat 

negated after 2007 as policies by the Federal Reserve and other 

factors brought mortgage rates down to historic lows, reducing 

the potential for large payment shocks for conventional ARMs. 

Nevertheless, during 2007-2009 in particular, conventional-toFHA refinance volumes rose rapidly. Because these loans were 

fully underwritten to FHA standards, their early performance 

has not been materially different than FHA’s other fully underwritten loans in the same years (see exhibits IV-5 and IV-6 later 

in this section). 

The FHA’s countercyclical support enabled borrowers 

with unsustainable conventional mortgages to refinance 

into fixed-rate FHA mortgages. 

In addition to providing help to homeowners with unsustainable 

conventional loans, FHA also enabled borrowers with existing 

FHA loans to refinance through its streamlined FHA-to-FHA 

refinance programs. Streamline refinancing, which was an 

option for FHA borrowers that existed before the crisis, became 

increasingly important during the crisis as a way for FHA borrowers who might not otherwise qualify to take advantage of 

lower interest rates to reduce monthly payment burdens. The 

idea underlying a streamline refinance is that FHA, which already held the default risk on the loan, would not be taking on 

new risk if it insured a rate or term refinance of the loan (with 

no cash out other than to cover closing costs), even if the loan 

were underwater, or if the borrower’s credit history had deteriorated. A rate or term refinance involves either a reduction in 

the mortgage rate (to reduce monthly payment) or a change of 

the loan term (for example, from 30-year to 15-year—provided 

the new monthly payment does not exceed previous monthly 

payment) without the borrower taking any cash away from the 

39 Mortgagee Letter 10-29 restricted maximum financing to borrowers with a credit score of 580 or higher, maximum financing equal to 90 percent loan-to-value 

ratio for borrowers with a credit score of 500 to 579, and made borrowers with a credit score below 500 ineligible for FHA insurance. According to Fair Isaac, from 

2005 to 2011 Americans with credit scores of less than 500 represented 6.3 to 7.3 percent of the U.S. population. Thus, after tightening its underwriting guidelines, 

FHA financing remained available for approximately 93 percent of the U.S. population. Mortgagee Letter 10-29 reaffirmed that applicants with nontraditional 

credit history or insufficient credit (either of which could cause the applicant to have no credit score available) remain eligible for maximum financing if they meet 

the underwriting guidance in HUD Handbook 4155.1 4.C.3. Mortgagee letters can be accessed at http://portal.hud.gov/hudportal/HUD?src=/program_offices/ 

administration/hudclips/letters/mortgagee. 

Housing Finance Working Paper Series 33 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

transaction. As such, the original loan would not be required 

to be reunderwritten to approve the new streamline refinance 

loan.40 

As explained previously, FHA’s enabling of refinances was pivotal in arresting the self-perpetuating home price and default 

spiral shown in exhibit IV-3. The volumes of conventionalto-FHA refinances ranged from a low of 33,581 in 2005 and 

increased in each of the next 4 years, reaching 468,644 refinances in 2009.41 FHA-to-FHA refinances, including streamline 

refinances, also increased during this period from 124,902 in 

2005 to 367,802 in 2009. 

Although overall market origination volumes declined in 

2007 and 2008, the total number of FHA originations increased 

by more than 29 percent in 2007 and 166 percent in 2008. 

Exhibit IV-4 shows FHA quarterly market shares (in terms of 

loan count) and clearly shows the ramping up of FHA market 

shares for both purchase and refinance mortgages, with FHA 

purchase loan shares being especially high after 2007 compared 

with the years preceding the peak of home prices. The graph 

also shows that FHA’s market share of refinances increased 

sharply after Q3 2007, reflecting the ramp up in conventionalto-FHA refinances that FHA offered in its countercyclical role. 

As noted previously, in “normal” times, borrowers prefer conventional refinances but because conventional refinances were 

not available to many borrowers owing to tight underwriting 

standards, these borrowers turned to FHA refinances. 

FHA Enabled Home Purchases 

As discussed above, FHA maintained its traditional role of 

helping finance home purchases, especially to first-time homebuyers. Home Mortgage Disclosure Act (HMDA) data show 

that with the decline in home purchase demand from 2005 

to 2011 (with 2011 home purchase lending being 67 percent 

below 2005 levels; see Avery et al., 2012), the count of HMDA 

reporting institutions also declined such that in 2011 there 

were fewer reporting institutions than in any of the previous 

10 years. This decline, along with the tighter underwriting 

conditions (explained subsequently in this section) meant that 

many households were unable to qualify for conventional home 

purchase loans. As a result, FHA home purchase share rose 

dramatically as shown in exhibit IV-4. 

Exhibit IV-4. FHA Is Known To Have Ramped Up Its Support for Home Purchases; Less Well Known Is Its Support 

for Refinances During Crisis 

FHA as Share of Quarterly Mortgage Originations by Type (percent) 

45 

40 

35 

30 

25 

20 

15
 

10
 

5 

0 

Purchase 

2003 Q1 2003 Q3 2004 Q1 2004 Q3 2005 Q1 2005 Q3 2006 Q1 2006 Q3 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3 2011 Q1 2011 Q3 2012 Q1 

Refinance Combined 

Sources: Mortgage Bankers Association and U.S. Department of Housing and Urban Development 

40 In some streamline refinance cases for which financed closing costs bring the new loan balance above a stated threshold (with no other cash out), a new appraisal 

would be required. Thus, exhibits IV-6 and IV-7 (which appear later in this section) show breakouts for streamline refinances with or without new appraisals. In 

either case, new mortgage credit underwriting is not involved. 

41 To date, these conventional to FHA refinances over the period from 2007 to 2009 have performed better than standard and streamline FHA refinances. 

Housing Finance Working Paper Series 34 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Several laws temporarily expanded FHA loan limits 

along with those of the GSEs up to a high cost ceiling of 

$729,750. In October 2011, the high cost ceiling was 

rolled back to $625,500, but in November 2011, the 

FHA ceiling was restored to $729,750, making it higher 

than that of the GSEs. 

The increase in FHA’s home purchase market starting in 2008 

is due both to the withdrawal of private credit and to the 

increase in FHA’s loan limits. Loan limits have risen rapidly in 

recent years: in 2006, FHA could insure loans up to $200,160 

in all markets and up to $363,790 in high-cost markets. Several 

laws addressing economic recovery (EESA, HERA, and ARRA) 

temporarily expanded FHA loan limits along with those of the 

GSEs based on percentages of local median home price up to 

a high cost ceiling of $729,750. In October 2011, the high 

cost ceiling was rolled back to $625,500, but in November 

2011, FHA ceiling was restored to $729,750, making it higher 

than that of the GSEs. Thus, in 2012 FHA can insure loans up 

to $271,050 in all markets and up to $729,750 in high-cost 

areas whereas the GSEs are now limited to $417,000 in most 

markets and $625,500 in high-cost areas. HERA also directed 

the Federal Housing Finance Agency to move the GSEs to a 

county-based system of loan limits like FHA while raising the 

standard (outside areas at the floor or ceiling) from 95 percent 

of median house prices to 115 percent. Thus, starting in 2008 

FHA began insuring single-family mortgages of up to $729,750 

and supporting broader segments of the housing market (including jumbo conforming) and reminiscent of the early days 

of FHA in the midst of the Great Depression when the loan 

limit was set at $16,000 at a time when average the home price 

was in the neighborhood of $5,000.42 

With this raising of loan limits, a greater percentage of FHA 

loans endorsed since 2007 have been above the 2007 loan 

limits—that is, in the “jumbo conforming space.” For instance, 

whereas 7.7 percent of FHA’s endorsements in 2008 were 

above the old 2007 limits, this share increased to 12.8 percent 

in 2009 and 14.0 percent in 2011. Increased loan limits at 

a time of falling house prices has meant that FHA’s market 

share of originations had increased to 29.8 percent of purchase 

originations in 2011:43 a measure perhaps of the countercyclical 

role that it has played in the ongoing housing crisis. 

Exhibits IV-5 and IV-6 are illustrative of FHA’s ability to 

respond to the market in a relatively short time with the help 

of Congress. Exhibit IV-5 shows that going into the crisis FHA 

was at low volumes, and had large portions of its business 

in high-risk downpayment gift loans that were performing 

very poorly. Exhibit IV-6, however, shows that after the crisis 

began, FHA succeeded in eliminating the high-risk gift loans, 

increased its overall volume (purchase and refinance), and 

enabled product refinances (conventional to FHA) with the 

latter performing no worse than FHA’s ordinary refinance 

business. This illustration provides another example of FHA’s 

ability to address market challenges, which was also discussed 

in a historical context in section III. 

FHA Helps Homeowners Keep Their Homes 

Although FHA’s expansion of mortgage credit was critical to 

housing markets, the FHA’s support for the market extends 

beyond extension of credit to new FHA loans: FHA is the direct 

policy lever available to policymakers and has been used to 

test out policy programs to address the crisis. Although not 

as widely recognized as the U.S. Treasury’s Home Affordable 

Modification Program (HAMP) for conventional loans, FHA has 

actually extended loss mitigation aid to more than 1.4 million 

distressed homeowners with existing FHA loans since the 

second quarter of 2009 (see exhibit IV-7). 

FHA’s loss mitigation actions include, amongst other actions, 

the FHA Home Affordable Modification Program (FHAHAMP), which is not to be confused with the Treasury’s HAMP 

for conventional loans. FHA-HAMP is available to existing 

FHA-insured borrowers who meet eligibility requirements 

to avoid foreclosure by permanently reducing their monthly 

mortgage payment through the use of a partial claim, which 

in effect writes down the principal on the first lien, and 

establishes a silent second lien for the amount of the partial 

claim. The Helping Families Save Their Homes Act of 2009 

provided FHA the authority to pay a partial claim of up to 30 

percent of the unpaid principal balance as of the date of default 

in combination with a loan modification. In addition to FHAHAMP, FHA has encouraged its approved servicing lenders to 

make greater use of its existing loss mitigation programs, which 

have ramped up in volume considerably since the crisis. These 

42 On November 18, 2011, President Obama signed into law the Consolidated and Further Continuing Appropriations Act, PL-112-55, which extended FHA’s 

authorization to insure loans of up to $271,050 in all markets and up to $729,750 in high-cost areas through December 31, 2013. 

43 See exhibit IV-11. 

Housing Finance Working Paper Series 35 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Table IV-5. FHA Single-Family Insurance Program: Entering the Crisis

FHA Had Low Volumes and Was Seeking To Stop Insuring Purchase Loans With High-Risk, Seller-Funded Downpayment Assistance (Gifts From Nonprofits), 

Data as of July 2012

FY 2004 FY 2005 FY 2006

Type of 

FHA Mortgage

Downpayment 

Gift Source

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date

(percent)

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date 

(percent)

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date 

(percent)

First-time buyer No gift 234,430 24.4 6.8 127,744 24.9 9.1 113,220 26.6 10.6

Nonprofit/government 128,571 13.4 19.4 96,507 18.8 21.4 85,435 20.1 21.7

Relative/employer 91,241 9.5 8.6 55,831 10.9 11.3 50,229 11.8 12.6

Subtotal 454,242 47.3 10.7 280,082 54.7 13.8 248,884 58.5 14.8

Other home purchase No gift 81,911 8.5 5.7 43,643 8.5 8.0 39,803 9.4 10.0

Nonprofit/government 31,517 3.3 15.6 20,998 4.1 17.6 17,895 4.2 18.7

Relative/employer 18,440 1.9 8.4 9,121 1.8 10.4 7,416 1.7 12.8

Subtotal 131,868 13.7 8.4 73,762 14.4 11.0 65,114 15.3 12.7

Conventional-to-FHA No gift 56,351 5.9 6.6 33,247 6.5 8.5 60,114 14.1 11.3

refinance* Nonprofit/government 138 0.0 41.3 164 0.0 29.3 99 0.0 25.5

Relative/employer 206 0.0 13.1 170 0.0 18.8 184 0.0 12.5

Subtotal 56,695 5.9 6.7 33,581 6.6 8.7 60,397 14.2 11.3

FHA-to-FHA refinance No gift 26,104 2.7 4.4 11,825 2.3 6.9 14,696 3.5 12.2

(nonstreamline)* Nonprofit/government 1 0.0 0.0 0 0.0 0.0 2 0.0 50.0

Relative/employer 41 0.0 0.0 15 0.0 0.0 24 0.0 12.5

Subtotal 26,146 2.7 4.4 11,840 2.3 6.8 14,722 3.5 12.2

Streamline refinance N/A 221,275 23.0 5.5 90,663 17.7 8.0 26,014 6.1 9.7

(no appriasal) N/A 70,208 7.3 7.8 22,399 4.4 12.3 10,360 2.4 14.8

Streamline refinance Subtotal 291,483 30.3 6.0 113,062 22.1 8.9 36,374 8.5 11.2

(with appriasal)

Total insured cases 960,434 100.0 8.6 512,327 100.0 11.8 425,491 100.0 13.6

* Some nonstreamiline refinances require a cash contribution to pay closing costs, buy out the ownership interest of another party (such as a divorce situation), or pay off the old first- and second-lien mortgage balances, which 

may come from a gift.

Note: Fiscal years begin on October 1 of previous calendar year and run through September 30.

Source: U.S. Department of Housing and Urban Development

Housing Finance Working Paper Series 36
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Table IV-6. FHA Single-Family Insurance Program: Response to the Crisis

FHA Volume Rises (Countercyclical Role), High-Risk Loans With Nonprofit Gifts Become Ineligible in 2008, and Homeowners Refinance out of High-Risk Conventional 

Loan Products Into FHA, Data as of July 2012

FY 2007 FY 2008 FY 2009

Type of 

FHA Mortgage

Downpayment Gift 

Source

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date

(percent)

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date 

(percent)

Total 

Insured 

Case Count

Percent of 

FY Insured 

Cases

Claim 

Rate to 

Date 

(percent)

First-time buyer No gift 98,302 23.1 10.1 240,999 22.2 5.7 548,034 29.9 1.7

Nonprofit/government 81,495 19.2 19.6 170,575 15.7 12.2 45,773 2.5 7.1

Relative/employer 41,673 9.8 11.8 80,711 7.4 7.0 187,872 10.3 2.2

Subtotal 221,470 52.1 13.9 492,285 45.3 8.2 781,679 42.7 2.2

Other home purchase No gift 33,995 8.0 8.7 87,474 8.0 5.7 174,202 9.5 1.9

Nonprofit/government 16,534 3.9 18.2 37,142 3.4 11.7 9,916 0.5 7.8

Relative/employer 6,395 1.5 12.1 14,753 1.4 7.3 29,754 1.6 2.4

Subtotal 56,924 13.4 11.8 139,369 12.8 7.4 213,872 11.7 2.3

Conventional-to-FHA No gift 107,403 25.3 11.1 356,512 32.8 8.2 466,590 25.5 2.9

refinance* Nonprofit/government 60 0.0 0.0 54 0.0 16.7 24 0.0 4.2

Relative/employer 276 0.1 15.9 914 0.1 11.5 2,030 0.1 3.7

Subtotal 107,739 25.4 11.1 357,480 32.9 8.2 468,644 25.6 2.9

FHA-to-FHA refinance No gift 16,483 3.9 11.5 31,438 2.9 7.4 38,231 2.1 3.0

(Nonstreamline)* Nonprofit/government 0 0.0 28.6 3 0.0 0.0 1 0.0 0.0

Relative/employer 21 0.0 0.0 45 0.0 16.7 133 0.0 2.3

Subtotal 16,504 3.9 11.5 31,486 2.9 7.4 38,365 2.1 3.0

Streamline refinance N/A 14,905 3.5 12.5 51,482 4.7 10.9 280,265 15.3 5.1

(no appriasal) N/A 7,182 1.7 14.4 15,290 1.4 10.2 49,172 2.7 4.1

Streamline refinance Subtotal 22,087 5.2 13.1 66,772 6.1 10.7 329,437 18.0 5.0

(with appriasal)

Total insured cases 424,724 100.0 12.8 1,087,392 100.0 8.2 1,831,997 100.0 2.9

* Some nonstreamiline refinances require a cash contribution to pay closing costs, buy out the ownership interest of another party (such as a divorce situation), or pay off the old first- and second-lien mortgage balances, which 

may come from a gift.

Note: Fiscal years begin on October 1 of previous calendar year and run through September 30.

Source: U.S. Department of Housing and Urban Development

Housing Finance Working Paper Series 37
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit IV-7. FHA Has Role in Helping Distressed Homeowners 

Cumulative Mortgages Receiving Aid Since April 1, 2009 (millions) 

Apr-09 

Jun-09 

Aug-09 

Oct-09 

Dec-09 

Feb-10 

Apr-10 

Jun-10 

Aug-10 

Oct-10 

Dec-10 

Feb-11 

Apr-11 

Jun-11 

Aug-11 

Oct-11 

Dec-11 

Feb-12 

Apr-12 

Jun-12 

0 

1 

2 

3 

FHA loss mitigation HAMP modifications 

Note: Data exclude trial modifications. 


Sources: U.S. Department of the Treasury and U.S. Department of Housing and Urban Development
 

loss-mitigation programs include special forbearance, partial 

claim (intended to bring loan arrearages current and limited to 

1 year of principal and interest payments), and loan modifica

tions (non-HAMP).44 

A promising recent FHA initiative is the expanded use of dis

tressed note sales through FHA’s Distressed Asset Sales Program 

beginning in 2010. This initiative includes a new pilot started 

in 2012, the Neighborhood Stabilization Loan Sales initiative, for 

which Departmental policies around future sales are still being 

refined. Under FHA’s distressed asset sale programs, seriously 

delinquent loans (notes) are sold competitively to investors (ei

ther for-profit or nonprofit) at a market-determined price gen

erally below the outstanding principal balance. FHA processes 

an insurance claim, removes the FHA insurance, and transfers 

the note to the investor. For some note sales, the investors are 

not restricted in how they resolve the loan default. In others, 

including the Neighborhood Stabilization initiative, restrictions 

are placed on the investor. Restrictions, when applied, gener

ally have included a prohibition on starting foreclosure on any 

properties for a minimum of 6 months, giving the new loan 

servicer time to work through loan retention options. Because 

the loans are sold for less than the unpaid balance, the investor 

has the ability to reduce the loan principal, or otherwise modify 

the loan terms while still being able to earn a reasonable return 

on the initial investment. The Neighborhood Stabilization Loan 

­

­

­

­

­

Sales initiative is designed to help stem the flow of distressed 

properties hitting distressed markets and therefore requires 

that no more than 50 percent of the loans in the pool be sold 

as vacant REO properties, which provides an incentive for the 

investor to offer some REO properties in the pool for rent when 

home retention was not possible. 

FHA Disproportionately Serves Racial and Ethnic 

Minority Borrowers 

Historically, FHA endorsements have been provided to minority 

and low-income households that struggled to secure conventional market financing. At the home price peak in 2006, many 

subprime lenders targeted racial and ethnic minority communities and, accordingly, FHA’s minority market share declined. 

As home prices declined and defaults rose, however, FHA reemerged as a critical source of financing for minorities seeking 

homeownership. As shown graphically in exhibit III-4, and with 

additional detail in exhibit IV-8, FHA’s 2006 home purchase 

market share was 5.3 percent overall and among Black and His

panic borrowers was 8.0 percent, and 5.1 percent, respectively. 

In 2009, FHA’s home purchase market share overall reached a 

high of 37.3 percent and in 2010 FHA’s home purchase market 

share to Black and Hispanic borrowers, reached 59.6 and 59.3 

percent, respectively. Although minority households were dis 

proportionately hurt by the foreclosure crisis and minority 

­

­

44 In addition to the listed loss mitigation programs which help FHA borrowers remain in their homes, FHA also has other loss mitigation programs—preforeclosure 

sale, and deed-in-lieu of foreclosure—which help borrowers who are unable to retain their homes through one of the other options. 

Housing Finance Working Paper Series 38 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

 

 

Exhibit IV-8. FHA Home Purchase Mortgage Originations as Share of All Home Purchase Originations by Race/Ethnicity 

Year 

Count Percent 

Black Hispanic Black Hispanic Total 

2011 64,658 117,402 53.5 54.0 30.7 

2010 83,743 134,745 59.6 59.3 36.2 

2009 87,203 145,337 58.8 58.4 37.3 

2008 83,846 107,857 46.2 39.7 25.5 

2007 40,113 36,084 13.5 8.8 7.0 

2006 35,648 35,155 8.0 5.1 5.3 

homeownership rates declined, the losses would have been far 

worse without the support provided by the FHA through its 

home purchase, refinance, loss mitigation, and other activities. 

Since 2009 to date, nearly 60 percent of homes purchased by Black and Hispanic buyers were financed with 

FHA loans. 

FHA Kept Low-Downpayment Loans Available 

FHA has also traditionally played a large role in low-downpayment, 

high loan-to-value ratio (LTV) mortgage lending for home purchases. As house prices declined and mortgage losses rose, FHA 

was pressured to restrict low downpayment homeownership 

programs. The FHA resisted this pressure and continued to 

provide support for qualified creditworthy households seeking 

homeownership but lacking the significant assets often required for downpayments on conventional loans. Whereas the 

FHA chose to maintain its low downpayment loan programs 

for creditworthy borrowers, it sought to shore up its finances 

and to protect the MMI Fund by adjusting mortgage insurance premiums and downpayment requirements for higher 

risk, low-FICO borrowers. Mortgagee Letter 10-29 restricted 

maximum financing to borrowers with a credit score of 580 or 

higher, maximum financing equal to 90 percent LTV for borrowers with a credit score of 500 to 579, and made borrowers 

with a credit score below 500 ineligible for FHA insurance.45 

Exhibit IV-9 shows that leading up to the home price peak, 

FHA’s market share of borrowers making a downpayment of 

4 percent or less declined from 71 percent in 2001 to 26 percent in 2007. Yet by 2009 at the height of the credit contraction, 

the FHA endorsed nearly 79 percent of mortgage loans with 

a downpayment of 4 percent or less. The graph also shows 

that FHA’s support for the market was not limited to lowdownpayment borrowers as FHA’s purchase share of the formerly prime 5- to 19-percent downpayment market segments 

were also more than 50 percent in 2009 and 2010. Without 

FHA’s continued commitment to low-downpayment home 

purchase lending, the pool of qualified borrowers would have 

shrunk, further reducing demand for homes, further depressing 

home prices, and putting additional stress on housing markets 

nationwide. 

Without FHA’s continued commitment to low-downpayment 

home purchase lending, the pool of qualified borrowers 

would have shrunk, further reducing demand for homes. 

FHA’s Role in Recent Years 

During 2004–2007, the PLS sector of the market grew in share 

and became the preferred conduit for securitizing loans made 

to “weak borrowers” or those with lower FICO, high LTV and 

additional risk layers, such as IO and low or no documentation. 

These years saw the proliferation of subprime and Alt-A loans. 

Exhibit IV-10 (taken from Goodman et al., 2012) shows the 

“loosening” of underwriting standards between 2004 and 2007 

and the subsequent tightening of these underwriting standards 

in the market.46 Between 2004 and 2007, whereas underwriting 

standards loosened considerably in the PLS sector, they loosened only slightly in FHA/U.S. Department of Veterans Affairs 

(VA) or in the GSE space. Exhibit IV-11 shows the origination 

volume by year, holder of risk and key loan characteristics. 

45 http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/letters/mortgagee. 

46 In exhibit IV-11, tighter standards are associated with higher average origination FICO credit scores, lower average LTV ratios, lower share of originations with 

ARMs, and lower share of originations with IO features. 

Housing Finance Working Paper Series 39 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit IV-9. FHA Purchase Origination Market Share by Downpayment Percentage and Vintage Year 

Percent of Market Originations in Category 

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 

60 

50 

40 

30 

20 

10 

0 

70 

80 

90 

4 or less 5–9 10–14 15–19 20–24 25–30 

Source: LPS Applied Analytics 

In additional to the individual risk characteristics such as 

those illustrated in exhibit IV-11, another symptom of loose 

underwriting is the layering of risk. For instance, many loan 

products originated during the housing bubble had multiple 

risk features: many borrowers obtained low/no documentation 

loans that also had high LTVs or second liens attached. Other 

risk layering features included the presence of IO options 

wherein the loan is essentially nonamortizing and the most 

risky of these loan products were the IO ARMs with a short 

initial period of 2 or three years after which interest rates rose 

sharply. Note that exhibit IV-10 does not reflect the favorable 

pricing in the nonagency sector for risk-layered loans (including low/no documentation, Alt A and stated income/stated 

assets) which were the mainstay of the PLS sector. The PLS 

sector priced these risk-layered loans very favorably and such 

loans proliferated during the peak of the housing bubble. 

Underwriting standards remained roughly constant in 

FHA/VA/USDA programs through the housing boom and 

the bust unlike the pro-cyclical trend in the PLS market. 

With the collapse of the PLS sector, some of these risk-layered 

loans did make their way into the GSEs in 2007 but this trend 

was reversed by the tightening of underwriting standards at the 

GSEs: origination FICOs dipped for the GSEs and originating 

LTVs inched up (the origination LTV at FHA/VA actually 

dipped and origination FICOs declined in 2007). The share of 

Refinances increased sharply in 2007 as some of the borrowers 

of these risk-layered PLS loans sought refinances into loans 

with the FHA/VA and the GSEs. This increase in FHA refinance 

share is evident in exhibit IV-5 under “Conventional to FHA 

Refinances” and represents one of the countercyclical roles 

played by FHA (and the GSEs) during the credit crisis—that 

is, product refinances which typically benefited consumers 

who were faced with large rate resets after the expiration of 

teaser rates. Through most of 2007, as the PLS sector dried 

up in terms of market share, it was the GSEs that gained most 

of the market share. By the end of 2007, however, the GSEs 

had tightened their credit underwriting requirements after 

realizing that their gain in market share was coming in the 

form of risk layered loans that would ultimately have higher 

loss severity. Thus, from 2008 onwards, the Ginnie Mae (that 

is combined FHA/VA/U.S. Department of Agriculture) share 

Housing Finance Working Paper Series 40 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit IV-10. Origination Volumes by Year, Holder of Risk, and Selected Loan Characteristics

Issue Balance ($ M) Orig. FICO Orig. LTV

Year Portfolio FHA/VA PLS FHLMC FNMA Portfolio FHA/VA PLS FHLMC FNMA Portfolio FHA/VA PLS FHLMC FNMA

2001 8,027 237,472 237,663 140,193 195,791 698 656 690 714 708 73.7 95.7 73.6 74 74.3

2002 17,476 258,643 351,107 350,103 483,890 722 655 690 721 715 68.3 95.8 72.6 70.8 71.5

2003 55,387 315,345 545,060 679,158 1,139,018 729 658 686 730 723 68.5 95 73.3 68.1 68.4

2004 70,613 174,183 809,647 349,172 510,354 725 650 677 721 718 72.2 95.8 76.6 71.2 71.2

2005 117,146 126,043 1,101,897 373,965 483,878 725 653 680 725 721 72.9 96 77 71.5 71.7

2006 183,366 112,430 1,000,064 346,611 468,775 720 654 679 725 720 73.6 96.1 77.7 72.6 72.9

2007 218,094 136,728 357,809 427,708 606,776 720 643 703 723 718 75 95.3 75.5 74.3 75.2

2008 105,208 380,911 1,352 339,015 530,635 741 667 736 740 737 70 95.3 71.3 71.4 72.3

2009 56,206 603,455 362 458,641 774,847 753 696 764 761 756 67.3 95.6 56.1 67.1 67.4

2010 74,407 484,259 414 372,725 594,935 765 707 773 760 762 65.4 95.6 58.9 69.5 68.4

2011 76,519 359,915 836 297,591 550,008 766 709 770 761 761 66.3 95.1 64 69.9 69.4

Issue % Refi % ARM % IO

Year Portfolio FHA/VA PLS FHLMC FNMA Portfolio FHA/VA PLS FHLMC FNMA Portfolio FHA/VA PLS FHLMC FNMA

2001 67 25 64 63.8 63.3 29 3.4 37 5.9 5.1 2.8 0.1 4 0 0.1

2002 70.6 32.5 68 74.6 70.1 28.5 7.2 49 8.4 9.5 1.8 0.1 12 0 0.4

2003 70 49.4 68 81.3 78.1 30.9 5.7 55 7.6 10.2 6.8 0 17 0 1

2004 46.3 35 55 60.4 58.2 59.1 11.9 73 14.4 21.9 27.9 0 32 0.2 5.1

2005 44.2 31 52 56 54.2 63.3 7.2 73 16.2 22 36.6 0 38 7 10.3

2006 46.5 30.6 54 47.2 49.1 33 3.2 68 19.9 16.7 26.3 0.1 34 16.6 15.7

2007 48.6 36.6 60 51.3 50.6 34.9 2 57 18.1 10.3 30 0.6 45 22.6 15

2008 57.2 39.5 56 59.1 58.8 44.3 2.1 63 8.6 7.9 26.1 0 60 7.1 5.5

2009 65.8 47.7 80 80.2 77.5 34 2.3 87 0.8 2.9 18.6 0 69 0.2 0.9

2010 73.1 42.4 64 78.9 77.2 27.4 6.2 17 4.4 6.3 8.9 0 17 0.4 1.3

2011 68.5 41.5 55 78.4 76.5 26.8 8.2 14 8.6 6.6 10.7 0 14 0.1 0.7

41

Source: Case-Shiller®, 1010 data, Amherst Securities as reported in Amherst Mortgage Insight, May 30, 2012

Housing Finance Working Paper Series
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

Exhibit IV-11. Senior Loan Officers Reporting Tighter Underwriting Conditions 

Net Change in Percent 

1990 Q31991 Q31992 Q31993 Q31994 Q3 1995 Q3 1996 Q3 1997 Q3 1998 Q3 1999 Q3 2000 Q3 2001 Q3 2002 Q3 2003 Q3 2004 Q3 2005 Q3 2006 Q3 2007 Q3 2008 Q32009 Q3 2010 Q32011 Q3 

– 10 

– 20 

0 

10 

20 

30 

40 

50 

60 

70 

80 

All mortgages Prime mortgages only 

Source: Federal Reserve Board 

of market securitization rose from 4.7 percent of originations 

to 19.6 percent in 2008 to 21.8 percent in 2011. As noted in 

the May 30, 2012 Amherst Mortgage Insight, “However, in 

government lending programs, lending standards remained 

roughly constant, and much more activity has gravitated to 

these programs” (Goodman et al. 2012: 4). 

These lending standards were consciously kept at a nearconstant level to serve the market even in times of market 

turmoil and were crucial to the countercyclical role played 

by the government agencies. Another critical component that 

helped this role was the raising of the conforming loan limit in 

2008 for FHA and GSEs, as noted previously in this section. 

Tighter Credit Underwriting After 2008 

As seen in exhibit IV-10, originating FICOs have been rising 

for all sectors after 2008 with the originating LTVs falling for 

the GSEs and portfolio loans indicating the tightening of their 

underwriting. Through these years, the originating LTV for 

FHA/VA stayed steady in the 95-percent range indicating that 

it has now effectively become the sole source of high LTV loans 

and for borrowers with low credit scores. 

This tightening of credit standards is evident in other data as 

well. The Federal Reserve survey of senior loan officers shows 

that banks tightened underwriting standards every quarter 

from late 2006 through mid-2010 with very little easing since 

then. Exhibit IV-10 shows the dramatic tightening of credit 

in 2007 and 2008, which peaked with 74 percent of senior 

loan officers reporting tighter underwriting conditions on 

prime mortgages.47 Although underwriting conditions have 

not become tighter since then, they nevertheless remain tight: 

The July 2012 survey reports that “lending standards for most 

categories of loans remained at least somewhat tighter, on balance, than the middle of their respective ranges since 2005.”48 

Thus, in 2012, the housing market is faced with historically 

low interest rates and high housing affordability (as measured 

47 The “net change” represented in exhibit IV-11 is the fraction of banks that tightened standards minus the fraction that reported having eased standards. Thus, 

negative net changes imply that more banks reported having eased standards than tightened standards. 

48 The July 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices, accessed on 9/28/2012 from http://www.federalreserve.gov/boarddocs/snloansurvey/ 

201208/fullreport.pdf, p.7: “With respect to loans to households, a majority of the banks reported that lending standards for all five categories of residential mortgage 

loans included in the survey (prime conforming mortgages, prime jumbo mortgages, subprime mortgages, nontraditional mortgages, and HELOCs) were at least 

somewhat tighter than the middle of the range that those standards have occupied since 2005, whereas smaller but still significant fractions of domestic banks also 

reported that standards were tighter than the midpoint for prime credit card, subprime credit card, auto, and other consumer loans.” 

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The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

by the NAR’s housing affordability index) and yet remains 

anemic as evidenced by housing market activity (sales and 

prices). Policymakers and legislators are faced with the daunting task of healing housing markets while reforming them. The 

White Paper on Reforming America’s Housing Finance Market 

that was released by Treasury and the U.S. Department of 

Housing and Urban Development in February 2011 endorsed 

“returning FHA to its traditional role as targeted lender of 

affordable mortgages” (U.S. Treasury and HUD, 2011: 14). The 

White Paper recommends “a reformed and strengthened FHA” 

that will ensure that “creditworthy first-time home borrowers 

and families with modest income can access a mortgage” (U.S. 

Treasury and HUD, 2011: 19). 

Finally, any discussion of FHA’s countercyclical role during 

the current crisis should consider the costs incurred by FHA 

in performing this role. Loans FHA insured during the 2005 to 

2009 period are likely to suffer the most (in terms of lifetime 

performance) from the recent national housing recession. 

These loan vintages contained high shares of seller-funded 

downpayment gifts, which historically have performed 

much worse than other FHA loans. These vintages also were 

underwritten when home prices were near or at their peak in 

mid-2006, with the subsequent 33-consecutive-month declines 

in national price levels creating the most potential for negative equity. FHA’s relatively low market shares during these 

high-loss boom years, however, has helped mitigate the effect 

of these loan vintages on FHA. In certain states like California, 

for which falling home prices were especially severe, FHA had 

even more limited exposure because of lower precrisis loan limits that restricted origination volumes. In addition to precrisis 

loan vintages, the surviving FHA mortgages originated between 

2009 and 2012 will enter their peak default periods during 

2013 through 2017. As FHA stepped up its countercyclical 

role, and the relatively high volumes of FHA originations in the 

2009-2012 period, which has resulted in about 78 percent of 

the entire MMI Fund concentrated in mortgages in these loan 

vintages as of 2012, the MMI Fund is expected to realize high 

claim losses in the next several years. 

Housing Finance Working Paper Series 43 
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Appendix. Key Questions on Future Role of FHA
 

The authors hope that this paper serves as a useful foundation 

for considering the Federal Housing Administration’s (FHA’s) 

future role in housing finance as both institutional and regulatory reforms are debated. FHA’s history has shown that the 

public policy debate after FHA’s financial crisis of the 1980s 

was driven by balancing the dual objectives of carrying out 

FHA’s purpose and mission and maintaining and improving 

its financial soundness. In the current environment, FHA is 

still engaged in helping to mend the ailing housing market. 

Looking forward to a time when that objective will have been 

substantially accomplished, numerous policy questions remain 

to be addressed. Some questions involve balancing the costs 

and benefits of FHA assuming a countercyclical role when 

future market distress may occur at the same time it is meeting 

the other aspects of its mission. This and other questions 

about FHA’s institutional role are integral to the policy debate 

framed by the White Paper on Reforming America’s Housing 

Finance Market that was jointly released by the Departments 

of Treasury and Housing and Urban Development in February 

2011 (U.S. Treasury and HUD, 2011). 

FHA is a valuable direct policy lever and has been used to 

address credit market imperfections, market failures and 

to provide countercyclical support. It has helped address 

market imperfections by providing increased homeownership 

opportunities to creditworthy low- and moderate-income 

families, minority households and first-time homebuyers that 

the conventional market was unable to serve. FHA has also 

expanded access to credit in all regional markets and smoothed 

regional variations that might have surfaced otherwise. FHA 

has demonstrated innovative processes in mortgage finance 

such as underwriting borrowers with nontraditional credit 

that have since become more mainstream practices. As, the 

paper has detailed in sections III and IV, FHA has provided 

significant countercyclical support with regional recessions 

(such the oil patch recession of the 1980s) and the national 

housing bubble in recent years. (Regional recessions have been 

more common than national ones and FHA has been a valuable 

policy instrument in mitigating them). Furthermore, FHA has 

applied the lessons it has learned in the past to the actions it 

has taken in dealing with the current crisis: both to protect its 

fiscal health and also to support its dual mission of bolstering 

the housing market during tough times and providing access 

to homeownership for underserved populations. Although the 

final accounting for the cost of actions taken to deal with the 

current crisis is still to be determined, FHA and policymakers 

will likely seek answers to the following questions. 

•	 What is the cost of the current level of countercyclical 

support being provided? Is it appropriate given the benefits 

secured? 

•	 In the future, are other institutional structures possible that 

will support/augment/replace this role? Should FHA’s countercyclical role be confined to segments of the market such 

as the underserved populations? How might FHA interact 

with private mortgage insurance (PMI) companies and 

other institutions in the future: should operations overlap 

considerably as in the past or very little? Is this overlap to be 

addressed via regulation or through pricing? 

•	 Will FHA need to become active in developing standards, 

innovating new guidelines, and providing information 

on loan performance to the industry, such as identifying 

creditworthy borrowers among households whose credit was 

impaired during the crisis? 

•	 How will regulatory reform affect these discussions? What is 

the appropriate “credit box” for Qualified Mortgages (QMs) 

that balances the responsible lending standards (in terms of 

taking ability to repay into consideration) with availability of 

credit? How will the market react to the cumulative effect of 

these reforms? 

•	 How will demographic trends affect FHA’s role and market 

share? Demographic trends such as slowing down in the rate 

of household formation may reduce the demand from first 

time buyers who have traditionally relied heavily on FHA 

financing. The State of the Nation’s Housing Report from the 

Joint Center for Housing Studies at Harvard University notes 

“a sharp slowdown in average annual household growth in 

2007-2011 to 568,000 in 2011 which is less than half the 

pace in the first half of the 2000s or even the 1.15 million 

average in the late 1990s” (Joint Center for Housing Studies 

of Harvard University, 2012: 6). The Report notes that two 

causative factors: a decline in the rate at which individuals 

(especially those younger than age 35) form households 

(or headship rates) and a sharp drop in immigration which 

could contribute to a decrease in first-time homebuyers, a 

traditional FHA constituency. 

Housing Finance Working Paper Series 44 
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As the Treasury/HUD White Paper has pointed out, the 

current housing crisis has exposed deep flaws in our housing 

finance system. The White Paper does not rule out a dramatic 

transformation in the role of government in the housing market 

as it offers three options for the housing finance system. These 

options offer widely different degrees of government support 

and along with different associated costs and benefits. 

Option 1: A privatized system of housing finance with the government insurance role limited to the FHA, U.S. Department of 

Agriculture (USDA), and U.S. Department of Veterans Affairs 

(VA) assistance to narrowly targeted groups of borrowers. 

Option 2: A privatized system of housing finance with assistance from the FHA, USDA and VA for narrowly targeted 

groups of borrowers and a guarantee mechanism to scale up 

during times of crisis. 

Option 3: A privatized system of housing finance with FHA, 

USDA and VA assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private 

capital. 

As policymakers debate and choose among these options, they 

will be making difficult trade-offs between providing broad 

access to mortgages for all households with risks to taxpayers 

and market stability and resiliency. Another set of difficult 

trade-offs will be involved in the phasing of these reforms: ensuring housing market recovery will need to be balanced with 

long-term reform of the entire housing finance structure. 

In addition, questions emerge related to regulatory reforms that 

are under consideration which are likely to affect FHA’s role 

going forward. These reforms are detailed in the Qualified Residential Mortgage (QRM) proposed rule, the QM proposed rule, 

and Basel III capital proposed rules for financial institutions. 

The outcomes of these rulemakings could affect how and at 

what price the conventional market will be able to serve future 

homebuyers of varying credit risk profiles. If FHA continues to 

perform its traditional role of serving those creditworthy, lower 

wealth households not well served by the conventional market, 

these rules could affect the size of the potential FHA market. 

All three proposals are expected to be finalized in the near future and the final provisions of each rule may be quite different 

from those contained in the proposed rules. This appendix will 

discuss the challenges, concerns and reactions to the proposed 

rules because the final rules have not yet been published. It 

is likely (and hoped) that the concerns raised here will be addressed in the final rules. 

QRM or “Skin in the Game” Rules 

The Dodd-Frank Act requires issuers to retain 5 percent of the 

credit risk on loans they securitize (that is, they retain some 

“skin in the game”) unless the loan is a QRM in which case 

those loans are exempt from the 5-percent requirement. FHA/ 

VA/USDA loans and government-sponsored enterprise (GSE) 

loans while the GSEs are in conservatorship are exempt from 

the 5-percent requirement.49 Six federal agencies that have been 

charged with jointly issuing the QRM rule (the Federal Deposit 

Insurance Corporation [FDIC], Federal Housing Finance Agency 

[FHFA], the Federal Reserve Board, the U.S. Department of 

Housing and Urban Development, the Office of the Comptroller of Currency and the Securities and Exchange Commission) 

issued their proposed QRM rule in 2011, have received comments 

and have not yet announced plans to issue the final rule.50 The 

consensus is that the regulators will likely finalize the QRM 

after the final Qualified Mortgage or QM rule is issued. 

The proposed QRM definition is a closed-end loan with the 

following characteristics. 

•	 A maximum loan-to-value ratio (LTV) of 80 percent for 

purchase loans, 75 percent for rate and term refinances, and 

70 percent for cash out refinances. 

•	 A maximum front-end and back-end Debt-to-Income or DTI 

ratio of 28 and 36, respectively. 

•	 On any debt, the borrower cannot be 30 days past due, 

never 60 days past due in the past 24 months, or have any 

bankruptcy, repossession, foreclosure, deed-in-lieu, short 

sale or judicial judgment on any debt in the past 3 years. 

•	 Points and fees on QRM cannot exceed 3 percent of the loan 

amount. 

•	 The loan cannot have negative amortization, a balloon term, 

term longer than 30 years and in the case of an adjustablerate mortgage (ARM), rate increases are capped at 2 percentage points per year and 6 percentage points over the life of 

the loan. 

49 Note that GSE loans could continue to be exempt from risk retention requirements should regulators decide so. 

50 See “Credit Risk Retention, Proposed Rule.” 76 Federal Register 24090-24186.29. April 2011. 

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These rules, as proposed would restrict a large share of the 

recent mortgage market from QRM designation. An FHFA 

study showed that only 19.8 percent of GSE loans made 

from 1997 to 2009 would have been QRM-eligible (Federal 

Housing Finance Agency, 2011). Only 30.5 percent of GSE 

loans made in 2009 (a year of very tight credit underwriting 

at the GSEs) would have been QRM-eligible. One argument in 

favor of a restrictive QRM designation is to require nearly all 

securitizations to involve retained risk by the issuer (that is, for 

most to retain “skin in the game”) with only a small fraction of 

securities involving very safe mortgages being exempt. Many 

have suggested preference for a less restrictive QRM definition, 

however, expanding LTVs to 90 or even 95 percent to capture 

more of the market (Moody’s Analytics, 2011). Consumer 

advocates such as the Center for Responsible Lending have 

pointed out that even allowing LTVs to expand to 90 percent 

(with PMI) will still adversely affect borrowers, especially lowand moderate-income and minority households (Center for 

Responsible Learning, 2012b). 

Many industry participants, consumer advocates (including the 

Coalition for Sensible Housing Policy) and trade groups have 

argued that instead of the 10-15 basis point increase anticipated in the analysis of the proposed QRM rule, interest rates 

would actual increase by 80-185 basis points for non-QRM 

loans. If the higher estimates of effect on mortgage rates are 

correct, a narrow definition of QRM may severely restrict the 

securitization of nongovernment mortgage loans. 

Proposed Regulatory Change: QM51 

When a lender originates a QM loan under the requirements 

set forth in the proposed QM rule,52 they are making a reasonable and good-faith determination, based on verified and 

documented information, that at the time the loan is closed, 

the consumer has a reasonable ability to repay it according to 

its terms, including all applicable taxes, insurance (including 

mortgage insurance) and assessments. The QM provisions apply to nearly all mortgage loans53—whether securitized or held 

in portfolio, whether held by private entities or by government 

or government sponsored entities. 

Under the proposed QM rule, lenders can comply with the 

ability-to-repay requirement in four ways. 

1. By originating a mortgage loan after considering and 

verifying eight factors.54 

2. By originating a QM loan: The proposed rule offers two 

alternative approaches to protecting lenders from liability 

when they originate a QM loan—”a legal safe harbor” and 

a “rebuttable presumption” from liability for QM loans.55 

The CFPB is expected to adopt one of these approaches in 

the final rule. Under the legal safe harbor approach, legal 

safe harbor would be available only for a mortgage that 

met certain specific conditions.56 Under the rebuttable 

presumption of compliance, in addition to the requirements 

listed for safe harbor, the lender is also required to consider 

and verify the borrower’s employment status, monthly 

payment for any simultaneous mortgage(s), borrower’s 

current debt obligations, monthly DTI ratio or residual 

income and borrower’s credit history. 

3. By originating a “balloon payment QM” for small lenders 

operating predominantly in rural or underserved areas that 

will be holding the loan in portfolio. 

4. By refinancing a “nonstandard” mortgage into a “standard 

mortgage” with certain restrictions. 

51 The regulatory landscape discussion here relies heavily on the detailed discussion provided in Canfield Press L.L.C. (2012). 

52 See Regulation Z, Truth in Lending, Proposed Rule, 76 Federal Register 91. pp. 27390-27506. 

53 The proposed rule excludes HELOCs, time shares, and reverse loans. Subordinate closed-end loans are covered. 

54 The eight factors are (1) the borrower’s current or reasonably expected income or assets, other than the value of dwelling that secures the loan; (2) the borrower’s 

current employment status if current income from employment is used to determine ability to repay the loan; (3) the loan payment based on the fully indexed-rate 

and on fully amortizing payments that are substantially equal; (4) the borrower’s monthly payment on any simultaneous mortgage loan that the lender knows—or 

has reason to know—will be made, and for HELOCs, the payment is based on the amount of credit drawn at the closing of the QM loan; (5) the borrower’s monthly 

payment for mortgage-related obligations; (6) the borrower’s current debt obligations; (7) the borrower’s monthly debt-to-income ratio or residual income; and 

(8) the borrower’s credit history. 

55 By definition, “the safe harbor approach” ensures that the lenders face minimal putback or litigation risk if the loan is originated per QM rule. The rebuttable 

presumption approach on the other hand has some built-in litigation risk but provides the basis with which the lender can defend their decision. 

56 (1) Does not include negative amortization, interest-only payments, or balloon payments or have a loan term exceeding 30 years; (2) total points and fees that 

generally do not exceed 3 percent of the loan amount (with alternative thresholds proposed for smaller loans); (3) lender considered and verified borrower income or 

assets; and (4) where the underwriting is based on the maximum interest rate in the first 5 years, takes all mortgage-related obligations into account (including taxes 

and insurance) and that uses a payment schedule that fully amortizes the loan over its term. 

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The Dodd-Frank Act provides for “enhanced damages” for 

violation of the ability-to-pay requirements by expanding the 

statute of limitations from 1 to 3 years and permits borrowers 

to assert the ability-to-pay violations as a defense to foreclosures even after the 3-year limit. 

Although both legal-safe-harbor and the rebuttable-presumption 

approach provide the borrower the opportunity for judicial 

review of a claim that the ability-to-repay standard was not 

satisfied, a significant difference exists between the two. As 

industry experts have pointed out, within a litigation context, 

only the stated standard or factors of safe harbor can be applied 

by the court, and only this approach would minimize litigation 

risk and put-back risk (whereby the loan originator may be 

required to repurchase a defaulted loan previously removed 

from its balance sheet and put into a mortgage-backed security 

pool) to the lender/originator. By definition, the rebuttable 

presumption inherently has some litigation and put-back risk 

built into it and is viewed less favorably by industry and trade 

groups. On the other hand, some consumer advocates have 

argued that adopting a safe-harbor provision is contrary to the 

spirit of the Dodd-Frank Act and that the absence of legal consequences for creditors would provide for the same conditions 

that led to the financial crisis in the first place. 

Additionally, industry and trade groups57 have pointed out that 

an undefined or vaguely defined rebuttable-presumption standard could have a significant effect on the cost and availability 

of credit as the costs of defending against future litigation or 

of carrying a put-back loan on balance sheet are likely to be 

passed on to borrowers in the form of higher rates and fees 

and of additional disclosures.58 Furthermore, these sources 

say lenders are likely to reduce their exposure to such risks by 

tightening credit standards to stay well inside of those established by the QM rule and thus will face reduced incentives to 

originate non-QM loans. 

In March 2012, a coalition including the Center for Responsible 

Lending, the Consumer Federation of America, the Leadership 

Council on Civil Rights and Human Rights and The Clearinghouse Association jointly presented a “term sheet” to the CFPB 

in an effort to forge a compromise that defined the terms under 

which the borrower could rebut the presumption compliance 

with QM rules (The Clearing House, 2012). Despite this 

attempt at compromise, a comment letter (American Bankers 

Association, 2012) from 23 industry and trade groups has 

stated that establishing a rebuttable presumption of compliance 

would “force lenders to retreat to far more conservative lending 

standards” and called for the inclusion of a legal safe harbor. 

Consumer advocates such as the Center for Responsible Lending, the Consumer Federation of America and the Leadership 

Council on Civil Rights and Human Right have explained 

why their position on the proposed QM has changed: their 

comment letter from July 29, 2012 contains extensive analysis 

of data from various sources that shows that “low-wealth, 

low-income and minority consumers will be at greater risk of 

being excluded from the QM market unless creditors can apply 

a bright line standard which is easily measured, understood, 

and can be applied at scale across underwriting platforms and 

organizations” (Center for Responsible Lending, 2012a: 3). 

The CFPB is set to issue its final rule at the end of 2012. 

Whether that rule is based on safe harbor or as a rebuttable 

presumption, it is very likely that non-QM loans, which by definition are also non-QRM (QRM is a subset of QM), are unlikely 

to be originated because they will face significantly higher capital 

retention requirements. If non-QM loans are originated by 

some lenders, the loans would likely involve premium pricing 

because of their higher litigation and put-back risks. Establishing the appropriate “credit box” for QM is important.59 Without 

such definition, lenders will likely use the more restrictive QRM 

definition as the de facto QM definition. The current QRM 

proposal is quite narrow requiring for instance, a 20-percent 

downpayment for purchase loans and would exclude large 

segments of the current mortgage market. Additionally, unless 

this box is wide and broad, critical market segments (likely 

low-income, low-wealth and minority borrowers) will be either 

excluded or will be able to get a mortgage only at much higher 

interest rates and costs than might otherwise be possible. 

Proposed Basel III Capital Standards 

Regulatory capital requirements such as those under the Basel III 

Accord are intended to ensure that banks retain a sufficient 

cushion to absorb losses during times of economic stress. Regulators determine the amount of capital required for different 

57 See the ABA’s comments, for instance, at http://www.aba.com/aba/documents/news/QMletter41312.pdf.
 

58 Goodman et al. (2012) estimate that each violation of the “ability to repay” statute could cost the lender $70,000–$100,000.
 

59 The term “credit box” refers to a graphic representation of the range of risk levels over multiple credit risk factors, often depicted as a rectangular “box.” One 


example would be a credit box showing acceptable ranges of LTV on one dimension and debt-to-income ratio on the other. 

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types of assets using a risk-weighting scheme, with low-risk 

assets (such as government securities) having little or zero 

capital requirements, whereas assets that represent greater risk 

require a larger capital cushion. Thus, these risk weights also 

provide a policy lever by which regulators indirectly influence 

the type of activities banks elect to engage in. 

In 1988, the Basel Committee developed a new capital framework (Basel I) that was designed to make minimum capital 

requirements uniform across member countries and to take the 

riskiness of the bank’s portfolio into account in setting capital 

requirements. A minimum capital requirement of 8 percent 

was established in all member countries (including the United 

States) and bank assets were divided into broad categories with 

a risk weight for each asset category. For instance, in the United States, commercial loans are risk weighted at 100 percent 

risk, residential mortgages at 50 percent, GSE backed securities 

at 20 percent and government obligations (such as Ginnie Mae 

securities) are given a 0-percent weight. 

In 2004, the Basel Committee agreed to a new capital framework, (Basel II), but before Basel II was actually used by any 

U.S. banking institutions, the financial crisis hit and the Basel 

Committee determined that refinements were needed. Basel III 

rules were released in December 2010 and implementation of 

Basel III in the United States requires the three Federal Banking 

agencies to issue proposed regulation. The OCC, the FDIC 

and the Federal Reserve Board began the process by issuing 

proposed regulations in the summer of 2012 that both community and regional banking organizations and the very largest 

international banks will be required to adopt. In general, the 

Proposed Risk Weights for Residential Mortgage Exposuresa 

proposed rules will increase the capital needed for residential 

mortgage finance. Although a complete analysis of the proposal 

is beyond the scope of this paper, consider the following 

examples where the proposed rules directly affect mortgage 

financing and—60 

•	 Increase the risk weight for residential mortgages held in 

portfolio. 

•	 Increase the risk weight assigned to mortgage servicing 

rights. 

•	 Double the capital required to be held against undrawn 

home equity lines of credit (unless banks retain the right to 

cancel the line at any time). 

•	 Increase the regulatory burden on banking institutions for 

holding private-label securities relative to other types of 

securities. 

Consider the risk weight for residential mortgages held in portfolio. Currently, prudently underwritten residential mortgages 

are assigned a risk weight of 50 percent, implying that the 

bank has to hold only one-half the capital for such a residential 

mortgage as for a commercial loan. Under the proposed Basel 

III rules, all mortgages belong in one of two categories and are 

further subdivided based on LTV. Category 1 mortgages have 

lower capital charges than Category 2 loans.61 

The table in this appendix summarizes the proposed risk 

weights and the significant increase in risk weights for 

Category 2 loans. 

Loan-to-Value Ratio (%) Category 1 Residential Mortgage Risk Weight (%) Category 2 Residential Mortgage Risk Weight (%) 

≤ 60 35 100 

>60 and ≤80 50 100 

>80 and ≤90 75 150 

≥90 100 200 

a

 See page 33, Table 5 in the news release at http://www.occ.treas.gov/news-issuances/news-releases/2012/nr-ia-2012-88b.pdf. 

60 See Natter (2012) and K&L Gates (2012). 

61 Category 1 loans must be a first mortgage, must have a term not exceeding 30 years, cannot have a balloon payment or a negative amortization feature, cannot 

allow for deferment of principal payments, and must be underwritten using documented and verified income and after considering all the borrower’s obligations 

(including taxes, insurance, and assessments). Furthermore, the creditor must have made a reasonable determination that the borrower can repay the loan using 

the maximum allowable interest rate in the first 5 years and if the loan is an ARM, the interest-rate adjustments are capped at 2 percent per year and no more 

than 6 percent over the life of the loan. Category 2 is a catchall category for all mortgage loans that are not Category 1 loans. Moreover, PMI does not count when 

determining LTV because PMI providers have varying financial strengths. 

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According to the proposed rule, the current risk based capital 

treatment for residential mortgage exposure that is unconditionally guaranteed by the U.S. government or its agencies will 

be maintained. That is, residential mortgages unconditionally 

guaranteed by the U.S. government would retain their risk 

weighting of zero and conditionally guaranteed loans (such 

as those guaranteed by the GSEs) will retain a risk rating of 

20 percent. This treatment means that under the new proposed 

rules, the capital requirements on a loan with nongovernment 

mortgage insurance will become much higher. In certain 

market segments such as high-LTV lending, this treatment may 

have the consequence of raising the cost of loans with PMI (as 

banks/originators pass on the extra cost of holding capital on 

to borrowers) and therefore leaving FHA with a higher share of 

these loans. Further, some industry experts have cautioned that 

the effect of these rules (if enacted in current form) in conjunction with regulations to be issued under the Dodd-Frank Act 

could adversely affect the origination of loans by private capital 

and its subsequent securitization in certain market segments 

such as high-LTV segments. 

Housing Finance Working Paper Series 49 
The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market

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