FEDERAL HOUSING 

ADMINISTRATION

Analysis of Options 

for Modifying Its 

Products, Market 

Presence, and Powers

Report to Congressional Requesters

September 2013

GAO-13-682

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-682, a report to 

congressional requesters

ptember 2013

September 2013

FEDERAL HOUSING ADMINISTRATION

Analysis of Options for Modifying Its Products, 

Market Presence, and Powers 

What GAO Found

GAO identified a number of proposed options for adjusting product terms and 

conditions to help improve the Federal Housing Administration’s (FHA) long-term 

viability (see fig. below). FHA has raised the premiums that it charges borrowers 

several times in recent years and has taken steps to tighten its underwriting 

standards—for example, by setting a minimum required credit score. Some 

mortgage market observers have argued that further changes such as revising 

underwriting standards to focus on borrowers’ residual income, requiring higher 

down payments, or reducing seller concessions (that is, funds sellers provide to 

buyers to help pay for closing costs) could help FHA better manage credit risk. 

However, such changes would entail trade-offs. For instance, some said that

raising down-payment requirements would improve loan performance, but others 

said that this move would delay homeownership for many borrowers. Similarly, 

raising premiums could potentially increase revenue, but this potential would be 

constrained if it caused volume to decline. Further, low-risk borrowers with fewer 

down-payment constraints could choose less costly loans from other sources, 

leaving FHA with more high-risk borrowers. These changes could have a direct 

effect on the availability of credit for borrowers. 

Options to Improve FHA’s Long-Term Viability or Reduce Its Market 

Presence

GAO also identified options that could either directly or indirectly change FHA’s 

market presence, which increased after the housing crisis, or address its financial 

viability (see fig. below). Among the proposals that would have a direct effect are 

those limiting FHA insurance to loans below a lowered ceiling or to borrowers 

who met new income guidelines. Many stakeholders and FHA itself view FHA’s 

current loan limits, which range from $271,050 to $729,750 for one-unit 

properties in the contiguous United States, as too high. Some note that the 

agency may insure larger loans than the housing enterprises Fannie Mae and

Freddie Mac. The current FHA limits were put in place in response to declines in 

mortgage lending during the housing crisis, when the private sector’s role in 

financing mortgages shrank. However, as the market has improved, some have 

noted that lowering loan limits would allow private capital to return to the market 

View GAO-13-682. For more information, 

contact Mathew J. Scirè at (202) 512-8678 or 

sciremj@gao.gov.

Why GAO Did This Study

FHA has historically provided 

mortgage guarantees for home buyers, 

particularly first-time, minority, and 

lower-income borrowers. In 2012, FHA 

insured about $227 billion in singlefamily mortgages, and its overall 

insurance portfolio was about $1.1 

trillion. Its market presence expanded 

during the recent housing crisis as the 

conventional market contracted and 

Congress increased the limit on the 

size of loans FHA may insure. But 

FHA’s financial condition has 

weakened, and FHA has not met its 2

percent statutory minimum capital ratio 

since 2009. In its most recent budget, 

the agency stated that its capital 

reserve account might require an 

infusion of federal funds.

FHA, industry participants, and 

researchers have suggested a number 

of options for improving FHA’s longterm viability or for limiting FHA’s 

market presence. These options have 

potential implications for taxpayers, 

borrowers, and others. This report 

discusses the options—which fall into 

three broad categories: (1) changes to 

product terms and conditions, (2) 

changes that would restrict FHA’s 

market presence, and (3) changes to 

FHA’s operations and powers—and 

their implications. It also describes the 

possible effects of broader housing 

finance reform on FHA. 

GAO interviewed a variety of industry 

stakeholders and researchers and 

reviewed studies and other documents 

to identify options for reforming FHA 

and their implications.
Highlights of GAO-13-682 (Continued)

United States Government Accountability Office

and focus FHA on low- and moderate-income and first-time home buyers, a shift that many observers consider 

appropriate. Other proposed changes, such as reducing insurance coverage to less than 100 percent of the loan amount 

or entering into risk-sharing agreements with private partners, may indirectly reduce FHA’s market presence. However, 

applying a partial coverage model would limit availability of credit to some borrowers. For some lenders, the additional 

exposure might prompt the purchase of additional insurance coverage from third parties, the cost of which would be 

passed on to borrowers. Some argue that under a risk-sharing structure private partners would assume and better 

manage credit risk. But creating such a structure would require careful consideration of how risks are borne, how pricing is 

determined, how incentives are aligned between FHA and its partners, and how FHA’s role in stabilizing mortgage 

markets would be impacted. Others point to the additional counterparty risk posed by risk-sharing arrangements, which 

would necessitate greater federal oversight. Finally, these options might also affect FHA’s ability to respond to changing 

market conditions. 

FHA’s Share of Loan Originations, 2001-2012

FHA and industry observers have also suggested changes to FHA’s structure and powers that could enhance its flexibility 

and capacity to manage risk. Some of these changes would bring FHA’s corporate powers more in line with those of other 

government corporations and increase its autonomy, providing it with enhanced enforcement powers and greater authority 

to change program requirements and invest in staff and technology. FHA has already requested additional enforcement 

authority. FHA and other observers have also argued that FHA needs greater power to change loan products or loan 

features without a lengthy rulemaking process and additional information technology resources—resources for which FHA

must currently compete within HUD. Expanding FHA’s operational and managerial powers would give the agency more 

flexibility, and increasing its enforcement powers would allow it to more effectively oversee lenders. But any expansion of 

FHA’s authority may need to be limited and transparency requirements heightened, including for the rulemaking process.

Even with no changes to its existing organizational structure and authorities, FHA can do more to enhance program 

efficiency and effectiveness and protect taxpayers. GAO has made a number of recommendations aimed at improving 

FHA’s loss mitigation efforts, management of real-estate owned inventories, risk assessment, human capital 

management, and information technology systems. In response to these recommendations, FHA has taken steps, such 

as developing a plan for conducting an inaugural risk assessment and a workforce analysis and succession plan. 

Finally, efforts to further regulate housing finance and the continuing uncertainty over resolution of Fannie Mae and 

Freddie Mac present challenges to any efforts to reform FHA. Following the collapse of the mortgage market, Congress 

passed a number of mortgage reforms that could impact FHA’s market share and role because they could affect the price 

at which the conventional market will be able to serve future home buyers of varying credit risk profiles. Similarly, the 

administration has put forth several options for reforming the federal role in the mortgage market, including reform of

Fannie Mae and Freddie Mac. Each of these options could have an impact on FHA’s role in the mortgage market. Partly 

for this reason, GAO identified modernization of the federal role in housing finance as a high-risk area in early 2013. Any 

changes to the federal tools that support housing finance should be made in concert and with full recognition of the 

interdependence among FHA, the enterprises, and federal regulation.
Page i GAO-13-682 FHA Viability and Market Presence

Letter 1

Background 3

Changes to Product Terms and Conditions Could Help Mitigate 

Risk and Increase Financial Viability but Could Also Limit 

Borrowers’ Access to Credit 10

Proposed Changes That Restrict the Borrowers FHA Serves Would 

Affect the Agency’s Role in the Mortgage Market 22

Greater Operational and Managerial Powers Could Give FHA 

Greater Flexibility but Could Limit Congressional Direction 36

Broader Housing Market Reforms Could Impact FHA’s Role 53

Agency Comments 59

Appendix I Objectives, Scope, and Methodology 60

Appendix II GAO Contact and Staff Acknowledgments 63

Tables

Table 1: Descriptions of Compensating Factors 11

Table 2: FHA Down-Payment Requirements and Related 

LTV Ratios 15

Table 3: Increases to FHA Annual Premiums Effective 

April 1, 2013 19

Figures

Figure 1: FHA’s Share of Loan Originations, 2001-2012 5

Figure 2: Estimates of the Fund’s Capital Ratio, 2001-2012 7

Figure 3: End-of-Year Balances in the Fund’s Capital Reserve 

Account, 2008-2012 9

Figure 4: Percentage of FHA Purchase Loans by Borrower Income, 

2000-2013 27

Contents
Page ii GAO-13-682 FHA Viability and Market Presence

Abbreviations

APA Administrative Procedure Act

APOR average prime offer rate

APR annual percentage rate

CFPB Bureau of Consumer Financial Protection

DTI debt service-to-income

FCRA Federal Credit Reform Act of 1990

FHA Federal Housing Administration

FHFA Federal Housing Finance Agency

HECM Home Equity Conversion Mortgages for Seniors

HERA Housing and Economic Recovery Act of 2008

HPML higher-priced mortgage loan

HUD Department of Housing and Urban Development

IT information technology

LTV loan-to-value

MBA Mortgage Bankers Association

MBS mortgage-backed securities

NPRM notice of proposed rulemaking

OMB Office of Management and Budget

PTI payment-to-income

QM qualified mortgage

QRM qualified residential mortgage

RHS Rural Housing Service

TOTAL Technology Open to Approved Lenders

USDA Department of Agriculture

VA Department of Veterans Affairs

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Page 1 GAO-13-682 FHA Viability and Market Presence

441 G St. N.W.

Washington, DC 20548

September 9, 2013

The Honorable Jeb Hensarling

Chairman

Committee on Financial Services

House of Representatives

The Honorable Randy Neugebauer

Chairman

Subcommittee on Housing and Insurance

Committee on Financial Services

House of Representatives

The Department of Housing and Urban Development’s (HUD) Federal 

Housing Administration (FHA) has helped millions of families purchase 

homes through its single-family mortgage insurance programs, which 

insure private lenders against losses on mortgages that finance 

purchases of properties or that refinance existing FHA mortgages. In 

2012, FHA insured about $227 billion in single-family mortgages, and its 

overall insurance portfolio was about $1.1 trillion. In recent years, FHA 

has experienced a dramatic increase in its market share, partly because

the conventional mortgage market contracted during the 2007-2009 

financial crisis. At the same time, FHA has faced fiscal challenges. Since 

2009, its Mutual Mortgage Insurance Fund (the Fund) has not met 

statutory reserve requirements, as measured by the Fund’s estimated 

capital ratio.1

FHA has made a number of changes to address its fiscal challenges. 

However, mortgage market observers have stated that further actions are 

needed and have proposed options that could improve FHA’s long-term 

viability or reduce its market presence. These suggestions range from 

changes to its product features to broad changes to its organizational 

structure. You asked us to examine these options and their implications. 

The Fund is required to maintain a capital ratio of at least 2 

percent. Also, declining balances in the fund’s capital reserve account 

and significant underestimates of program costs have heightened the 

possibility that FHA will require additional funds to pay all future insurance 

claims on its existing portfolio.

 1

The capital ratio is the economic value divided by the insurance-in-force. The economic 

value of the Fund is the sum of existing capital resources plus the net present value of 

future cash flows. 
Page 2 GAO-13-682 FHA Viability and Market Presence

This report discusses the implications of options related to (1) changing 

FHA’s product terms and conditions for single-family mortgage insurance, 

(2) restricting FHA’s presence in the single-family housing market, and (3) 

altering FHA’s operations and powers within its single-family program.2 It 

also discusses the possible effects of broader housing finance reform on 

FHA. Options that included changes to FHA’s capital reserve 

requirements were not within the scope of our review. However, we 

previously recommended that in place of FHA’s 2-percent capital 

requirement, Congress or FHA specify the economic conditions the Fund 

would be expected to withstand without drawing on the U.S. Treasury.3

Additionally, in another report issued today, we compare the reserving 

practices and capital requirements of FHA to those of private mortgage 

insurers.4

To examine the options that have been proposed for improving FHA’s 

long-term viability or limiting its market presence, we identified relevant 

academic and industry studies from our previous products and ongoing 

work and from a literature search of databases. We reviewed these 

studies and other documents—including from FHA and HUD—to 

summarize and categorize options for FHA reform. The categories we 

indentified were potential changes to product terms and conditions, 

changes that affect FHA’s mortgage market presence, and changes to 

FHA’s operational powers and structure. We also reviewed studies and 

other documents to identify the potential implications of these options, 

including how the options affect cost and risk to the taxpayer, borrowers’

access to credit, FHA’s role and the market it serves, and other mortgage 

market participants. We conducted interviews with mortgage industry 

observers from industry, academic, government, and consumer 

organizations to obtain their views on the options and related implications 

that we identified and to obtain any additional relevant studies or papers. 

Appendix I contains additional information on our scope and 

methodology.

 2

FHA insures both forward and reverse single-family mortgages. Reverse mortgages 

permit borrowers to convert their home equity into cash advances. This report primarily 

focuses on FHA’s forward single-family insurance program. 

3

GAO, Mortgage Financing: FHA’s Fund Has Grown, but Options for Drawing on the Fund 

Have Uncertain Outcomes, GAO-01-460 (Washington, D.C.: Feb. 28, 2001). 

4

GAO, FHA Mortgage Insurance: Applicability of Industry Requirements Is Limited, but 

Certain Features Could Enhance Oversight, GAO-13-722 (Washington, D.C.: Sept. 9, 

2013). 
Page 3 GAO-13-682 FHA Viability and Market Presence

We conducted this performance audit from April 2013 to September 2013 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

FHA is a wholly owned government corporation within HUD.5 It was 

established in 1934 under the National Housing Act to broaden 

homeownership, shore up and protect lending institutions, and stimulate 

employment in the building industry.6

FHA’s single-family programs insure private lenders against losses from 

borrower defaults on mortgages that meet FHA criteria for properties with 

one to four housing units. FHA primarily insures forward mortgages for 

initial home purchases and refinancing, but also insures reverse 

mortgages that permit persons 62 years and older to convert their home 

equity into cash advances through its Home Equity Conversion 

Mortgages for Seniors (HECM) program.7 FHA provides most of its 

single-family mortgage insurance through programs supported by the 

Fund.8 FHA’s single-family insurance programs are administered by the 

Deputy Assistant Secretary for Single Family Housing, who reports to the 

Assistant Secretary for Housing-Federal Housing Commissioner.

 5

A government corporation is generally a federally chartered entity created to serve a 

public function of a predominantly business nature. 

6

FHA was created as a separate entity by the National Housing Act on June 27, 1934. It 

was later abolished as a separate entity and made an entity within HUD by the 

Department of Housing and Urban Development Act on September 9, 1965. 

7

With forward mortgages, the borrower’s monthly loan payments to the lender add to the 

borrower’s home equity and decrease the loan balance. With reverse mortgages, the 

borrower receives payments from the lender. The lender adds the principal and interest to 

the loan balance, reducing the homeowner’s equity. 

8

FHA also administers mortgage insurance programs that help to finance multifamily 

properties, health care facilities, hospitals, and manufactured homes under a separate 

insurance fund.

Background

FHA’s Single-Family 

Mortgage Insurance
Page 4 GAO-13-682 FHA Viability and Market Presence

FHA is a government mortgage insurer in a market that also includes 

private mortgage insurers. Private mortgage insurance policies provide 

lenders coverage on a portion (generally 20 to 30 percent) of the 

mortgage balance. However, borrowers who have difficulty meeting 

down-payment and credit score requirements for conventional loans may 

find it easier to qualify for a loan with FHA insurance, which covers 100 

percent of the principal balance of the loan involved in a claim and other 

eligible costs. Generally, borrowers are required to purchase mortgage 

insurance when the loan-to-value (LTV) ratio (the amount of the mortgage 

loan divided by the value of the home multiplied by 100) exceeds 80 

percent. FHA-insured borrowers are required to make minimum cash 

investments of 3.5 percent, which may come from the borrowers’ own 

funds or from certain third-party sources. Borrowers are also permitted to 

finance their mortgage insurance premiums, a practice that can create an 

effective LTV ratio of close to 100 percent. Congress has set limits on the 

size of the forward mortgages FHA may insure, which can vary by county. 

For the period from January 1, 2013, through December 31, 2013, the 

limits range from $271,050 to $729,750 for one-unit properties in the 

contiguous United States.

FHA’s single-family mortgage programs have played a prominent role in 

mortgage financing in the wake of the 2007-2009 financial crisis and 

housing downturn. In 2012, FHA insured about $227 billion in singlefamily mortgages, and its overall insurance portfolio was about $1.1 

trillion. The agency has played a particularly large role among minority, 

lower-income, and first-time homebuyers. In 2012, about 78 percent of 

FHA-insured loans went to first-time homebuyers, about 32 percent of 

whom were minorities. FHA is generally thought to promote stability in the 

market by ensuring the availability of mortgage credit in areas that may 

be underserved by the private sector or that are experiencing economic 

downturns. As the recent housing crisis and economic recession set in, 

the contraction of other segments of the mortgage market and legislated 

increases in the loan amounts eligible for FHA insurance resulted in 

higher demand for FHA-insured mortgages. FHA officials also noted that 

even if their volume had not increased, the agency’s share of the market 

would have increased because other segments of the market declined or 

were completely eliminated. According to HUD’s Housing Market 

Conditions, FHA’s share of the market for home purchase mortgages (in 

terms of loan originations) grew sharply, rising from approximately 4.5 

FHA’s Role in Mortgage 

Financing
Page 5 GAO-13-682 FHA Viability and Market Presence

percent in 2006 to approximately 26.1 percent in 2012.9

Figure 1: FHA’s Share of Loan Originations, 2001-2012

Looking at the 

entire mortgage market (including refinance activity), FHA’s share of the 

market also rose dramatically, and stood at 14.6 percent in 2012 

(see fig. 1).

A number of other private-sector and government institutions participate 

in the mortgage market.

• Private lenders offer home purchase and refinance mortgages and 

often work with mortgage brokers, independent contractors that 

originate the loan products of multiple lenders.10

 9

U.S. Department of Housing and Urban Development, Office of Policy Development and 

Research, U.S. Housing Market Conditions 4th Quarter 2012 (Washington, D.C.: February 

2013).

10Mortgage origination involves such functions as accepting loan applications and 

obtaining employment verifications and credit reports on the borrowers. It is distinct from 

mortgage underwriting, which refers to a risk analysis that uses information collected 

during the origination process to decide whether to approve a loan. 
Page 6 GAO-13-682 FHA Viability and Market Presence

• The Department of Veterans Affairs’ (VA) Loan Guaranty Service and 

the Department of Agriculture’s (USDA) Rural Housing Service (RHS) 

administer federal programs that insure or guarantee single-family 

mortgages made by private lenders.

• Private mortgage insurance companies offer mortgage insurance that 

protects private lenders against losses in the event the borrower 

defaults on the mortgage. Fannie Mae and Freddie Mac, two 

government-sponsored enterprises (the enterprises), purchase 

mortgages from lenders across the country, financing their purchases 

through borrowing or by issuing securities backed by the mortgages 

(mortgage-backed securities or MBS). The enterprises are currently 

under conservatorship.11

• Ginnie Mae is another wholly owned government corporation in HUD. 

It guarantees the timely payment of principal and interest of MBS 

backed by pools of federally insured or guaranteed mortgage loans, 

such as FHA, VA, or RHS.

The Omnibus Budget Reconciliation Act of 1990 required HUD to take 

steps to ensure that the Fund attained a capital ratio of at least 2 percent 

by November 2000 and maintained at least that level thereafter.12

 11On September 6, 2008, the enterprises’ regulator—the Federal Housing Finance 

Agency (FHFA)—placed them into conservatorship out of concern that their deteriorating 

financial condition threatened the stability of the financial markets.

The 

capital ratio is the Fund’s economic value divided by the insurance-inforce (outstanding insurance obligations). The act also required an annual 

independent actuarial review of the Fund’s economic net worth and 

soundness. This actuarial review is now a requirement in the Housing and 

Economic Recovery Act of 2008, which also requires an annual report to 

Congress on the results of the review. The Fund’s capital ratio dropped 

sharply in 2008 and fell below the statutory minimum in 2009, when 

economic and market developments created conditions that 

simultaneously reduced the Fund’s economic value (the numerator of the 

ratio) and increased the insurance-in-force (the denominator of the ratio). 

According to annual actuarial reviews of the Fund, the capital ratio fell 

from about 7 percent in 2006 to 3 percent in 2008 and dropped to below 2 

percent in 2009 (see fig. 2). In 2012, the ratio fell below zero to negative 

1.44 percent.

12Pub. L. No. 101-508.

FHA’s Mutual Mortgage 

Insurance Fund
Page 7 GAO-13-682 FHA Viability and Market Presence

Figure 2: Estimates of the Fund’s Capital Ratio, 2001-2012

Under the Federal Credit Reform Act of 1990 (FCRA), FHA and other 

federal agencies must estimate the net lifetime costs—known as credit 

subsidy costs—of their loan insurance or guarantee programs and include 

the estimated costs to the government in their annual budgets. Credit 

subsidy costs represent the net present value of expected lifetime cash 

flows, excluding administrative costs.13

 13For a mortgage insurance program, cash inflows consist primarily of fees and premiums 

charged to insured borrowers and proceeds from sales of foreclosed properties, and cash 

outflows consist mostly of payments to lenders to cover the cost of claims. 

When estimated cash inflows 

(such as borrower insurance premiums) exceed expected cash outflows 

(such as insurance claims), a program is said to have a negative credit 

subsidy rate and generates offsetting receipts that reduce the federal 

budget deficit. When the opposite occurs, the program is said to have a 

positive credit subsidy rate and therefore requires appropriations. 

Generally, agencies must produce annual updates of their subsidy 

estimates—reestimates—on the basis of information about actual 

performance and estimated changes in future loan performance. FCRA 

recognized the difficulty of making credit subsidy estimates that mirrored 
Page 8 GAO-13-682 FHA Viability and Market Presence

actual loan performance and thus provided permanent and indefinite 

budget authority for reestimates that reflected increased program costs.14

As the capital ratio declined, the Fund’s condition also worsened from the 

federal budgetary perspective. FHA annually estimates the subsidy costs 

of new activity for its loan insurance program and also reestimates, or 

annually updates, prior subsidy cost estimates. Historically, FHA 

estimated that its loan insurance program had a negative subsidy cost. 

On the basis of these estimates, FHA accumulated substantial balances 

in a capital reserve account, which represents amounts in excess of those 

needed for estimated claims or other costs and was used to cover 

reestimates reflecting unanticipated increases to those costs (such as 

higher-than-expected claims). In recent years, FHA has transferred 

billions of dollars annually from the capital reserve account to cover 

increases in estimated credit subsidy costs of the Fund (upward subsidy 

reestimates). As a result, balances in the capital reserve account fell 

dramatically, from $19.3 billion at the end of 2008 to an estimated $3.3 

billion at the end of 2012 (see fig. 3).

Upward reestimates increase the federal budget deficit unless 

accompanied by reductions in other government spending or an increase 

in receipts.

 14Budget authority is the authority federal law provides to enter into financial obligations 

that will result in immediate or future outlays involving federal funds. Permanent budget 

authority is available as the result of previously enacted legislation and is available without 

further legislative action. Indefinite budget authority is budget authority that, at time of 

enactment, is for an unspecified amount. 
Page 9 GAO-13-682 FHA Viability and Market Presence

Figure 3: End-of-Year Balances in the Fund’s Capital Reserve Account, 2008-2012

If the reserve account were to be depleted, FHA could draw on 

permanent and indefinite budget authority to cover reestimates indicating 

additional increases in estimated credit subsidy costs. The President’s 

budget for 2014 contained a $22.4 billion upward reestimate in FHA’s 

credit subsidy costs for the Fund. The budget indicated that the 

reestimate would be funded by depleting FHA’s capital reserve account in 

2013, using premiums collected in 2013 from new endorsements, and 

potentially drawing on $943 million in permanent and indefinite budget 

authority. However, to the extent that such premiums collected in 2013 

are different than FHA estimated, FHA may need to draw on more or less 

permanent and indefinite budget authority.
Page 10 GAO-13-682 FHA Viability and Market Presence

Mortgage industry observers have suggested changes to FHA’s product 

terms and conditions to lower its exposure to risk and improve its capital 

position. These proposed changes include tightening its underwriting 

standards and increasing down payments and premiums charged. 

However, implementing one or a combination of these options could 

affect borrowers’ access to credit, create an adverse selection problem 

for FHA, or affect the agency’s role in terms of the types of borrowers it 

serves.15

Lenders must comply with FHA’s underwriting criteria when making FHAinsured loans. Underwriting is a risk analysis that uses information—such 

as a borrower’s credit history and cash assets, among other things—

collected during the origination process to decide whether to approve a 

loan. In order to qualify for an FHA-insured loan, a borrower must have a 

decision credit score of at least 500.16 In addition, a borrower’s paymentto-income (PTI) ratio may exceed 31 percent and debt service-to-income 

(DTI) ratio may exceed 43 percent only if compensating factors are 

documented.17

With some exceptions, lenders are required to use FHA’s Technology 

Open to Approved Lenders (TOTAL)—a mortgage scorecard—to 

 15In an insurance context, adverse selection occurs when individual insurance buyers may 

differ in their underlying risk factors in ways that are not fully observed by the insurer. If an 

insurer offers policy terms and rates designed to cover its costs based on the average 

risks of a group of potential buyers, the result may be that those buyers who are riskier 

than average purchase the insurance, and impose larger than average claims on the 

insurer, while those buyers who are less risky than average do not purchase the 

insurance. 

16FHA implemented this minimum required credit score in October 2010. A credit score is 

a numeric summary of the information in an individual’s credit reports that represents his 

or her potential credit risk. Three national credit bureaus calculate credit scores, which 

range from a low of 300 to a high of 850. A decision credit score is based on the middle of 

the three national credit bureau scores, or the lower of the two scores when all three are 

not available.

17The PTI ratio is the total monthly mortgage payment divided by gross income. The DTI 

ratio is the total mortgage payment plus recurring obligations divided by gross income.

Changes to Product 

Terms and Conditions 

Could Help Mitigate 

Risk and Increase 

Financial Viability but 

Could Also Limit 

Borrowers’ Access to 

Credit

Proposed Changes to 

FHA’s Underwriting 

Standards Would Involve 

Trade-offs That Could 

Affect Target Populations
Page 11 GAO-13-682 FHA Viability and Market Presence

underwrite loans.18 TOTAL evaluates the overall creditworthiness of an 

applicant based on a number of credit variables and determines the 

associated risk level for an FHA-insured loan. FHA requires lenders to 

manually underwrite loans that are not accepted by TOTAL to determine 

if the loan should be accepted or rejected.19

Table 1: Descriptions of Compensating Factors

Among other things, manual 

underwriting involves evaluating compensating factors to justify the 

approval of an FHA-insured mortgage. Table 1 describes the 

compensating factors lenders may consider when manually underwriting 

an FHA-insured loan for a borrower whose PTI ratio exceeds 31 percent 

or DTI ratio exceeds 43 percent.

Compensating factor Description

Housing expense payments The borrower has successfully demonstrated the ability to pay housing expenses greater 

than or equal to the proposed monthly housing expenses for the new mortgage over the 

past 12-24 months. 

Down payment The borrower makes a large down payment of 10 percent or higher toward the purchase of 

the property.

Accumulated savings The borrower has demonstrated an ability to accumulate savings and a conservative 

attitude toward using credit. 

Previous credit history A borrower’s previous credit history shows that he/she has the ability to devote a greater 

portion of income to housing expenses. 

Compensation or income not reflected 

in effective income

The borrower receives documented compensation or income that is not reflected in 

effective income, but directly affects his/her ability to pay the mortgage. This type of income 

includes food stamps and similar public benefits.

Minimal housing expense increase There is only a minimal increase in the borrower’s housing expense. 

Substantial cash reserves The borrower has substantial documented cash reserves (at least 3 months worth) after 

closing. The lender must judge if the substantial cash reserve asset is liquid or readily 

convertible to cash, and can be done so absent retirement or job termination, when 

determining if the asset can be included as cash reserves, or cash to close. 

Substantial nontaxable income The borrower has substantial nontaxable income. 

Potential for increased earnings The borrower has a potential for increased earnings, as indicated by job training or 

education in his/her profession. 

 18Lenders use TOTAL in conjunction with automated underwriting systems. 

19On July 15, 2010, FHA issued a proposed rule that would impose stricter reserve and 

DTI ratio requirements for loans that TOTAL refers for manual underwriting as well as for 

loans that need to be manually underwritten because the borrowers have no credit scores. 

As of August 30, 2013, the rule had not been finalized.
Page 12 GAO-13-682 FHA Viability and Market Presence

Compensating factor Description

Primary wage-earner relocation The home is being purchased because the primary wage earner is relocating, and the 

secondary earner has an established employment history, is expected to return to work, 

and has reasonable prospects for securing employment in a similar occupation in the new 

area. 

Source: FHA.

FHA recently revised TOTAL to tighten its underwriting standards. For 

example, according to FHA officials, the agency revised the cut points—

the points of separation within a population of mortgage scores that divide 

applications that are accepted in TOTAL from those that are not—in order 

to set the lifetime claim rate of its highest-risk loans at about 13 percent. 

In addition, some mortgage industry observers we spoke to said that 

lenders may apply additional, more stringent underwriting requirements, 

known as credit overlays. For example, a lender could require that 

borrowers have a minimum credit score of 620 in order to qualify for an 

FHA-insured loan.

Some of the literature we reviewed and those we spoke to suggested that 

FHA could further tighten its underwriting standards in order to reduce the 

risk to the Fund, as well as the agency’s high market share. However, as 

described in the following examples, tightening of FHA’s underwriting 

requirements may affect certain borrowers’ ability to obtain mortgage 

credit and FHA’s ability to serve families that are able to sustain a 

mortgage, but do not qualify for conventional financing.

Some mortgage industry observers have suggested raising FHA’s 

minimum credit score requirement to, for example, 580 or 620. We 

previously found that lower credit scores were associated with a higher 

likelihood of default.20

 20See GAO, Home Mortgages: Provisions in a 2007 Mortgage Reform Bill (H.R. 3915) 

Would Strengthen Borrower Protections, but Views on Their Long-term Impact Differ, 

FHA officials also told us that lower credit scores 

increase the likelihood of delinquency and default among borrowers. 

Accordingly, increasing the credit score requirement, all else being equal, 

could make FHA less subject to adverse selection based on its credit 

policy and help to reduce the level of risk in the overall portfolio.

GAO-09-741 (Washington, D.C.: July 31, 2009) and Mortgage Financing: Additional 

Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance, 

GAO-06-24 (Washington, D.C.: Nov. 9, 2005).

Increasing FHA’s Minimum 

Credit Score Requirement
Page 13 GAO-13-682 FHA Viability and Market Presence

However, FHA data also show that the percentage of borrowers with 

FHA-guaranteed loans and credit scores below 620 was relatively small 

in 2009—approximately 10 percent of loans endorsed by FHA. Thus, 

implementing a credit score floor of 620—the conventional mortgage 

standard—likely would not significantly reduce FHA’s market share, 

absent any other changes to FHA’s underwriting standards, other 

program requirements, or the current lending volume.

Some mortgage industry observers noted that increasing FHA’s credit 

score requirement would decrease access to mortgage credit and delay 

or prevent homeownership for borrowers with lower credit scores. One 

paper we reviewed noted that more restrictive credit score requirements 

excluded a larger share of borrowers from the market in relation to the 

percentage of defaults they prevented.21 One mortgage industry observer 

also said that a higher minimum credit score requirement likely would 

have a disparate impact on minority borrowers. In addition, in a 2007 

paper, the Federal Reserve found that different demographic groups had 

substantially different credit scores.22

Some mortgage industry observers also suggested that FHA implement a 

residual income requirement. Residual income is the amount of net 

income remaining after the deduction of payments for debts and 

obligations (including the mortgage), and is thus a measure of a 

borrower’s ability to make such payments without creating a substantial 

financial burden on the household. These observers pointed to VA’s 

The study found that on average 

blacks and Hispanics have lower credit scores than non-Hispanic whites 

and Asians.

 21Roberto G. Quercia, Lei Ding, and Carolina Reid, Balancing Risk and Access: 

Underwriting Standards and Qualified Residential Mortgages (Center for Community 

Capital and Center for Responsible Lending: January 2012). This study examined the way 

different qualified residential mortgage guidelines could affect access to mortgage credit 

and loan performance. It estimated the additional impacts on defaults and access resulting 

from setting qualified residential mortgage underwriting guidelines over and above the 

proposed product restrictions for qualified mortgages, which exclude loans with features 

associated with higher default rates such as lack of income documentation, hybrid 

adjustable-rate mortgages with teaser payments, interest only and balloon payments, and 

negative amortization. The authors used a nationally representative database on loan 

performance that included information on loan characteristics and borrower characteristics 

to conduct this analysis. Later in this report we discuss qualified residential mortgage and 

qualified mortgage rules in more detail. 

22See Board of Governors of the Federal Reserve System, Report to the Congress on 

Credit Scoring and Its Effects on the Availability and Affordability of Credit (Washington, 

D.C.: August 2007). 

Implementing a Residual 

Income Requirement
Page 14 GAO-13-682 FHA Viability and Market Presence

mortgage insurance program, which requires that lenders calculate the 

balance available for family support and compare that figure to the 

residual income guidelines that are based on family size, loan amount, 

and geographic location. For example, the guideline for a family of two 

living in the midwest with a loan of $80,000 or more is a minimum of $738 

in residual income. For the same family in the west, it is a minimum of 

$823. Lenders also consider the borrower’s DTI ratio, but according to 

VA, that is a secondary underwriting factor to the residual income.23

One industry observer we spoke to said that implementing a residual 

income test could be difficult, though not impossible, because determining 

whether borrowers were capable of paying for other expenses presented 

practical challenges. One paper we reviewed noted the lack of adequate 

empirical data and models documenting the relationship between residual 

income, DTI ratios, and loan performance.24

 23VA program guidance notes that a DTI ratio of greater than 41 percent requires close 

scrutiny unless the residual income exceeds the relevant residual income guideline by at 

least 20 percent. 

This paper concluded that 

without such information, it would be difficult to determine the residual 

income thresholds that would most effectively produce high-quality 

mortgages without excluding lower-income borrowers from access to 

credit.

24Quercia, Ding, and Reid, Balancing Risk and Access.
Page 15 GAO-13-682 FHA Viability and Market Presence

In addition to meeting the underwriting requirements outlined earlier, a 

borrower generally must make a cash investment (down payment) in the 

property to obtain an FHA-insured mortgage.25 The amount of the down 

payment required depends on the borrower’s credit score (see table 2). 

Down payment funds may come from the borrower’s own savings or from 

certain third-party sources.26

Table 2: FHA Down-Payment Requirements and Related LTV Ratios

Credit score Minimum down payment

Related LTV ratio/maximum 

FHA-insured financing

500-579 credit score

a

10% 90%

580 and above credit 

score

3.5 b 96.5

Source: FHA.

a

LTV ratio is calculated on the base loan amount, excluding up-front premiums. According to FHA, 

nearly all insured borrowers finance the up-front premium, which today is 1 percent of the base 

mortgage amount. For a loan with a minimum down payment of 3.5 percent, the resulting LTV ratio 

with the financed premium would be higher than 96.5. We discuss up-front premiums below. 

Borrowers must still provide cash for the down payment, or obtain those funds from an approved 

third-party source.

b

HUD has proposed setting a 95 percent LTV maximum (5 percent down payment) on loans of 

$625,500 or more.

In addition, borrowers also must pay for related closing costs. Currently, 

FHA permits a seller to pay up to 6 percent of the lesser of the purchase 

price or the appraised value of a home on behalf of a buyer to help fund 

these closing costs. Such payments are referred to as “seller 

concessions.” In July 2010, FHA proposed reducing allowable seller 

 25Down payment is considered equity in the property, and thus affects a borrower’s LTV 

ratio. For example, if a borrower makes a 5 percent down payment, the LTV ratio at 

origination would be 95 percent, assuming no other investments.

26In 2009, Congress eliminated seller-funded down-payment assistance (that is, 

assistance from nonprofit organizations that received at least part of their funding from 

property sellers). In a report and subsequent testimony, we discussed the risks associated

with seller-funded down-payment assistance, including the higher delinquency and 

insurance claim rates and the fact that FHA-insured homes bought with seller-funded 

nonprofit assistance typically appraised at and sold for about 2 to 3 percent more than 

comparable homes bought without such assistance. See GAO, Seller-Funded DownPayment Assistance Changes the Structure of the Purchase Transaction and Negatively 

Affects Loan Performance, GAO-07-1033T (Washington, D.C.: June 22, 2007) and 

GAO-06-24. 

Increasing FHA’s DownPayment Requirement 

and Reducing Seller 

Concessions Could 

Increase Borrowers’

Cash Contributions
Page 16 GAO-13-682 FHA Viability and Market Presence

concessions to 3 percent of the lesser of the purchase price or the 

appraised value of a home in order to align its policy with conventional 

mortgage lenders and reduce the risk exposure to the Fund. In 

announcing the change, FHA noted that the then current level exposed 

FHA to excess risk by creating incentives to inflate the appraised value of 

homes.27 In February 2012, FHA amended this plan in a proposed rule 

that permitted seller concessions in the amount of the lesser of 3 percent 

of the purchase price or the appraised value of a home, or $6,000, 

whichever was greater.28

Some of the literature we reviewed and mortgage industry observers we 

interviewed suggested increasing FHA’s requirement from 3.5 percent to, 

for example, 5 percent. Some said that increasing FHA’s down-payment 

requirements would help to decrease risk in its portfolio. A substantial 

amount of the research we reviewed for a 2005 report on risks associated 

with FHA products indicated that LTV ratios and credit scores were 

among the most important factors in estimating the risk level associated 

with individual mortgages.

According to FHA officials, the agency is in the 

process of addressing comments on the proposed rule. The officials said 

that they did not know when the rule would be finalized.

29

Others noted that increases to FHA’s down-payment requirements would 

delay or prevent homeownership for many borrowers who often lack 

sufficient funds to make a large down payment. Supporting this argument, 

in 2011 FHA found that over 40 percent of all borrowers would not have 

had the additional funds to make a 5 percent down payment, based on 

Our own analysis corroborated these 

findings. We found that, in general, mortgages with higher LTV ratios 

(smaller down payments) and lower credit scores were riskier than 

mortgages with lower LTV ratios and higher credit scores.

 2775 Fed. Reg. 41217 (July 15, 2010). 

2877 Fed. Reg. 10695 (Feb. 23, 2012).

29See GAO, Mortgage Financing: Actions Needed to Help FHA Manage Risks from New 

Mortgage Loan Products, GAO-05-194 (Washington, D.C.: Feb. 11, 2005).

Increasing FHA’s DownPayment Requirement
Page 17 GAO-13-682 FHA Viability and Market Presence

information collected from loan applications.30

Some of those we spoke to and the literature we reviewed said that FHA 

should reduce seller concessions. According to FHA, about 21 percent of 

loan originations in 2009 and 2010 had seller concessions of more than 3 

percent of the property value.

In addition, one mortgage 

industry observer said that increased down-payment requirements could 

have a disparate impact on minorities.

31 Allowing higher seller concessions makes 

FHA-insured loans more accessible than conventional loans because 

borrowers do not have to invest as much cash at closing. For example, 

according to FHA, under current policy, concessions on higher-priced 

homes can reach almost $44,000. FHA and one mortgage industry 

observer suggested that reducing seller concessions could reduce the 

risk of exposure to the Fund from incentives that inflated the appraised 

value of homes. Our work on seller-funded down-payment assistance 

demonstrated that funds provided by seller-funded nonprofits had the 

effect of increasing the selling price of the home, leaving the borrower 

with less equity and FHA with more risk than they would have 

otherwise.32

Conversely, some have highlighted the importance of providing 

assistance to those borrowers who have difficulty accumulating sufficient 

funds to become homeowners. For example, one mortgage industry 

observer we spoke with said that reducing allowable seller concessions 

would be like increasing the down-payment requirement. In commenting 

on FHA’s proposed rule, representatives of this group said that FHA must 

This suggests that transactions involving seller concessions 

could result in higher sales prices than would occur without seller 

concessions.

 30FHA based its analysis on information lenders collected from borrowers’ loan 

applications between August 2010 and July 2011. Specifically, lenders are required to 

verify the amount of liquid assets each borrower has available to close the loan. They 

report to HUD both that amount and the assets remaining after closing. The difference 

between these two numbers is the required cash payment to close the loan. That cash 

requirement includes not only the down payment, but also any loan origination fees, 

prepaid items, and initial escrows required of the borrower and not paid by other sources. 

Thus, the total cash paid at closing can be much higher than just the down-payment 

requirement. From this information, HUD derived the number of borrowers with LTV ratios 

above 95 percent that would not have had sufficient funds to pay down the loan to a 95 

percent LTV (or make a 5 percent down payment).

31Property value is the lesser of the purchase price and the appraisal amount. 

32See GAO-06-24. 

Reducing Seller Concessions
Page 18 GAO-13-682 FHA Viability and Market Presence

strike a balance between managing risks and ensuring that its product is 

offered as widely as possible to qualified borrowers. They said that the 

proposed changes in seller concessions would adversely impact 

homebuyers seeking FHA-insured mortgages. Because of similar 

concerns, FHA revised its original proposal for reducing seller 

concessions. In its revised proposed rule, FHA noted that an across-theboard reduction to 3 percent would have had a disproportionately 

negative impact on borrowers with low and moderate incomes who were 

purchasing modestly priced homes. Therefore, the agency revised its 

proposal to allow concessions of the greater of 3 percent or $6,000, so 

that borrowers purchasing homes valued at less than $200,000 could 

receive seller concessions of more than 3 percent.

FHA has raised premiums several times in recent years, but such 

increases have not been risk-based. Most recently, FHA increased the 

annual insurance premiums most borrowers pay between 0.05 and 0.10 

percentage points. FHA now charges the maximum allowable premium 

for loans of $625,500 or more, and although FHA also increased 

premiums for smaller-value loans, these premiums still remain below the 

maximum FHA is permitted to charge (see table 3). FHA can continue to 

raise up-front and annual premiums to the statutory maximums (generally 

3 percent of the original insured principal mortgage amount for up-front 

premiums and between 1.5 and 1.55 percent of the remaining insured 

principal amount for annual premiums). In addition, since June 3, 2013, 

FHA has required most new borrowers to continue paying annual 

premiums, regardless of the value of their loans.33 Previously, premiums 

could be canceled after the first 5 years once the principal amount 

declined to 78 percent of the original value. According to FHA, the 

reversal of the premium cancelation policy and the increase in premiums 

would generate approximately $3 billion for the Fund for every $100 

billion in new endorsements.

 33For any mortgage involving an original principal obligation (excluding financed up-front 

premiums) less than or equal to 90 percent LTV, the annual premium will be assessed

until the end of the mortgage term or for the first 11 years of the mortgage term, whichever 

occurs first. For any mortgage involving an original principal obligation (excluding financed 

up-front premiums) with an LTV greater than 90 percent, FHA will assess the annual 

premium until the end of the mortgage term or for the first 30 years of the term, whichever 

occurs first. See HUD Mortgagee Letter 2013-04.

Pricing Changes Could 

Raise the Cost of Credit for 

Some Borrowers
Page 19 GAO-13-682 FHA Viability and Market Presence

Table 3: Increases to FHA Annual Premiums Effective April 1, 2013

Term greater than 15 years

Base loan 

amount Loan-to-value

Previous 

mortgage 

insurance 

premium

Current 

mortgage 

insurance 

premium

Statutory 

maximum 

Less than or 

equal to 

$625,500

Less than or 

equal to 95%

1.20% 1.30% 1.50%

Less than or 

equal to 

$625,500

Greater than 

95%

1.25 1.35 1.55

Greater than 

$625,500

Less than or 

equal to 95%

1.45 1.50 1.50

Greater than 

$625,500

Greater than 

95%

1.50 1.55 1.55

Term less than or equal to 15 years

Any amount Less than or 

equal to 78%

0% 0.45% 1.50%

Less than or 

equal to 

$625,500

78.01 to 90% 0.35 0.45 1.50

Less than or 

equal to 

$625,500

Greater than 

90% to less 

than or equal to 

95%

0.60 0.70 1.50

Less than or 

equal to 

$625,500

Greater than 

95%

0.60 0.70 1.55

Greater than 

$625,500

78.01 to 90% 0.60 0.70 1.50

Greater than 

$625,500

Greater than 

90% to less 

than or equal to 

95%

0.85 0.95 1.50

Greater than 

$625,500

Greater than 

95%

0.85 0.95 1.55

Source: FHA.

Some mortgage industry observers said that FHA could raise its up-front 

and annual premiums. For example, FHA could raise premiums to the 

statutory maximums, as outlined in table 3 above. One mortgage industry 

observer we spoke to and some of the literature we reviewed indicated 

that increases in FHA’s premiums could result in more revenue for the 

Further Increases to Premiums
Page 20 GAO-13-682 FHA Viability and Market Presence

Fund, provided that the increases did not reduce the volume of new FHAinsured mortgages enough to offset the increased revenue.

However, we and others have noted that increases in the cost of 

mortgage insurance could increase the likelihood of adverse selection for 

FHA if its pricing were far different from its competitors.34

Further, others have noted that increased premiums could price some 

borrowers out of the market. As previously discussed, some mortgage 

industry observers have noted that many FHA borrowers have limited 

cash assets to pay for down-payment and closing costs. According to 

FHA, nearly all FHA-insured borrowers finance the up-front premium, so 

the net effect of increasing it would likely be to raise the borrowers’

mortgage payments.

That is, low-risk 

borrowers with fewer down-payment constraints could choose less costly 

loans from other sources, effectively making private mortgage insurance 

more competitive with FHA insurance. This shift in borrowers potentially 

could result in an increase in the overall risk of FHA’s portfolio because 

FHA would be insuring relatively more high-risk borrowers. In this case, 

an increase in premiums can result in both lower premium revenue as 

low-risk borrowers no longer purchase FHA insurance, and an increased 

claim rate among the remaining higher-risk borrowers.

FHA officials said that the agency was unlikely to implement further 

increases in annual premiums in the near future. They said that FHA 

loans could become unaffordable to some borrowers when interest rates 

increase. We also found that FHA’s recently announced policy 

lengthening the duration of premium assessments might have an adverse 

impact on borrowers. Mortgagee Letter 2013-04, implemented on June 3, 

2013, mandates that the monthly mortgage insurance premium on FHA 

loans with LTV ratios exceeding 90 percent apply for the life of the loan, 

rather than terminating after the first 5 years once the principal amount 

declines to 78 percent LTV. FHA has acknowledged that this policy 

change will increase the annual percentage rate (APR) on FHA 

mortgages and may result in mortgages whose interest rates qualify them 

 34See GAO, Federal Housing Administration: Modernization Proposals Would Have 

Program and Budget Implications and Require Continued Improvements in Risk 

Management, GAO-07-708 (Washington, D.C.: June 29, 2007). 
Page 21 GAO-13-682 FHA Viability and Market Presence

as higher-priced mortgage loans (HPML).35 Under Regulation Z, HPMLs 

must meet certain requirements, including those related to repayment 

ability, prepayment penalties, and escrows.36

Some of the literature we reviewed and mortgage industry observers we 

spoke to suggested that FHA assess premiums using “risk-based pricing.”

Risk-based pricing takes into account borrowers’ risk attributes such as 

credit score, DTI ratio, product type, and LTV ratio. As described earlier, 

FHA’s current premiums are based on the size and term of the loan and 

the LTV ratio and do not consider credit score and other risk factors, a 

practice FHA refers to as “average pricing.” Using this method, low-risk 

borrowers pay the same actual price for insurance coverage as high-risk 

borrowers. For example, all FHA borrowers with loans at or below 

$625,500, LTV ratios less than or equal to 95 percent, and terms of 

greater than 15 years pay the same premiums, even though other 

measures of risk, such as credit scores, indicate that they represent a 

variety of risks. Risk-based pricing could address the adverse selection 

problem that is a possibility under average pricing (that is, when 

premiums charged do not align with the actual risks of borrowers so that 

low-risk borrowers are charged too much for insurance and thus seek it 

elsewhere). One mortgage industry observer also noted that it would 

more accurately align FHA’s revenues with its potential claims.

After consulting with the 

Bureau of Consumer Financial Protection (also known as CFPB), FHA 

issued guidance to lenders that explained their responsibilities for 

meeting both HPML and FHA requirements.

Conversely, others have argued that risk-based pricing would place FHA 

in the position of having to raise the mortgage financing costs of 

borrowers with weaker credit. To the extent that relatively low-risk 

borrowers might face lower premiums, they likely would not leave FHA. 

But other borrowers could face higher premiums, and those who could 

not qualify either for an FHA or conventional mortgage could be priced 

out of the market. For example, in 2007 we found that an FHA proposal to 

implement risk-based pricing would have affected the availability of FHA 

 35Regulation Z generally defines an HPML as a loan secured by the consumer’s home 

with an APR that exceeds the average prime offer rate (APOR) for a comparable 

transaction by 1.5 or more percentage points for loans secured by a first lien, or by 3.5 or 

more percentage points for loans secured by a subordinate lien. An APOR means an 

annual percentage rate that is derived from average interest rates and other loan pricing 

terms of low-risk mortgages. 12 C.F.R. § 1026.35(a). 

36See 12 C.F.R. § 1026.35(b), (e).

Implementing Risk-Based 

Pricing
Page 22 GAO-13-682 FHA Viability and Market Presence

insurance for about 20 percent of the home purchase borrowers that FHA 

insured in 2005.37 This group would not have qualified for mortgage 

insurance under the parameters of the proposal because of high LTV 

ratios and low credit scores. FHA officials said that they are aware that 

the agency risks losing some lower-risk borrowers under its current 

pricing scheme. Therefore, they said that the agency has set pricing so 

that it covers the expected losses of the highest risk loans that its 

underwriting permits, with the idea that if FHA were to face increasing 

competition for its lower-risk borrowers, it would be charging a sufficiently 

high premium to cover expected losses on all newly insured loans.

As noted earlier, FHA’s share of loan originations has increased in recent 

years. During 2006, FHA insured approximately 4.5 percent of purchase 

mortgages. At its peak in 2009, it insured 32.6 percent of purchase 

mortgages, and in 2012 still insured 26.1 percent of purchase mortgages 

originated that year. Mortgage industry observers have proposed options 

that would limit FHA’s market presence as a way of either reducing FHA’s 

liability or better ensuring that it serves a certain market—that is, low- or 

moderate-income borrowers and first-time homebuyers. These options 

include changes that would have a direct effect on FHA’s market share, 

such as reducing loan limits from current levels and determining borrower 

eligibility based on income. Options that could have an indirect effect on 

FHA’s market presence include reducing FHA’s insurance coverage to 

less than 100 percent of the value of the loan and entering into risksharing agreements with private partners. Concerns have been raised 

that options affecting FHA’s market presence might also affect its ability 

to serve its traditional countercyclical role to stabilize the housing market 

during times of increased stress or credit contraction.

 37See GAO-07-708. In addition, in May 2008, HUD announced that it would implement 

risk-based premiums based on credit scores and LTV ratios for most of its single-family 

mortgage programs. 73 Fed. Reg. 27704 (May 13, 2008); HUD Mortgagee Letter 2008-16. 

However, in July of the same year, the Housing and Economic Recovery Act of 2008 

placed a 1-year moratorium on FHA’s implementation of the new pricing structure. Pub. L. 

No. 110-289, § 2133. In its notice implementing the moratorium, HUD stated that it would 

issue another notice when the moratorium concluded. 73 Fed. Reg. 51505 (Sept. 3, 

2008); HUD Mortgagee Letter 2008-22. HUD has not, to date, announced an end to the 

moratorium. 

Proposed Changes 

That Restrict the 

Borrowers FHA 

Serves Would Affect 

the Agency’s Role in 

the Mortgage Market
Page 23 GAO-13-682 FHA Viability and Market Presence

Congress raised the loan limits on FHA-backed forward mortgages 

following the recent housing crisis and has continued to extend the higher 

limits. Currently, the loan limits vary by county, ranging from $271,050 to 

$729,750 for one-unit properties in the contiguous United States. These 

limits are set to expire on December 31, 2013. Mortgage industry 

observers have recommended that FHA’s loan limits be lowered to 

reduce FHA’s market share. Some recommend reducing the loan limits to 

what they were prior to the crisis, while others propose reducing them 

further.38 FHA data show that large loans are a small portion of FHA’s 

loan pool. Loans that exceeded $450,000 (somewhat higher than the 

national conforming loan limit) comprised only 4 percent of active FHA 

loans as of October 31, 2011.39 As of this date, 82 percent of FHA’s 

active pool included loans with a balance of $271,050 or less. Because of 

the small number of high-value loans that FHA has endorsed, a reduction 

in loan limits might not have a large effect on its overall market share. 

However, for certain high-cost markets, a reduction in FHA’s loan limits 

would have a greater impact. For example, according to FHA, in fiscal 

year 2012 about 24 percent of the loans FHA insured in Hawaii and about 

10 percent of those it insured in California exceeded $450,000. Further, 

more than half of the loans over $450,000 endorsed during this time 

period were for properties located in California. We previously found that 

a possible reduction in the conforming loan limit could result in certain 

homebuyers in high-cost markets such as California needing to either 

provide a larger down payment or seek alternate financing.40

 38In January 2007, FHA single-family loan limits ranged from $200,160 to $362,790 for 

one-unit properties. 

39Fannie Mae and Freddie Mac are restricted by law to purchasing single-family 

mortgages with origination balances below a specific amount known as the “conforming 

loan limit.” Loans above this limit are known as jumbo loans. A permanent formula for the 

annual establishment of the conforming loan limit was established under the Housing and 

Economic Recovery Act of 2008 (HERA). The 2013 national conforming loan limit for oneunit properties is $417,000. In certain high-cost areas designated by statute (Alaska, 

Hawaii, Guam, and the U.S. Virgin Islands) or by the Federal Housing Finance Agency, 

the conforming loan limit for one-unit properties extends to $721,050 depending on 

geographic area. 

40GAO, Housing Finance: Implications of Alternative Methods of Adjusting the Conforming 

Loan Limit, GAO/RCED-95-6 (Washington, D.C.: Oct. 5, 1994). 

Reducing Loan Limits 

Could Focus FHA on Lowto Moderate-Income 

Borrowers and Reduce Its 

Market Share
Page 24 GAO-13-682 FHA Viability and Market Presence

Industry observers have proposed approaches to reducing the current 

loan limits.41 For example, one researcher suggests limiting loans to no 

more than 100 percent of county median house price. The Mortgage 

Bankers Association (MBA) testified that Congress should allow the 

current limits to expire at the end of 2013 and reduce the loan ceiling to 

match the enterprises’ conforming loan limits. FHA officials said that at 

the end of 2013 the loan limits would return to the levels established in 

HERA—limits that FHA has determined are appropriate for 2014.42

Further, a reduction in loan limits would allow FHA to focus on low- to 

moderate-income borrowers and first-time homebuyers, the groups that 

many industry observers see as FHA’s traditional market. In a February 

2013 report, the Bipartisan Policy Center Housing Commission stated that 

a key objective for FHA should be to return to what it sees as FHA’s 

traditional mission of serving primarily first-time homebuyers—something 

that could be achieved in part through a gradual reduction in loan limits.43

A reduction in loan limits may have implications for FHA’s financial 

condition, however. According to some industry observers, high-value 

loans improve the performance of the Fund and provide additional 

revenue beyond what a population of only low- and moderate-income 

borrowers would provide. FHA data show lower delinquency rates and 

A number of observers suggest that FHA is serving a population of 

borrowers far beyond those targeted by its traditional mission. For 

example, one observer noted that reducing FHA’s loan limits by 

approximately 50 percent would still enable the agency to reach its 

intended population of first-time, minority, and low-income borrowers. 

Observers also noted that loan limits act as a proxy for income, with lower 

limits focusing FHA’s efforts on low-wealth borrowers. As noted above, 

about 78 percent of FHA-insured loans went to first-time homebuyers in 

2012.

 41See, for example, Bipartisan Policy Center Housing Commission, Housing America’s 

Future: New Directions for National Policy (Washington, D.C.: February 2013); Jason Gold 

and Andrew Winkler, Guidelines for Federal Housing Administration Reform (Washington, 

D.C.: Progressive Policy Institute, March 2013); Robert Van Order and Anthony Yezer, 

FHA Assessment Report: The Role of the Federal Housing Administration in a Recovering 

U.S. Housing Market (Washington, D.C.: George Washington University School of 

Business, June 2011); and Edward J. Pinto, How FHA Hurts Working-Class Families and 

Communities (Washington, D.C.: American Enterprise Institute, December 2012).

42Pub. L. No. 110-289, § 2112(a)(1). 

43Bipartisan Policy Center Housing Commission, Housing America’s Future.
Page 25 GAO-13-682 FHA Viability and Market Presence

serious delinquency rates among loans with the highest balances (6 

percent and 4 percent, respectively, of all active loans over $625,000 as 

of October 31, 2011). In contrast, loans under $271,000 had a 

delinquency rate of 17 percent and a serious delinquency rate of 9 

percent. Factors other than loan size could contribute to these 

delinquency rates. For example, FHA officials noted that many high-value 

loans were endorsed following the housing crisis when the economy had 

improved and may perform better as a result. FHA officials could not point 

to analysis that would support the argument that high-value loans, all else 

being equal, perform any differently than smaller loans in terms of default, 

or the severity of the resulting losses. Nonetheless, FHA officials stated 

that a broader pool of insurable loans helps to better manage portfolio 

risk.

According to a number of industry observers, by reducing loan limits the 

agency would effectively step back from the high-wealth market, allowing 

private lenders to step back into the market during the recovery. Some 

industry observers have raised concerns about FHA crowding out private 

capital. They note that lower loan limits would not have a significant effect 

on FHA lending but would allow high-wealth buyers to be served in the 

conventional market, a shift they consider appropriate at this time. 

However, some industry observers have noted that the higher loan limits, 

which have been in effect since 2008, have allowed FHA to fulfill its 

countercyclical role of providing credit to borrowers when the private 

market was generally frozen. One organization stressed that the housing 

recovery was not complete, that lending remained constrained in many 

markets, and that Congress should be cautious about lowering loan limits. 

Industry observers also note that the elevated loan limit was particularly 

important in high-cost markets and that FHA continues to serve a 

significant role in these markets today. One observer argued that the 

relatively low FHA loan limits in effect prior to the crisis limited FHA’s 

presence in high-value areas that suffered a more severe contraction 

during the housing crisis, which helped mitigate FHA’s losses. Some said 

that FHA loan limits should be relatively constrained during most years, 

but raised when needed to provide stability in housing finance. Others 

noted that whatever loan limit FHA might use, it should be adjusted to 

allow for the variability in home prices across the country. FHA told us 

that it needs to have the flexibility to alter market-limiting policies—for 

example, by reinstating high loan limits quickly—to properly execute its 

countercyclical role.
Page 26 GAO-13-682 FHA Viability and Market Presence

Some mortgage industry observers have suggested that eligibility should 

be based on borrowers’ income in order to refocus FHA on its traditional 

role of providing mortgage credit to low- and moderate-income 

borrowers.44

 44See, for example, Gold and Winkler, Guidelines for Reform; and Pinto, How FHA Hurts

Working-Class Families.

FHA data show that 64 percent of its purchase loans and 47 

percent of its refinance loans in fiscal year 2012 were made to low- and 

moderate-income borrowers. As shown in figure 4, the income levels of 

borrowers approved for purchase loans have varied over time. During the 

recent housing crisis, the proportion of FHA-insured mortgages made to 

low-income borrowers dropped substantially just as the proportion to 

high-income borrowers increased. Between 2005 and 2008, the share of 

FHA borrowers that had low incomes dropped about 16 percent, while the 

share that had high incomes increased about 14 percent. FHA has 

continued to endorse a larger proportion of high-income loans through 

2012. These shifts are consistent with the increased loan limits in effect 

during the period. That is, loan limit increases expanded FHA’s portion of 

the market that would be sought after by households with relatively higher 

income.

Eligibility Limits Based on 

Income Rather Than Loan 

Amount Would Target 

Lower-Income Borrowers, 

but Could Also Restrict 

Access to Credit
Page 27 GAO-13-682 FHA Viability and Market Presence

Figure 4: Percentage of FHA Purchase Loans by Borrower Income, 2000-2013

Note: Data for fiscal year 2013 are from October 2012 through April 2013.

According to some of the literature, income limits would affect the market 

that FHA serves, targeting FHA’s guaranty to low- and moderate-income 

borrowers. In recent congressional hearings, industry observers 

encouraged a system of assessing borrowers according to area median 

income targets to determine program eligibility.45

 45Congress recently held multiple hearings on options for FHA reform, including before the 

Committee on Financial Services, U.S. House of Representatives, on February 6, 2013; 

before the Subcommittee on Housing and Insurance, Committee on Banking, Housing, 

and Urban Affairs, United States Senate, on February 28, 2013; and before the 

Committee on Financial Services, U.S. House of Representatives, on April 10, 2013. 

In a 2011 white paper 

on reforming the housing finance market that was developed by the U.S. 

Department of the Treasury (Treasury) and HUD, the administration 

presented one option for reform that would strictly limit FHA eligibility to 
Page 28 GAO-13-682 FHA Viability and Market Presence

low- and moderate-income borrowers, leaving the risk for high-income 

borrowers to the private market.46

A change to income-based eligibility could restrict certain borrowers’

access to credit. In its white paper, the administration cautioned that 

some borrowers, who may be ineligible when their income exceeds a 

threshold, may find it difficult to afford the cost of a conventional 30-year 

fixed-rate mortgage. Observers point to the additional costs, such as 

higher premiums and interest rates, that some borrowers might face if 

they must seek conventional mortgage insurance. Multiple observers 

have noted that even borrowers with relatively strong incomes have 

difficulty accumulating sufficient savings for a down payment, especially 

in high-cost areas.

Several industry observers and FHA said that a system of income 

verification to determine FHA eligibility would also be difficult to 

implement. For example, one observer we interviewed noted that FHA’s 

current loan application process required prospective borrowers to 

provide documentation of qualifying income, but said that additional 

sources of income were not considered. According to this observer, if 

maximum income levels were in place, lenders would have to gather 

documentation for all income sources and assess the borrower’s income 

against all liabilities and expenses, which could give borrowers an 

incentive to under report income. FHA officials told us that basing 

eligibility on income would create compliance risks for lenders and would 

be time consuming. Yet another industry observer added that income 

verification could also affect lenders’ behavior, making them fearful of 

increased liability under indemnification agreements if they failed to 

correctly identify all borrower income to verify a borrower’s eligibility.47

 46The Department of the Treasury and the Department of Housing and Urban 

Development, Reforming America’s Housing Finance Market: A Report to Congress

(Washington, D.C.: February 2011). 

The FHA Commissioner noted that income verification was difficult to 

implement in other programs, such as the Low-Income Housing Tax 

47FHA is authorized to require certain lenders to sign indemnification agreements under 

which the lender is to repay FHA for any losses that it incurs after a loan defaults and the 

property has been sold. 
Page 29 GAO-13-682 FHA Viability and Market Presence

Credit Program.48

Further, while income limits could be structured to vary by geographic 

area, as loan limits now do, implementation could be difficult. Some 

observers described to us the complexity of implementing and monitoring 

income limits that vary by geographic area, and one suggested that a 

national income ceiling rather than income limits set by area median 

income might be a more expedient policy. FHA officials and industry 

observers told us that determining program eligibility based on 

appropriate loan limits is an effective substitute for income limits in order 

to target the program to low- and moderate-income borrowers.

FHA officials told us that loan limits, rather than income 

limits, could help FHA focus the market it served.

Some observers have further argued that limiting eligibility based on 

income could affect FHA’s ability to manage credit risk. Some argue that 

FHA-insured loans made to borrowers with higher income perform better 

than loans to lower-income borrowers. However, we have not seen 

analysis that would support the argument that income alone is a predictor 

of credit risk. Limiting eligibility based on income may reduce the number 

of insured loans, which could constrain FHA’s ability to manage risk. An 

industry observer noted that FHA was intended to be more universally 

available than a program for only the lowest-risk borrowers might be. FHA 

officials noted the importance of maintaining a broad-based insurance 

pool. FHA officials also stated that they were not aware of studies 

concluding that serving only low-income borrowers would improve the 

agency’s financial condition.

Finally, this option could limit FHA from serving its countercyclical role in 

the future. In its white paper, the administration warned that reducing 

FHA’s market share too much—for example, by serving only low- and 

moderate-income borrowers—could affect its ability to ensure access to 

capital during a crisis.49

 48Enacted in 1986, the Low-Income Housing Tax Credit Program provides an incentive for 

developers and investors to provide affordable rental housing for households whose 

income is at or below specified income levels. 26 U.S.C. § 42. The program is jointly 

administered by the Internal Revenue Service and housing finance agencies, statechartered authorities established to help meet the affordable housing needs of the 

residents of their states. The program is an indirect financing source and resembles a 

grant program in that housing finance agencies are responsible for allocating the credit on 

a competitive basis to owners of qualified low-income rental projects. 

The paper emphasized that without sufficient 

49Treasury and HUD, Reforming America’s Housing Finance Market. 
Page 30 GAO-13-682 FHA Viability and Market Presence

government support to mitigate a credit crisis, downturns could be more 

severe, increasing costs to the taxpayer.

Currently, FHA insures 100 percent of the principal balance of the loan 

involved in a claim and other eligible costs. Some mortgage industry 

observers have suggested that FHA’s loan coverage be reduced in order 

to limit FHA’s risk and market share. VA’s guaranty program is often cited 

as a model, as it insures only 25 to 50 percent of the original principal in 

the case of a default. Various levels of reduced loan coverage have been 

suggested for FHA, ranging from 90 percent coverage, which some 

observers say would have little impact, down to 25 percent coverage.

Industry observers proposing this change point to a reduction in taxpayer 

risk as a key benefit.50 They argue that a lower level of insurance 

coverage would reduce FHA’s liability for defaulted loans by reducing the

severity of the agency’s loss. We have also found that a reduction in 

insurance coverage could have a beneficial effect on the Fund. In May 

1997, we examined the potential effects of reducing FHA’s insurance 

coverage and found that lower coverage would reduce both the volume of 

FHA-insured loans and income from premiums but would also reduce 

FHA’s losses and ultimately have a beneficial effect on the Fund.51 Others 

have noted that a reduction in loan coverage could provide lenders an 

incentive to improve underwriting quality, thus reducing the risk of default. 

Some have cited the relatively superior delinquency and default rates in 

the VA program as evidence of careful origination by lenders that must 

assume some credit risk for VA-guaranteed loans.52

 50See, for example, Mark Calabria, Fixing Mortgage Finance: What to Do with the Federal

Housing Administration, no. 123 (Washington, D.C.: Cato Institute, February 2012). 

Nonetheless, it is 

important to note that VA limits its eligibility to veterans who have served 

in a branch of the armed services and received an honorable discharge, 

certain currently serving members of the Reserves or National Guard, 

and spouses of veterans under certain circumstances. It therefore starts 

with a universe of eligible borrowers that are different from the population 

that might seek an FHA-insured mortgage. Also, as mentioned in the 

previous section, VA underwriting differs somewhat from that of FHA, with 

51See GAO, Homeownership: Potential Effects of Reducing FHA’s Insurance Coverage 

for Home Mortgages, GAO/RCED-97-93 (Washington, D.C.: May 1, 1997). 

52See, for example, Calabria, Fixing Mortgage Finance, and Pinto, How FHA Hurts 

Working-Class Families. 

Reducing FHA’s Insurance 

Coverage Would Reduce 

Losses, but Might Not 

Protect Taxpayers and 

Could Increase Costs for 

Borrowers
Page 31 GAO-13-682 FHA Viability and Market Presence

greater attention given to the veteran’s residual income. Further, the VA 

program provides supplemental servicing to borrowers that face difficulty 

making mortgage payments. These and other differences need to be 

considered before it can be concluded that differences in insurance 

coverage explain the differences between VA and FHA default rates.

Industry observers also discussed the impact of a reduction in insurance 

coverage on borrowers’ access to credit. Because lenders would be 

exposed to additional risk, they could increase fees and interest rates, 

which some industry observers noted in testimonies to Congress. Also, 

for some lenders the additional exposure might prompt the purchase of

additional insurance coverage from third parties, the cost of which could 

be passed on to borrowers. We have reported that without the guaranty 

for FHA-endorsed mortgages, lenders would likely make fewer and more 

costly loans, making homeownership more expensive, limiting borrowers’

access to credit, and reducing FHA’s presence in underserved 

communities.53

Further, some industry observers testified to Congress or told us that 

reduced FHA insurance coverage could simply transfer taxpayer risk from 

FHA to Ginnie Mae.

Our analysis showed that if lenders imposed stricter 

underwriting criteria or increased fees and interest rates, high-risk 

borrowers would be disproportionately unable to access FHA-endorsed 

mortgages. We found that reducing insurance coverage would limit FHA’s 

ability to stabilize distressed communities and housing markets during 

regional economic downturns.

54

 53See 

That is, any additional risk borne by the lender 

would pose additional risk to Ginnie Mae as the guarantor of the 

securities issued by that lender. This risk would require Ginnie Mae to 

provide more intense monitoring of its counterparties’ financial condition, 

potentially increasing the fees it required to provide its guarantee. FHA 

officials agreed that Ginnie Mae would assume additional counterparty 

GAO/RCED-97-93. 

54Ginnie Mae guarantees the timely payment of principal and interest on securities issued 

by financial institutions and backed by pools of federally insured or guaranteed mortgage 

loans. Ginnie Mae is a wholly owned government corporation and defines its mission as 

expanding affordable housing by linking capital markets to the nation’s housing markets. 

Ginnie Mae relies on approved issuers to issue and service their mortgage-backed 

securities, and on agencies, such as FHA and VA, to guarantee the underlying mortgages 

against borrower default. Ginnie Mae faces counterparty risk when an issuer fails or 

defaults, which would require Ginnie Mae to ensure that investors receive monthly 

principal and interest payments and service the underlying loans. 
Page 32 GAO-13-682 FHA Viability and Market Presence

risk with a reduction in coverage. Ginnie Mae officials noted that issuers 

would likely seek additional third-party assurance, most likely through 

additional mortgage insurance, to manage the additional risks they might 

face. As a result, borrowers could face further costs. Issuers could also 

take other steps, such as limiting the amount of FHA-insured lending they 

would permit or overlaying additional credit requirements, which would 

limit their participation in the program. In addition, MBA testified that this 

option would limit the ability of independent mortgage bankers and other 

small lenders to manage risk. It noted that small mortgage lenders were 

not structured to take on large amounts of credit risk and might restrict 

credit to borrowers, or leave the mortgage industry.

Other observers note that reducing FHA’s loan coverage would facilitate 

the return of private capital. For example, one stated that the 100 percent 

coverage that FHA provides combined with its expanded market share 

created a barrier to the reentry of private capital to U.S. residential 

mortgage finance. The same observer noted that capital regulations and 

other requirements strongly favor obligations with a government 

guarantee over those supported by private capital.

FHA does not currently engage in single-family risk sharing. To protect 

the taxpayer by sharing risk with the private market, various industry 

observers have suggested that the agency explore this option. In 2002, 

the Millennial Housing Commission recommended that Congress 

authorize FHA to initiate single-family risk-sharing demonstration 

programs, stating that FHA should have broader authority to choose its 

partners, loss position, and types of credit enhancements (including 

reinsurance as well as insurance or reinsurance on pooled loans).55

 55The Millennial Housing Commission was established by Congress in 2000 to study the 

federal role in meeting the nation’s housing challenges. It issued a report in 2002, which 

includes recommendations for a variety of reforms to federal housing programs. See 

Meeting Our Nation’s Housing Challenges: Report of the Bipartisan Millennial Housing 

Commission (Washington, D.C.: May 2002). 

The 

report also stated that while FHA could absorb risk better than private 

lenders, potential partners could have superior risk assessment and 

management systems and might be able to provide access to new 

products and delivery systems targeting communities with underserved 

borrowers that FHA did not yet reach. In 2007, we found that a publicprivate risk-sharing arrangement would recognize the government’s ability 

Proposals for Entering into 

Risk-Sharing Agreements 

with Private Partners Vary
Page 33 GAO-13-682 FHA Viability and Market Presence

to spread risk.56 We also found that private mortgage industry participants

generally were more flexible and responsive to market pressures and 

better able to innovate and adopt new technologies quickly. Industry 

observers have continued to promote various forms of risk sharing to 

improve FHA’s financial condition.57

Two main approaches for risk sharing have been proposed by industry 

observers:

• Coinsurance. This approach would create agreements between FHA 

and private mortgage insurers. The private mortgage insurer would 

conduct an independent underwriting of the borrower and the 

mortgage being sought. If the borrower and the mortgage underwriting 

terms met the conditions that both FHA and the private insurer agreed 

on, the private insurer would take the first loss on the loan, and FHA 

would cover the remaining loss. One industry observer suggested that 

the agency should reduce taxpayer risk by assuming losses only after 

private partners absorbed first losses of 25 to 35 percent. Another 

risk-sharing arrangement between FHA and other partners could be a 

model similar to FHA’s Multifamily Risk-Sharing Programs through 

which the agency shares proportional risk at varying levels between 

10 and 90 percent with Fannie Mae, Freddie Mac, and housing 

finance agencies among others.

• Reinsurance. Large portfolio lenders and the enterprises will at times 

enter into reinsurance contracts with approved counterparties to sell 

portions of credit risk in their loan portfolios. According to a private 

mortgage insurer testifying before a congressional committee, this 

approach has the benefit of minimizing impacts on lenders and the 

potential to be implemented more quickly than a coinsurance 

arrangement. The representative noted that FHA should have the 

flexibility to selectively test such arrangements.

Risk sharing could affect taxpayers’ risk, according to industry observers. 

It could protect the taxpayer, not only because private partners would 

assume some of the risk but also because the quality of the underwriting 

might improve because private partners would want to minimize the 

 56See GAO-07-708. 

57Industry observers have proposed multiple methods of sharing risk. We discuss some of 

these proposals. 
Page 34 GAO-13-682 FHA Viability and Market Presence

likelihood of loss. However, to the extent that FHA would offer both full 

mortgage insurance and engage in risk sharing, it could be subject to 

adverse selection. That is, private partners could seek relatively low-risk 

borrowers for the shared-risk product, leaving FHA with the riskiest 

borrowers. One report notes that under risk-sharing agreements, private 

partners may act in other ways that are contrary to FHA’s interest.58 For 

example, according to this report, if FHA takes only a catastrophic loss 

position, the partner may have little incentive to minimize FHA’s losses 

once the partner’s maximum exposure level has been reached. Sharing 

risk on a pro rata basis, starting with the first dollar of loss and ending 

with the last dollar of loss, creates stronger incentives for FHA’s risksharing partners to use sound underwriting terms and service their loans 

diligently. We have found that this is particularly true when there is a more 

equal division of risk.59

Risk sharing would also affect the role that Ginnie Mae plays in 

guaranteeing timely payment of principal and interest on mortgagebacked securities. That is, like reducing FHA’s loan guarantee coverage 

below 100 percent, risk sharing changes the nature of Ginnie Mae’s 

exposure to counterparty risk, according to observers. Ginnie Mae would 

need to undertake assessment of a new class of counterparties—the 

private partner providing the insurance coverage—while continuing to 

assess the counterparty risk of its issuers, one observer noted. Ginnie 

Mae officials confirmed that any FHA risk-sharing agreements would 

increase the agency’s counterparty risk and noted that they would 

probably require issuers to hold more capital to mitigate this risk. One 

If FHA agrees to assume the first portion of loss 

on default, the partner may not feel the need to protect against a high 

incidence of claims as long as the loss severity is not expected to reach 

its maximum level of exposure. The partner would also need to be 

sufficiently capitalized or otherwise protected to withstand its portion of 

the loss. Also, one observer warned that FHA would be at risk because it 

lacked the capacity to analyze risk-sharing proposals, which could place it 

in a weak position with partners. Consistent with this, FHA officials told us 

that FHA would need to increase its staff and analytic capacity to safely 

implement risk-sharing agreements.

 58Sarah Rosen Wartell, Single-Family Risksharing: An Evaluation of its Potential as a Tool 

for FHA, prepared for the Millennial Housing Commission, June 2002. 

59See GAO, Housing Finance: FHA’s Risk-Sharing Programs Offer Alternatives for 

Financing Affordable Multifamily Housing, GAO/RCED-98-117 (Washington, D.C.: 

Apr. 23, 1998). 
Page 35 GAO-13-682 FHA Viability and Market Presence

paper emphasized that risk sharing would also require FHA to monitor 

counterparty risk and provided a number of approaches for doing so.60

Ultimately, any risk-sharing arrangement would need to carefully consider 

the structure of premiums and the way they were shared between parties. 

Identifying the type and level of premium needed by the federal 

government requires considering not only expected losses from loans that 

default and losses exceeding a predetermined level, but also unexpected 

losses from infrequent but costly adverse market conditions on both the 

national and regional level. Some argue that the federal government 

would still absorb catastrophic risk regardless of how risk sharing and 

premiums are structured. In this case, FHA would need to receive 

premiums across a broad spectrum of the market.

In addition, like other options for improving FHA’s viability, risk sharing 

could impact other mortgage market participants and reduce borrowers’

access to credit, according to observers. Depending on how FHA 

structured risk sharing, including how widely it would be applied to FHA’s 

future endorsements, this option could reduce participation by smaller 

mortgage lenders, particularly community banks, which might have 

difficulty meeting the eligibility criteria for such a program, according to 

some industry observers. Others have expressed concern that risk 

sharing could raise the cost of the mortgage credit, as private investors 

would demand a market rate of return. While this trade-off might be 

viewed as acceptable in terms of improved underwriting, in times of 

market contraction risk sharing could significantly raise the cost and limit 

the availability of credit to borrowers, according to one observer. That is, 

FHA’s role in stabilizing mortgage markets could be affected by its 

partners’ willingness to continue underwriting during market contractions. 

This may limit FHA’s ability to serve as a countercyclical force during 

such national or regional housing downturns.

 60Rosen Wartell, Single-Family Risksharing. According to the author, counterparty risk 

management in risk sharing might involve: (1) monitoring carefully the performance of the 

product for which the parties share risk, understanding not only your own revenue 

expectations and risk exposure, but that of the counterparty; (2) understanding the other 

business lines of the risk-sharing partner and monitoring carefully their performance; (3) 

monitoring the financial health of the risk-sharing partner and its ability to meet its 

obligations, especially in economic stress conditions; (4) requiring appropriate segregation 

of revenues from the risk-sharing product; (5) mandating that the partner maintain certain 

reserves, levels of liquidity, and capital ratios; and (6) mandating that the partner maintain 

certain ratings from independent ratings agencies. 
Page 36 GAO-13-682 FHA Viability and Market Presence

Some of the literature we read stressed the importance of FHA serving a 

countercyclical role, as it has in the past, including by mitigating the effect 

of the 2007-2009 financial crisis on the housing market. One observer 

cautioned that broad changes, such as risk sharing, applied to FHA’s 

entire portfolio, or too quickly implemented without a full understanding of 

the potential effects of the change, could reduce its flexibility to adjust to 

larger housing market shifts. Others have stated that risk sharing might 

constrain the agency’s countercyclical flexibility because FHA and its 

private partners might not have the same incentives. During a downturn, 

private partners in risk-sharing arrangements would likely lack the 

incentive to serve deteriorating markets. Further, if FHA could endorse 

only loans that involved a private partner, a contraction of private credit 

could prevent it from expanding when such action was needed most. 

Another observer encouraged a small, discretionary or piloted approach 

to any risk-sharing program, suggesting that it was not necessary to make 

this option mandatory for each new endorsement. FHA officials cautioned 

that risk sharing should only be considered in the context of broad 

mortgage market reform, which has yet to be resolved.

Although FHA is a wholly owned government corporation within HUD, it 

does not have the corporate powers other government corporations have. 

Some mortgage industry observers have suggested that making FHA an

independent government corporation—more autonomous from HUD—

could give it greater operational and managerial flexibility and the ability 

to be nimble when faced with changes in the housing market or problems 

in its programs. For example, FHA could have enhanced enforcement 

powers, greater authority to make changes to program requirements, and 

additional authorities to invest in technology and staff. Some of these 

authorities would bring FHA’s corporate powers more in line with other 

government corporations. However, FHA and others said that these 

flexibilities could be implemented within FHA’s existing organizational 

structure. But even within the existing structure, many of these options 

would require congressional action to implement. Further, these reform 

options are not mutually exclusive—that is, one or more options could be 

implemented—and implementation of these options would involve tradeoffs between, for example, congressional direction and agency flexibility, 

or between efforts to minimize costs to borrowers and to make the 

program self-sustaining.

Greater Operational 

and Managerial 

Powers Could Give 

FHA Greater 

Flexibility but Could 

Limit Congressional 

Direction
Page 37 GAO-13-682 FHA Viability and Market Presence

Some mortgage industry observers have suggested that making FHA an 

independent government corporation could increase its flexibility to 

respond to changing market conditions and mitigate risks. FHA is a wholly 

owned government corporation within HUD but does not have some of 

the powers that other government corporations have.61 Specifically, 

Congress sometimes exempts government corporations from key 

management laws to provide them with greater flexibility than federal 

departments and agencies typically have in hiring employees, paying 

these employees competitive salaries/benefits, disclosing information 

publicly, and procuring goods and services. In 1995, we assessed the 

extent to which FHA and other government corporations had to comply 

with 15 selected federal statutes.62 FHA reported that it had to comply 

with 14 of the 15 federal statutes, while other government corporations 

reported greater flexibility.63

Some observers have suggested that one way to give FHA increased 

flexibility would be to increase its corporate powers. For example, a 1994 

National Academy of Public Administration study stated that FHA’s 

For example, Amtrak reported full adherence 

to two statutes. In addition, when FHA was moved within HUD in 1965, 

Congress assigned the corporate powers of FHA to the Secretary of 

HUD, who has delegated them to the Assistant Secretary for 

Housing/FHA Commissioner.

 61FHA was created as a separate entity by the National Housing Act on June 27, 1934. It 

was later abolished as a separate entity and made an entity within HUD by the 

Department of Housing and Urban Development Act on September 9, 1965. 

62The 15 federal statues we considered were the Privacy Act of 1974 (5 U.S.C. 552a), 

Freedom of Information Act of 1966 (5 U.S.C. 552), Government in the Sunshine Act (5 

U.S.C. 552b), Title 5: Employee Classification (5 U.S.C. 5101-5115), Title 5: Pay Rates 

and Rate Systems (5 U.S.C. 5331-5338 and 5341-5349), Federal Property and 

Administrative Services Act of 1949 (41 U.S.C. 251-260), Federal Tort Claims Act (28 

U.S.C. 2671, et seq.), Federal Managers Financial Integrity Act of 1982 (31 U.S.C. 3512 

(b), (c)), Anti-Deficiency Act (31 U.S.C. 1341), Government Corporation Control Act of 

1945 (31 U.S.C. 9101, et seq.), Government Performance and Results Act of 1993 (Pub. 

L. No. 103-62, Aug. 3, 1993), Chief Financial Officers Act of 1990 (Pub. L. No. 101-576, 

Nov. 15, 1990, as amended), Inspector General Act of 1978 (5 U.S.C. app.), Federal 

Credit Reform Act of 1990 (2 U.S.C. 661-661f), and Ethics in Government Act of 1978

(Pub. L. No. 95-521, Oct. 26, 1978, as amended). See GAO, Government Corporations: 

Profiles of Existing Government Corporations, GAO/GGD-96-14 (Washington, D.C.: Dec. 

13, 1995). 

63At that time, FHA told us that it was not subject to the Federal Property and 

Administrative Services Act of 1949 but had administratively adopted the statute’s 

requirements. Ginnie Mae, another corporation within HUD, reported full adherence to 12 

of the 15 statutes. 

Making FHA an 

Independent Government 

Corporation Could Provide 

It with More Flexibility
Page 38 GAO-13-682 FHA Viability and Market Presence

commissioner did not have the flexibility to adjust FHA products to 

respond to changing market conditions, such as fluctuating interest rates, 

and that the commissioner had to operate within the budgeting and 

administrative parameters of a traditional federal agency.64 The report 

recommended that Congress transfer the corporate powers of FHA from 

the HUD secretary to the corporation, permitting it to function with greater 

operational autonomy within HUD. It also recommended that Congress 

vest management of FHA in a single administrator appointed by the 

President, with Senate confirmation for a 6-year term of office. Under this 

proposal, the administrator would be compensated at the same level as 

the chief executive officer of comparable government corporations. In 

2002, the Millennial Housing Commission made a similar proposal, but its 

proposal would combine FHA and Ginnie Mae and establish a corporate 

board of directors.65

Other observers have suggested moving FHA outside of HUD. For 

example, one paper suggested organizing FHA as an independent 

government agency, a government-sponsored enterprise, or even a 

privatized entity structured as an assigned risk pool that would spread risk 

for otherwise uninsurable borrowers across insurance carriers in 

proportion to the size of their portfolios.

Recently, some observers have suggested similar 

structures.

66

 64See National Academy of Public Administration, Renewing HUD: A Long-Term Agenda 

for Effective Performance, report prepared for HUD (Washington, D.C.: July 1994). 

Because FHA’s organizational structure has changed little since 1994, we determined that 

this report was still relevant. 

According to the author, any of 

these structures could make underwriting, pricing, and administration 

more efficient while achieving what he viewed as the agency’s social 

objectives of providing credit enhancements through insurance to serve 

otherwise marginal low-income, first-time, and often minority homebuyers. 

He further stated that the FHA commissioner should have an appointment 

independent of HUD and for a term that would extend beyond a single 

administration term. Another observer testified that setting up FHA 

outside of HUD would reduce incentives for future administrations to 

impose policies on FHA that limited its flexibility and increased risks. 

However, two observers we interviewed said that making FHA an 

independent corporation outside of HUD would make it more difficult for 

65Millennial Housing Commission, Meeting Our Nation’s Housing Challenges. 

66Kerry D. Vandell, “FHA Restructuring Proposals: Alternatives and Implications,” Housing 

Policy Debate, vol. 6, issue 2 (1995). 
Page 39 GAO-13-682 FHA Viability and Market Presence

Congress to hold it accountable. FHA, which was created in 1934, 

operated outside of a cabinet department for decades before becoming 

part of HUD, which was created in 1965. In addition, some people we 

interviewed said that FHA should remain affiliated with HUD so that it 

could collaborate closely with other department offices on housing policy 

and remain part of a cabinet-level agency.

According to the literature, making FHA more autonomous could provide 

it the flexibility to determine the best way to meet policy goals set by 

Congress or HUD and mitigate risk. For example, in a congressional 

testimony an observer suggested that FHA be provided the authority, 

without further congressional action, to create or alter specific insurance 

programs. Such authority, the observer argued, would enable FHA to 

react promptly to changes in market and other conditions. In addition, the 

observer stated that hiring, salaries, personnel management, and 

procurement could be freed from federal government constraints in order 

to be more consistent and competitive with the private sector. Some of 

the literature we reviewed noted that FHA had exercised greater control 

over its resources when it was independent of HUD.

However in June 2007, we found that making FHA an independent 

government corporation could have budgetary and oversight implications 

that would need to be considered.67

 67

For example, Congress would have 

to determine the extent to which (1) the corporation’s earnings in excess 

of those needed for operations and reserves would be available for other 

government activities and (2) the corporation would be subject to federal 

budget requirements. Also, if the corporation were created outside of 

HUD, Congress would have to consider whether oversight of the 

corporation would require a new institution or could be done by an 

existing organization. In addition, an observer said that making FHA an 

independent government corporation or providing it with certain 

flexibilities, such as powers to change its products, could make FHA 

loans more attractive to borrowers who should be served by the private 

sector. Although such autonomy would also permit FHA greater capacity 

to manage risk, two observers we interviewed suggested that any 

additional autonomy or flexibility should be accompanied by clear 

direction on FHA’s mission to serve borrowers not otherwise served by 

the private sector.

GAO-07-708.
Page 40 GAO-13-682 FHA Viability and Market Presence

FHA and others have said that although making the agency an 

independent government corporation could increase the agency’s 

flexibility, the agency could be given increased flexibility without such 

changes. For example, mortgage industry observers have suggested 

giving FHA enhanced enforcement powers, greater authority to make 

changes to program requirements, and additional authorities to invest in 

technology and staff. Many of these options would require congressional 

action to implement. Notwithstanding the potential benefit and costs of 

these options, there are a number of steps that FHA could undertake 

under its existing authority, including actions we have previously 

recommended.

In order to originate FHA-insured loans, lenders must be approved by 

FHA to participate in its mortgage insurance programs. Virtually all of the 

lending institutions approved to participate in FHA’s single-family 

mortgage insurance programs have direct endorsement authority, 

meaning that they can underwrite loans and determine their eligibility for 

FHA mortgage insurance without HUD’s prior review. Direct endorsement 

lenders can apply to participate in the Lender Insurance Program, which 

enables high-performing lenders to approve mortgages for FHA insurance 

without a pre-endorsement review by HUD. To hold lenders accountable 

for program violations or poor performance, FHA may (1) suspend their 

direct endorsement authority, (2) terminate their loan origination or 

underwriting authority through its Credit Watch program, or (3) take 

enforcement action through the Mortgagee Review Board.68

 68Under the Credit Watch Program, FHA has the authority to address deficiencies in a 

lender’s performance by terminating a lender’s approval to originate or underwrite FHAinsured loans in an area where its default and claim rate exceeds the established 

thresholds. The termination of a lender’s approval using the Credit Watch default and 

claim analyses is separate and apart from any action taken by the Mortgagee Review 

Board. The Mortgagee Review Board is empowered to take administrative action against 

FHA-approved lenders that are not in compliance with FHA lending requirements such as 

entering into settlement agreements with lenders to bring them into compliance or 

withdrawing a lender’s FHA approval so the lender cannot participate in FHA programs. 

The Board can also impose civil money penalties, probation, and suspension and issue 

letters of reprimand. 

FHA Could Gain Greater 

Flexibility without 

Changing Its 

Organizational Structure

Giving FHA Enhanced 

Enforcement Powers
Page 41 GAO-13-682 FHA Viability and Market Presence

In its proposed budget for fiscal year 2014, FHA requested a number of 

additional enforcement powers. Specifically:

• Since 2010, FHA has asked for enhanced indemnification authority for 

direct endorsement lenders.69 Currently, FHA has authority to require 

indemnification only for lenders that participate in FHA’s Lender 

Insurance Program. According to FHA, granting the agency this 

authority would enable it to obtain indemnification from all of its 

approved lenders for loans that do not comply with its guidelines. 

Legislation proposed in March 2013 includes a provision intended to 

address this issue.70

• HUD may terminate a lender’s approval to originate or underwrite 

FHA-insured loans in a specific geographical area if a lender’s branch 

office default and claim rate exceeds the established Credit Watch 

Termination thresholds.71 However, FHA is also seeking authority to 

terminate origination and underwriting approval on a broader 

geographic basis, stating that such authority would enhance its ability 

to review lender performance. If a lender was found to have an 

excessive rate of early defaults or claims, FHA would have greater 

flexibility in terminating the lender’s ability to originate or underwrite 

single-family mortgages for FHA insurance. FHA has been seeking 

this authority since 2010. Again, the 2013 proposed legislation 

includes such a provision.

• To help make loss mitigation more effective, FHA is seeking authority 

to, on a case-by-case basis, transfer servicing of loans to institutions 

 69Indemnification agreements require lenders to repay FHA for any losses that it incurs 

after a loan defaults and the property has been sold. 

70The FHA Emergency Fiscal Solvency Act, H.R. 1145 (2013). 

71Under Credit Watch, FHA considers terminating a lender’s authority to originate loans in 

a specific geographical area if a lender’s branch office default and claim rate exceeded the 

national average and also exceeded the average local HUD field office default and claim 

rate by 200 percent. If a lender had more than one branch office facing Credit Watch 

termination action in a particular period, FHA can decide to evaluate the overall 

performance of the lender in the field office jurisdiction and, if unacceptable, terminate a 

lender’s ability to originate and underwrite loans in the entire jurisdiction. 
Page 42 GAO-13-682 FHA Viability and Market Presence

better equipped to reduce losses.72 Specifically, this authority would 

allow FHA to require any of the following actions when a servicer 

underutilized FHA’s loss-mitigation tools or the agency deemed the 

action necessary to protect the interests of the Fund: (1) transfer 

servicing from the current servicer to a specialty servicer designated 

by FHA; (2) require a servicer to enter into a subservicing 

arrangement with an entity identified by FHA; or (3) require a servicer 

to engage a third-party contractor to assist in some aspect of loss 

mitigation such as borrower outreach. According to FHA, such 

authority would permit the agency to better avoid losses from poor 

servicing of FHA-insured loans, yielding better results for borrowers 

and FHA.

• Finally, FHA is seeking greater flexibility in establishing the metrics it 

uses to compare lender performance so that it can more effectively

assess lender performance during all market conditions. As discussed 

previously, FHA is currently required by statute to compare lenders’

default and claim rates by geographic area. With enhanced authority 

to set alternative performance metrics, FHA said it would be able to 

compare a lender’s rate of early defaults and claims (for insured 

single-family mortgage loans) with the rates of other lenders on any 

basis determined appropriate. Examples of metrics include 

geographic area, varying underwriting standards, or populations 

served.

The majority of the observers we interviewed said that FHA needed 

authority for enhanced enforcement actions. For example, some said that 

FHA needed these additional powers to more effectively manage risk and 

avoid unnecessary losses. Others suggested additional options—for 

example, requiring lenders to take back loans that defaulted within the 

first 6 months. However, one observer said that the prospect of tough 

administrative and legal actions already provided strong incentives for 

lenders to carefully follow FHA program guidelines. Two stakeholders we 

interviewed stated that increased scrutiny of lenders by FHA and others 

had increased concern among lenders about the risks of litigation. As a 

result, lenders have moved to further restrict credit in recent years. Many 

 72When home buyers fall behind on their mortgage obligations, FHA instructs mortgage 

servicers (typically large financial institutions) to assist the home buyers in bringing their 

mortgage payments current, because foreclosure proceedings can impose high costs on 

financial institutions and homeowners. These and other efforts are referred to as “loss 

mitigation.”
Page 43 GAO-13-682 FHA Viability and Market Presence

FHA lenders have taken the step of imposing additional requirements 

(known as credit overlays) on FHA loans, potentially making it more 

difficult for borrowers to obtain FHA loans.

FHA and some mortgage industry observers have suggested that the 

agency should have more authority to make changes to program 

requirements, including emergency powers. Currently, FHA must go 

through the rulemaking process or seek legislative authority to make 

major changes to its programs. For example, after problems with loans 

with seller-funded down-payment assistance were identified, it was 

several years before these loans were disallowed. HUD’s latest annual 

report on the Fund noted that the effect of loans with seller-funded downpayment assistance on the Fund was expected to be more than $15 

billion in losses.73 Problems associated with these loans are well 

documented. A March 2005 HUD contractor study found that property 

sellers who provided down-payment assistance through nonprofits often 

raised sale prices of the homes involved to recover the required 

payments that went to the organizations.74 As noted previously, in 

November 2005, we also found that loans with this type of assistance had 

inflated prices and defaulted more often than loans without such 

assistance.75

FHA is currently trying to address losses from its HECM program (reverse 

mortgages that permit persons 62 years and older to convert their home 

equity into cash advances), but has not been able to make programmatic 

changes that it has determined might stem them. In a testimony on HUD’s 

fiscal year 2014 proposed budget, the Secretary attributed the potential 

need for $943 million in permanent and indefinite budget authority for the 

In October 2007, FHA published a rule that prohibited sellerfunded down-payment assistance. Subsequently, the rule was struck 

down by the courts on procedural grounds. Congress ultimately prohibited 

the use of this assistance in January 2009.

 73HUD, Annual Report to Congress Regarding the Financial Status of the FHA Mutual 

Mortgage Insurance Fund, Fiscal Year 2012 (Washington, D.C.: Nov. 16, 2012). 

74Concentrance Consulting Group, An Examination of Downpayment Gift Programs 

Administered by Nonprofit Organizations, prepared for the U.S. Department of Housing 

and Urban Development (Washington, D.C.: March 2005). 

75See GAO-06-24. 

Giving FHA Greater Authority 

to Change Program 

Requirements, Including 

Emergency Powers
Page 44 GAO-13-682 FHA Viability and Market Presence

Fund in fiscal year 2013 to losses in the HECM program.76 FHA has 

proposed a number of changes to the HECM program, such as 

mandating the use of escrow accounts to ensure continued and timely 

payment of property charges, including taxes and insurance. However, 

FHA officials said that the average time for a rulemaking of this type was 

about 18 months—a length of time that exposed the agency and the Fund 

to risks that could be avoided if, for example, it could make changes 

through a mortgagee letter. Recently, FHA was provided authority to 

establish through mortgagee letters any requirements that HUD 

“determines are necessary to improve the fiscal safety and soundness” of 

the HECM program.77

Several proposals have been put forward that would increase FHA’s 

ability to make changes to its programs. One observer has recommended 

that Congress give the HUD secretary special emergency powers to 

suspend FHA insurance programs or make emergency modifications to a 

program when the HUD secretary finds that current program terms 

expose the taxpayers to an elevated risk of loss and fail to serve the 

public interest. In addition, a paper that lays out the current 

administration’s plan to reform the nation’s housing finance market stated 

that the administration should work with Congress to give FHA more 

FHA officials told us that a mortgagee letter could 

be issued within 30 to 60 days. Another approach to dealing with the 

issue would be to limit the ability of borrowers to withdraw up-front the 

maximum amount allowable under the program. HUD noted that the vast 

majority of borrowers in the HECM program take out 80 percent or more 

of the maximum amount possible in one initial cash draw, and that this 

increases the likelihood that they have insufficient funds to pay items 

such as property taxes. In its November 2012 annual report to Congress, 

FHA announced that it would take immediate action to reduce the amount 

borrowers are permitted to draw out at the time of origination of their 

HECM loan. The report notes that the change would protect FHA from 

losses and reduce the likelihood of borrower default due to nonpayment 

of taxes and insurance. Although FHA points to other actions that will be 

needed to reform the HECM program, this example demonstrates the 

importance of FHA exercising the authority it already has.

 76Shaun Donovan, Secretary of the U.S. Department of Housing and Urban Development, 

FY 2014 Budget Request for the Department of Housing and Urban Development, 

testimony before the Senate Committee on Appropriations Subcommittee on 

Transportation, Housing and Urban Development, and Related Agencies, 113th Cong., 

1st sess., April 11, 2013.

77Pub. L. No. 113-29 (enacted August 9, 2013). 
Page 45 GAO-13-682 FHA Viability and Market Presence

flexibility to respond to stress in the housing market and manage its risk 

more effectively.78

Two observers we interviewed expressed concern about giving FHA 

greater authority to make significant program changes, stating that such 

authority should be reserved for Congress. One noted that during the 

recent housing crisis Congress showed that it was able to act quickly to 

change FHA program requirements when needed by increasing the loan 

limit requirements. Also, he told us that FHA did not need congressional 

action to change its programs. For instance, FHA could create an interim 

rule to quickly handle a problem while going through the official 

rulemaking process to make a permanent change.

It added that doing so would mean giving FHA 

flexibility to adjust fees and programmatic parameters more quickly than it 

can today. Regardless, two observers pointed to the need for offsetting 

any additional flexibility that might be afforded to FHA with clear limits to 

this authority, such as limits on the duration of such changes absent a 

formal rulemaking process.

79

FHA has reported that the more than 40 information systems its singlefamily programs use are outdated, unable to sustain the increasing 

volume of insurance applications, and costly to maintain. In addition, 

Similarly, the other 

observer said that FHA could make some changes through mortgagee 

letters and the rulemaking process. However, according to FHA, HUD’s 

Office of General Counsel has advised that not all procedures or policies 

may be changed by interim rule and interim rules can be particularly 

sensitive to litigation and a legal stay. Thus it is the General Counsel’s 

opinion that statutory authority is often the safest and fastest route to 

make changes. 

 78Treasury and HUD, Reforming America’s Housing Finance Market. 

79The basic process by which agencies develop and issue regulations is spelled out in the 

Administrative Procedures Act (APA) (5 U.S.C. §§ 551–570a). APA generally requires 

agencies to (1) publish a notice of proposed rulemaking (NPRM) in the Federal Register; 

(2) allow interested persons an opportunity to comment on the rulemaking process by 

providing “written data, views, or arguments;” (3) issue a final rule accompanied by a 

statement of its basis and purpose; and (4) publish the final rule at least 30 days before it 

becomes effective. However, prior notice and public comment is not always required. APA 

allows agencies to issue final rules without the use of an NPRM in certain cases, including 

when the agency determines for “good cause” that notice and comment procedures are 

“impracticable, unnecessary, or contrary to the public interest” (5 U.S.C. § 553(b)(B)). One 

common type of rule often issued without an NPRM is the interim final rule, which 

generally is effective immediately but provides an opportunity for public comment after the 

rule’s issuance. 

Providing FHA with Additional 

Funding to Upgrade 

Information Technology
Page 46 GAO-13-682 FHA Viability and Market Presence

recent increases in FHA’s business volume have exacerbated its 

information technology (IT) constraints. A consultant FHA hired to 

examine technology constraints and identify risks related to processing 

workloads (for single-family programs) reported in 2009 that critical 

elements of IT infrastructure were at capacity, causing work slowdowns 

and poor customer service. For example, network overloads slowed 

systems in the afternoon, when work hours overlapped at the 

homeownership centers (which are in different time zones). To partially 

address these issues, HUD upgraded the mainframe’s system capacity 

and made changes to certain applications to improve response time. 

Nevertheless, during a period in which transaction levels continued to 

increase, FHA had reached the limit of hardware and software capacity 

on IT systems.

Moreover, the audit of FHA’s 2011 and 2012 financial statements 

identified a significant deficiency related to IT systems and stated that 

FHA management and the HUD Office of the Chief Information Officer 

should mitigate persistent IT control deficiencies.80 The audit report noted 

that expensive and manual compensating controls, including monthly 

reconciliations of data among the interfaced systems, were needed to 

manage the numerous systems and that security and access controls had 

weaknesses. We found in November 2011 that the large number of 

systems resulted in hundreds of interfaces, which meant that changing 

one system required extensive effort to maintain the interfaces across 

systems.81

To address system constraints, FHA has initiated the FHA Transformation 

Initiative to improve FHA’s management of insurance programs through 

the development and implementation of a modern financial services 

information technology environment that is expected to improve loan 

endorsement processes, collateral risk capabilities, and fraud 

prevention.

The multiple systems and interfaces also presented 

challenges for maintaining appropriate accessibility levels, security 

controls, and privacy standards.

82

 80A significant deficiency is one or a combination of deficiencies in internal control that is 

less severe than a material weakness, yet important enough to merit attention by those 

charged with governance. 

For fiscal years 2010 and 2011, HUD reported that the 

81GAO, Federal Housing Administration: Improvements Needed in Risk Assessment and 

Human Capital Management, GAO-12-15 (Washington, D.C.: Nov. 7, 2011). 

82This environment is expected to provide case management for the life cycle of a loan 

and capture data from the loan origination and underwriting processes. 
Page 47 GAO-13-682 FHA Viability and Market Presence

Transformation Initiative funding made available was $58.5 million.83

According to FHA, the agency maintains an aggressive, robust, and 

varied project management and applications development portfolio aimed 

at deploying new and modernizing existing mortgage insurance 

capabilities and business processes. In June 2013, we found that HUD 

had not yet fully implemented key project management practices in 

executing and managing the IT projects associated with the FHA 

Transformation Initiative.84

However, some mortgage industry observers said FHA should be 

provided with additional funding to enhance its information technology. 

The congressionally appointed Millennial Housing Commission found that 

FHA’s dependence on the appropriations process for budgetary 

resources and competition for funds within HUD had led to 

underinvestment in technology, increasing the agency’s operational risk 

and making it difficult for FHA to work efficiently with lenders and other 

industry partners.

Specifically, while the department had 

developed project management documents such as charters and 

requirements management plans, none of these documents included all 

of the key details that could facilitate effective management of its projects 

such as full descriptions of the work necessary to complete the projects, 

cost and schedule baselines, or prioritized requirements, among other 

things. A lack of project management expertise along with HUD’s 

inadequate development and use of a project management framework 

and governance structure contributed to these deficiencies. Therefore, we 

recommended that HUD establish a plan of action to fully implement best 

practices, provide needed project management expertise, and improve 

the development and use of its project management framework and 

governance structure. HUD agreed with our recommendations to improve 

its framework and governance, but did not agree with the entirety of the 

recommendation to develop a plan of action or the need for providing 

project management expertise. The department described actions it 

would take to improve its project management practices in order to 

address the deficiencies identified.

85

 83HUD, HUD Transformation Initiatives Information Technology Fiscal Year 2011 

Expenditure Plan (Washington, D.C.: December 2011). 

Some observers we spoke with also cited competition 

for funds within HUD, and most supported providing FHA additional 

84GAO, Information Technology: HUD Needs to Improve Key Project Management 

Practices for Its Modernization Efforts, GAO-13-455 (Washington, D.C.: June 12, 2013). 

85Millennial Housing Commission, Meeting Our Nation’s Housing Challenges.
Page 48 GAO-13-682 FHA Viability and Market Presence

funding for these enhancements. One benefit of this option is that the 

technology enhancements could improve FHA’s operations. For example, 

an observer said that it supported the recent efforts that FHA had taken to 

improve its risk management and protect the safety and soundness of the 

agency, but added that these efforts could not be sustained without, 

among other things, state-of-the-art technology.

FHA officials also told us that the agency’s limited resources meant 

implementing technology improvements using a piecemeal approach, 

although it would be better if FHA could upgrade and integrate all of its 

systems at the same time. Specifically, the agency stated that sustained 

and timely funding through using receipts or direct appropriation would 

enable FHA to budget and procure support and services more 

strategically, systematically, and consistently.

In the current budget environment, funding for technology enhancement 

is limited. FHA technology investments must compete with other HUD 

technology investments. Some observers argue that FHA should be 

granted the authority to use a portion of its insurance premiums for 

technology enhancement.86 In a June 2007 report on FHA modernization, 

we found that Congress could grant FHA specific authority to invest a 

portion of the Fund’s current resources—that is, negative subsidies that 

accrue in the Fund’s reserves—in technology enhancement.87

 86Currently, FHA does accumulate reserves to cover the costs associated with insurance 

claims but may not use them for administrative expenses, such as salaries and 

technology. Rather, these expenses are paid from direct federal appropriations. The 

administrative expenses of other federal credit programs such as RHS’ single-family 

guaranteed loan program are also paid through direct appropriations rather than through 

program revenue. On the other hand, another federal credit program, the Export-Import 

Bank, is required to pay for administrative expenses out of fees it collects. 

However, 

FHA has not met its statutory capital ratio requirement since 2009 and 

using premium income for technology enhancement would further reduce 

the ratio. Even in more prosperous times, using the Fund’s current 

resources would have implications. Specifically, in our June 2007 report 

we found that using the Fund’s current resources for information 

technology would diminish its ability to withstand severe economic 

conditions and would also increase the federal government’s budget 

deficit, all other things being equal. Further, requiring FHA to use program 

revenue to pay for administrative costs could require it to increase the 

premiums charged to borrowers. To the extent that having greater control 

87GAO-07-708. 
Page 49 GAO-13-682 FHA Viability and Market Presence

over resources might improve agency efficiency and effectiveness, FHA 

may limit any potential premium increases needed to cover administrative 

expenses.

Congress also could consider allowing FHA to compensate its employees 

outside of federal pay scales. In November 2011, we reported that from 

2006 to 2010, Single Family Housing field staffing levels remained 

relatively constant, while key workload items, such as volume-driven loan 

reviews and the management of foreclosed homes, grew considerably.88

As a result, it may be difficult for FHA staff to mitigate risk. Some federal 

agencies, such as the Securities and Exchange Commission, the Federal 

Deposit Insurance Corporation, and FHFA, are permitted to pay salaries 

above normal federal pay scales in recognition of the special skills 

demanded by sophisticated financial market operations.89

 88

FHA and some 

mortgage industry observers have suggested that FHA be given similar 

authority. FHA officials told us that in order to appropriately manage the 

Fund, FHA needs a mix of staff with industry expertise, including those 

with strong operations management, and that flexibility in compensation 

would help FHA accomplish the right balance. An observer suggested 

that giving the HUD secretary authority to hire risk management, analytic, 

and technological system staff on a more generous pay scale could close 

some of the gap between private market participants and those charged 

with protecting taxpayers from economic harm. In addition, another 

observer recommended that FHA have the ability to more broadly use 

retention allowances and recruitment bonuses. This option could help 

FHA to recruit experienced staff to help the agency adapt to changes. 

Some suggest that, as with investments in technological enhancements, 

enhancements in compensation could be funded with the Fund’s premium 

income. The effect would be to provide FHA greater flexibility, but also 

would require program participants to absorb administrative costs that are 

currently borne by direct federal appropriation or would reduce resources 

available to pay claims and reduce the capital ratio.

GAO-12-15. 

89In 1989, the Financial Institutions Reform, Recovery and Enforcement Act (Pub. L. No. 

101-73) authorized certain financial regulators to determine their own compensation and 

benefits so that they could more effectively compete in the marketplace for qualified 

applicants. In 2002, the Investor and Capital Markets Fee Relief Act (Pub. L. No. 107-123) 

and in 2008, the Housing and Economic Recovery Act of 2008 gave the Securities and 

Exchange Commission and FHFA, respectively, similar authority as those federal banking 

regulatory agencies. These agencies are permitted by statute to pay salaries in excess of 

the Title 5 ceilings. 

Allowing FHA to Pay Its 

Employees Outside of Federal 

Pay Scales
Page 50 GAO-13-682 FHA Viability and Market Presence

Some mortgage industry observers have suggested that Congress give 

FHA authority to implement pilot programs. For example, one noted that 

too often the statutory and regulatory environment for FHA leads to “all or 

nothing” policy changes, although private mortgage industry participants 

frequently tested new strategies before applying them to an entire 

portfolio. She recommended that FHA be given authority to implement 

pilot programs quickly with the goal of better understanding, measuring, 

and mitigating risk. In addition, the Millennial Housing Commission found 

that the statutes and regulations to which FHA was subject dramatically 

increased the time necessary to develop and implement new products. It 

recommended that Congress expressly authorize FHA to introduce new 

products without requiring a new statute for each. In a June 2007 report, 

we found that such authority would offer FHA greater flexibility to keep 

pace with the rapidly changing mortgage market.90

In a February 2005 report, we recommended that FHA consider using 

pilots for new products and for any planned significant changes to its 

existing products.

However, we 

determined that Congress would have less control over FHA’s product 

offerings and that in some cases it might take years before a new 

product’s risks were well understood.

91

 90See 

Because FHA officials had questioned the 

circumstances under which they could use pilots when not required to do 

so by Congress, we also recommended that FHA seek the authority to 

offer new products on a limited basis, such as through pilots, if the 

agency determined that it lacked sufficient authority. In comments on the 

report, HUD did not specifically state whether it agreed with the 

recommendations. Rather, it stated that it was in basic agreement with 

GAO that all policy options, implications, and implementation methods 

should be evaluated when considering or proposing a new FHA product. 

For this review, however, FHA officials told us that FHA had the 

appropriate level of authority to pilot programs and had successfully 

piloted several. For example, FHA piloted a program that allowed lenders 

to sell foreclosure properties securing nonperforming FHA-insured loans 

to third parties at a reserve price slightly below the property value without 

conveying the properties to FHA. According to FHA, the agency plans to 

expand the program after finding that this method of disposing of 

properties yields lower losses for the Fund than FHA’s normal disposition 

process.

GAO-07-708. 

91See GAO-05-194. 

Giving FHA Greater Authority 

to Pilot New Products
Page 51 GAO-13-682 FHA Viability and Market Presence

Even with no changes to its existing organizational structure and 

authorities, FHA can do more to enhance program efficiency and 

effectiveness and protect taxpayers. We have made a number of 

recommendations aimed at improving FHA’s information technology, loss 

mitigation efforts, management of real-estate owned inventories, risk 

assessment, and human capital management.92 As previously mentioned, 

we recommended in June 2013 that HUD establish a plan of action to 

fully implement best practices in management of information technology, 

provide needed project management expertise, and improve the 

development and use of its project management framework and 

governance structure.93 In addition, in June 2012 we recommended that 

FHA periodically analyze the effectiveness and the long-term costs and 

benefits of its loss mitigation strategies and actions to more fully 

understand their strengths and risks and protect taxpayers from 

absorbing avoidable losses to the maximum extent possible.94

FHA could also mitigate losses on mortgages that it insures by improving 

its recovery rate for foreclosures by, for example, improving the 

foreclosure process itself and the process for selling its inventory of 

foreclosed properties. In 2002, we found that FHA’s existing procedures 

could delay the start of critical steps necessary to preserve the value of 

This report 

found that several agencies, including FHA, were not conducting 

analyses to determine the effectiveness of their loss mitigation actions. 

The experiences of Treasury, the enterprises, and our econometric 

analysis strongly suggested that such analyses could improve outcomes 

and cut program costs. In November 2012, FHA announced revisions that 

were designed to reduce the number of full claims against the Fund. 

Specifically, FHA changed the steps that loan servicers must take to 

assist home buyers in bringing their mortgage payments current. We 

requested and plan to assess the analysis HUD completed as the basis 

for this change in FHA’s loss mitigation strategies to determine whether it 

fully responds to our recommendation. And as noted previously, FHA has 

proposed additional revisions to its loss mitigation and foreclosure 

processes that would require congressional action.

 92See, for example, GAO-13-455 and GAO-12-15.

93GAO-13-455. 

94GAO, Foreclosure Mitigation: Agencies Could Improve Effectiveness of Federal Efforts 

with Additional Data Collection and Analysis, GAO-12-296 (Washington, D.C.: June 28, 

2012). 

Managing within Existing 

Authority
Page 52 GAO-13-682 FHA Viability and Market Presence

foreclosed properties and sell them quickly.95 We pointed to the fact that 

FHA divided custody of foreclosed properties between servicers and 

contractors, which could prevent the initiation of critical maintenance 

necessary to make properties attractive to potential buyers. We 

recommended that HUD make establishing unified property custody a 

priority. In 2012, FHA announced that it was expanding a pilot that would 

permit such unified custody. Under the expanded pilot, FHA permitted 

loan servicers to maintain custody of properties from foreclosure sales 

through final disposition, relieving FHA of the responsibility for managing 

and selling these properties. Because this program is a pilot, FHA 

continues to take into its inventory foreclosed properties. According to 

FHA, it has taken steps to improve recovery through techniques such as 

using best execution modeling to ensure an optimal asset disposition 

approach. In June 2013, we recommended a number of ways that FHA 

could improve on the performance of these properties—for instance, by 

ensuring that price reductions were based on an evaluation of market 

conditions rather than on standardized schedules.96

In a November 2011 report, we recommended specific improvements that 

FHA could make to its risk assessment processes and human capital 

management.

FHA agreed with 

these recommendations and identified actions that it had taken or 

planned to take in response to them.

97

Finally, we previously reported on opportunities to increase collaboration 

among the agencies responsible for overlapping and fragmented housing 

We recommended that FHA (1) integrate two ongoing 

efforts to assess risk, (2) conduct an annual risk assessment, and (3) 

establish ongoing mechanisms to anticipate and address risks that might 

be caused by changing conditions. To improve human capital 

management, we recommended that FHA develop workforce and 

succession plans for the Office of Single Family Housing. Since our 

report, FHA has taken several actions, including developing a plan for 

conducting an inaugural risk assessment and a workforce analysis and 

succession plan.

 95GAO, Single-Family Housing: Opportunities to Improve Federal Foreclosure and 

Property Sale Processes, GAO-02-305 (Washington, D.C.: Apr. 17, 2002).

96See GAO, Federal Housing Administration: Improving Disposition and Oversight 

Practices May Increase Returns on Foreclosed Property Sales, GAO-13-542

(Washington, D.C.: June 20, 2013). 

97GAO-12-15. 
Page 53 GAO-13-682 FHA Viability and Market Presence

programs and activities, including those that support homeownership, 

with the potential for realizing efficiencies. In 2000, we suggested that 

Congress consider requiring RHS and HUD to examine the benefits and 

costs of merging programs serving similar markets and providing similar 

products.98 In 2012, we found that the administration had formed a task 

force to evaluate the potential for coordinating or consolidating loan 

programs at HUD, RHS, and VA.99

Following the collapse of the mortgage market, policymakers proposed a 

number of mortgage reforms that could impact FHA’s market share and 

role. These reforms could affect the willingness of the conventional 

market to serve future home buyers of varying credit risk profiles and the 

fees that lenders would charge for conventional loans. The administration 

has put forth several options for reforming the federal role in the mortgage 

market, including reforming the enterprises (Fannie Mae and Freddie 

Mac). Each of these options has potential implications for FHA. Some of 

our recent work—a 2009 report on options for resolving the enterprises 

and our 2013 high-risk series—discussed the trade-offs associated with 

However, we found that the task 

force’s efforts had not yet incorporated key collaborative practices. We 

therefore recommended that HUD, USDA, and VA, and the Director of the 

Office of Management and Budget (OMB) take steps to establish a more 

rigorous approach to collaboration. In addition, we recommended that 

officials from HUD, Treasury, USDA, and VA evaluate and report on the 

specific opportunities for consolidating similar housing programs, 

including those that would require statutory changes. HUD and OMB 

expressed concern about implementing the recommendations while HUD 

was focused on the ongoing housing recovery. As we stated in the report, 

in addition to focusing on the ongoing housing crisis and government 

support for the housing market, focusing on achieving efficiencies and 

cost savings and the delivery of government support for housing is 

important. Given its financial condition, now more than ever it is important 

that FHA optimize its effectiveness across all aspects of its operations.

 98See GAO, Rural Housing: Options for Optimizing the Federal Role in Rural Housing 

Development, GAO/RCED-00-241 (Washington, D.C.: Sept. 15, 2000). 

99See GAO, Housing Assistance: Opportunities Exist to Increase Collaboration and 

Consider Consolidation, GAO-12-554 (Washington, D.C.: Aug. 16, 2012).

Broader Housing 

Market Reforms 

Could Impact FHA’s 

Role
Page 54 GAO-13-682 FHA Viability and Market Presence

options for resolving the enterprises, as well as how these efforts could 

affect FHA.100

Recent statutory and regulatory changes related to qualified mortgages 

(QM) and qualified residential mortgages (QRM) have the potential to 

affect FHA’s market share. The 2010 Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank Act) required lenders to make a 

reasonable and good faith determination, based on verified and 

documented information, that borrowers seeking residential mortgages 

have a reasonable ability to repay the loan according to its terms.101 The 

Dodd-Frank Act also established a presumption of compliance with the 

ability-to-repay requirements for a certain category of mortgages called

QM. The ability to repay provisions are similar to those implemented by 

the Board of Governors of the Federal Reserve System (Federal Reserve 

Board) in 2008 but cover all mortgages.102 The Dodd-Frank Act shifted 

rulemaking authority for these provisions and QM from the Federal 

Reserve Board to the CFPB. On January 30, 2013, CFPB published its 

final rule on ability to repay and QMs (effective January 10, 2014).103

Among other things, CFPB’s final rule establishes general underwriting 

criteria for QMs, including that the borrower have a DTI ratio of less than 

or equal to 43 percent. As previously discussed, FHA underwriting 

standards allow some borrowers to have DTI ratios that are greater than 

43 percent. While acknowledging that many borrowers with high DTI 

ratios likely could afford mortgages, CFPB was concerned that lenders 

would not make loans to these consumers in light of the current economic 

conditions. As a result, CFPB expanded the definition of a QM to include 

 100See GAO, Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing 

Enterprises’ Long-term Structures, GAO-09-782 (Washington, D.C.: Sept. 10, 2009), and 

High-Risk Series: An Update, GAO-13-283 (Washington, D.C.: Feb. 14, 2013). 

101Pub. L. No. 111-203, sec. 1411 (15 U.S.C. sec 1539c(a)). 

102In 2008, the Federal Reserve Board adopted a rule under the Truth in Lending Act 

(Regulation Z) prohibiting lenders from making “higher-priced mortgage loans” without 

assessing borrowers’ ability to repay the loans. The Federal Reserve Board implemented 

this rule in response to lending practices—for example, using loose underwriting 

standards and attracting borrowers with misleading rates—that ultimately contributed to 

the housing crisis and recession. Lenders have had to follow these requirements since 

October 2009. See 73 Fed. Reg. 44522 

(July 30, 2008). 

103See 78 Fed. Reg. 6408 (Jan. 30, 2013). 

Recent Statutory and 

Regulatory Changes Could 

Affect FHA’s Market Share
Page 55 GAO-13-682 FHA Viability and Market Presence

any loan that is eligible to be purchased, guaranteed, or insured by 

various federal agencies, including FHA, VA, USDA, and USDA’s RHS, or 

by the enterprises while they are operating under conservatorship. This 

rule is temporary and in general will remain in effect until these agencies 

finalize their own QM regulations. According to FHA, the agency is 

currently developing its QM regulations.

The Dodd-Frank Act also requires mortgage securitizers to retain a 

financial exposure of no less than 5 percent of the credit risk of any 

securitized residential mortgage that does not meet a separate set of 

criteria (to be defined by regulators) that are associated with a lower risk 

of default.104 Securitized mortgages that meet these criteria are exempt 

from this risk retention requirement and are considered QRM. All FHAinsured mortgages are exempt from the risk-retention requirement, and 

Fannie Mae and Freddie Mac mortgages are exempt as long as the 

agencies are in conservatorship. Federal regulators published a proposed 

QRM rule on April 29, 2011, that included a 20 percent down-payment 

requirement.105 However, federal regulators issued another proposed rule 

on August 28, 2013.106

Because the QM and QRM regulations will affect whether and at what 

price the conventional market will be willing to serve higher-risk 

borrowers, some have suggested that they could push these borrowers to 

FHA. For example, a recent HUD paper outlined several factors that may 

make higher-risk borrowers migrate to FHA: (1) conventional lenders are 

unlikely to originate non-QM loans (which by definition are also non-QRM 

loans, as QRM is a subset of QM) because they will face significantly 

higher capital retention requirements; (2) lenders that are willing to 

The new proposed rule offers two approaches. 

The first approach would define a QRM to have the same meaning as the 

term QM defined by the CFPB and, thus, would not include a downpayment requirement. The alternative approach, which according to the 

regulators “was not selected as the preferred approach,” would require 

lenders to retain risk in any loan with a down payment of less than 30 

percent.

 104Through securitization, the purchasers (securitizers) package mortgages into pools and 

issue securities, for which the mortgages serve as collateral. These securities pay interest 

and principal to their investors. 

105See 76 Fed. Reg. 24090 (Apr. 29, 2011).

106As of August 30, 2013, the proposed rule had not yet been published in the Federal 

Register.
Page 56 GAO-13-682 FHA Viability and Market Presence

originate non-QM loans will do so only at a higher cost to the borrower; 

and (3) the April 2011 QRM proposal is quite narrow, requiring for 

example, that borrowers make a 20 percent down payment, which may 

be a difficult threshold for first-time borrowers to meet.107 Another paper 

we reviewed concurred, positing that the April 2011 proposed QRM rule 

could make it extremely difficult to securitize high-LTV loans made to firsttime home buyers and other borrowers who could prudently manage low 

down-payment mortgages, resulting in a flood of loans to the enterprises 

and FHA.108 Depending on how the enterprises are ultimately resolved, 

most of these loans could flow to FHA.

On September 6, 2008, FHFA placed Fannie Mae and Freddie Mac into 

conservatorship because of concern that their deteriorating financial 

condition threatened the stability of the financial markets. According to 

FHFA, the two enterprises had a worldwide debt and other financial 

obligations totaling $5.4 trillion at the time they were placed in 

conservatorship. Defaulting on those obligations would have significantly 

disrupted the U.S. financial system. While the conservatorships can 

remain in place indefinitely as efforts are undertaken to stabilize Fannie 

Mae and Freddie Mac and restore confidence in financial markets, FHFA 

has said that the conservatorships were not intended to be permanent. 

Recent policy changes and proposals on how to restructure or wind down 

the two enterprises are likely to have an impact on FHA’s role in the 

mortgage market.

In August 2012, FHFA directed the enterprises to increase their 

guarantee fees on single-family mortgages by an average of 10 basis 

points. According to FHFA, the increase represented a step toward 

 107See HUD, Office of Policy Development and Research, The FHA Single-Family 

Insurance Program: Performing a Needed Role in the Housing Finance Market

(Washington, D.C.: December 2012). 

108Basil N. Petrou, Managing Partner of Federal Financial Analytics, Inc., Establishing the 

Proper Role of the Federal Housing Administration in the U.S. Mortgage-Finance System, 

testimony before the House Financial Services Committee, 113th Cong., 1st sess., 

February 6, 2013. 

The Resolution of Fannie 

Mae and Freddie Mac 

Could Impact FHA’s Role
Page 57 GAO-13-682 FHA Viability and Market Presence

encouraging greater participation in the mortgage market by private firms. 

One impact of this change could be to push business to FHA.109

In addition, in February 2011, Treasury and HUD jointly issued a proposal 

for reforming the federal role in housing finance.110

• Option 1. A privatized system of housing finance with the government 

insurance role limited to FHA, USDA, and VA assistance for narrowly 

targeted groups of borrowers.

The proposal would 

make private markets the primary source of mortgage credit and would 

place the burden of losses on the private market. In addition, banks would 

be required to adhere to underwriting standards that were more 

conservative than those currently in place and that would require 

homeowners to hold more equity in their homes. The plan also includes 

proposals for reducing the roles of Fannie Mae and Freddie Mac, and 

ultimately winding down both institutions, while at the same time ensuring 

access to quality, affordable housing. To this end, the report presents 

several proposals for structuring the government’s long-term role in a 

housing finance system in which the private sector is the dominant 

provider of mortgage credit:

• Option 2. A privatized system of housing finance with assistance from 

FHA, USDA, and VA for narrowly targeted groups of borrowers and a 

guarantee mechanism that could be scaled 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.

Under each of these options, FHA would continue to play a central role in 

providing mortgage credit to low- and moderate-income borrowers.

In a 2009 report, we also identified several options for revising the 

structure of the enterprises and outlined a framework for identifying the 

trade-offs associated with them:

 109Both the enterprises and Ginnie Mae compete in the mortgage securitization market—

the enterprises through the issuance of securities and Ginnie Mae through the guarantee 

of timely payment of principal and interest on securities issued by others. 

110Treasury and HUD, Reforming America’s Housing Finance Market.
Page 58 GAO-13-682 FHA Viability and Market Presence

• reconstitute the enterprises as for-profit corporations with government 

sponsorship but place additional restrictions on them,

• establish the enterprises as government corporations or agencies, or

• privatize or terminate the enterprises.111

In evaluating the trade-offs associated with these options, we noted that 

the credit needs of certain groups no longer served by the enterprises 

could be met by FHA. However, we also pointed out that some have 

questioned FHA’s capacity to manage large increases in its business, 

which could raise taxpayer risks. In addition, we previously had identified 

“modernizing the U.S. financial regulatory system” as a high-risk area. 

Because of continuing uncertainty over the resolution of Fannie Mae and 

Freddie Mac, the potential impact of their resolution on FHA, and 

concerns about FHA’s financial condition, in February 2013 we included 

FHA in this high-risk area, now called “modernizing the U.S. financial 

regulatory system and the federal role in housing finance.”112

As of March 31, 2013, over 90 percent of new mortgage volume had 

federal backing, either through FHA and Ginnie Mae or the enterprises. 

The heightened federal role in mortgage lending and the increased 

reliance on FHA insurance highlights the need for policymakers to ensure 

that changes made to FHA and the enterprises recognize the 

interdependence of these entities and that changes to federal regulations 

governing the mortgage market consider the interaction between public 

and private capital and reflect the roles and capacities of the agencies. 

Ultimately, FHA’s place in the housing finance system will depend on how 

the private market reacts to new regulations and how the federal 

government resolves Fannie Mae and Freddie Mac. It will also depend on 

which, if any, of the options outlined in this report policymakers pursue 

and how they are implemented.

 111See GAO-09-782. 

112See GAO-13-283. 
Page 59 GAO-13-682 FHA Viability and Market Presence

We provided a draft report to HUD for review and comment, and HUD 

had no comments.

As agreed with your offices, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies to the Secretary of Housing 

and Urban Development and other interested parties. In addition, the 

report will be available at no charge on GAO’s website at 

http://www.gao.gov.

If you or your staff have any questions about this report, please contact 

me at (202) 512-8678 or sciremj@gao.gov. Contact points for our Offices 

of Congressional Relations and Public Affairs are listed on the last page 

of this report. GAO staff who made major contributions to this report are 

listed in appendix II.

Mathew J. Scirè

Director, Financial Markets and 

 Community Investment

Agency Comments 
Appendix I: Objectives, Scope, and 

Methodology

Page 60 GAO-13-682 FHA Viability and Market Presence

Our objectives were to examine options that have been proposed for 

improving the long-term viability of the Federal Housing Administration 

(FHA) or reducing its market presence and the implications of these 

options. Specifically, we discuss the implications of options related to (1) 

changing FHA’s product terms and conditions for single-family mortgage 

insurance, (2) restricting FHA’s presence in the single-family housing 

market, and (3) enhancing FHA’s operations and powers within its singlefamily program. In addition, we discuss the possible effects of broader 

housing finance reform on FHA.

To identify proposed options for improving the long-term viability of FHA 

or limiting its market presence, we obtained relevant academic and 

industry studies based on our past and ongoing work and conducted a 

literature search of relevant databases. We reviewed and summarized the 

literature identifying options for change at FHA, including congressional 

testimonies and other documents from mortgage market participants 

(such as the Mortgage Bankers Association) and researchers (such as 

the Urban Institute, Cato Institute, and others). As noted above, we sorted 

these options into three categories: changes related to product terms and 

conditions, changes that could affect the market FHA serves, and 

changes related to FHA’s organizational structure or powers. We also 

reviewed and summarized the literature for implications associated with 

the proposed options (including the effects on the cost or risk to the 

taxpayer, borrowers’ access to credit, FHA’s role and the market it 

serves, and other mortgage market participants). Finally, we reviewed 

these materials for information on broader housing refinance issues that 

may affect FHA, including mortgage reforms and proposals for reform of 

Fannie Mae and Freddie Mac, two government-sponsored enterprises. 

We assessed the reliability of the key studies we used and determined 

them to be reliable for our purposes. We also obtained and reviewed 

documentation from the Department of Housing and Urban Development, 

FHA, and Ginnie Mae. This documentation included FHA’s mortgagee 

letters, which we reviewed to determine existing program policies and 

procedures and recent changes.

We obtained FHA data on (1) loans originated in 2009, including credit 

scores and down-payment percentages, (2) the effect of a potential 

increase in the down-payment requirement on loans for which 

applications were submitted in August 2010 through July 2011, (3) the 

percentage of loan originations in 2009 and 2010 that had seller 

concessions of more than 3 percent of the property value, (4) the 

percentage of loans that FHA insured in fiscal year 2012 that were above 

$450,000, by state, (5) the income distribution of FHA borrowers in fiscal 

years 2000-2013 (October through April), and (6) delinquency rates for all 

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 61 GAO-13-682 FHA Viability and Market Presence

active loans as of October 31, 2011, by loan size. To determine the 

reliability of this information, we reviewed information on the data and 

queried FHA officials about how its data are collected, verified, and 

maintained to identify potential data limitations. The FHA officials agreed 

these data were generally accurate and complete. Based on this work, we 

concluded that the data we received from FHA were sufficiently reliable 

for our purposes. We also used data published by Inside Mortgage 

Finance on mortgage originations for the first quarter of 2013. To 

determine the reliability of these data, we reviewed information on the 

data source and queried a knowledgeable official about the accuracy of 

the data. We determine the data were sufficiently reliable for our 

purposes.

Finally, we conducted interviews with mortgage industry participants, 

researchers, consumer groups, and three former FHA commissioners to 

discuss the proposed options and, in particular, their implications. 

Specifically, we interviewed representatives from the following 

organizations:

• American Enterprise Institute,

• Cato Institute,

• Center for American Progress,

• Center for Responsible Lending,

• Harvard Business School,

• Harvard University’s Joint Center for Housing Studies,

• Hudson Institute,

• Independent Community Bankers of America,

• Mortgage Bankers Association,

• Mortgage Insurance Companies of America,

• National Association of Home Builders,

• National Association of Realtors,

• National Community Reinvestment Coalition,

• National Council of State Housing Agencies, and

• Urban Institute.

We also interviewed FHA and Ginnie Mae officials. At each interview, we 

sought to obtain any additional relevant studies or papers.

We conducted this performance audit from April 2013 to September 2013 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 
Appendix I: Objectives, Scope, and 

Methodology

Page 62 GAO-13-682 FHA Viability and Market Presence

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.
Appendix II: GAO Contact and Staff 

Acknowledgments

Page 63 GAO-13-682 FHA Viability and Market Presence

Mathew J. Scirè, (202) 512-8678 or sciremj@gao.govsciremj@gao.gov

In addition to the individual named above, Paige Smith, Assistant 

Director; Stephen Brown; Marcia Carlsen; Emily Chalmers; Cory 

Marzullo; John McGrail; Marc Molino; Josephine Pérez; Andrew Stavisky; 

Julie Trinder; and Heneng Yu made major contributions to this report.

Appendix II: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(250727)
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