Mortgage Financing: Actions Needed to Help FHA Manage Risks from New Mortgage Loan Products
Published: 2005-02-11T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The U.S. Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), insures billions of dollars in home mortgage loans made by private lenders. FHA insures low down payment loans and a number of parties have made proposals to either eliminate or otherwise change FHA's borrower contribution requirements. GAO was asked to (1) identify the key characteristics of existing low and no down payment products, (2) review relevant literature on the importance of loan-to-value (LTV) ratios and credit scores to loan performance, (3) report on the performance of low and no down payment mortgages supported by FHA and others, and (4) identify lessons for FHA from others in terms of designing and implementing low and no down payment products.
section_title: What GAO Found
paragraphs: FHA and many other mortgage institutions provide many low and no down payment products with requirements that vary in terms of eligibility, borrower investment, underwriting, and risk mitigation. While these products are similar, there are some important differences, including that FHA has lower loan limits, allows closing costs and the up-front insurance premium to be financed in the mortgage, and permits the down payment funds to come from nonprofits that receive funds from sellers. FHA also differs in that it does not require prepurchase counseling. A substantial amount of research GAO reviewed indicates that LTV ratio and credit score are among the most important factors when estimating the risk level associated with individual mortgages. GAO's analysis of the performance of low and no down payment mortgages supported by FHA and others corroborates key findings in the literature. Generally, mortgages with higher LTV ratios (smaller down payments) and lower credit scores are riskier than mortgages with lower LTV ratios and higher credit scores. Some practices of other mortgage institutions offer a framework that could help FHA manage the risks associated with introducing new products or making significant changes to existing products. Mortgage institutions may impose limits on the volume of the new products they will permit and on who can sell and service these products. FHA officials question the circumstances in which they can limit volumes for their products and believe they do not have sufficient resources to manage a product with limited volumes. Mortgage institutions sometimes require additional credit enhancements, such as higher insurance coverage; and sometimes require stricter underwriting, such as credit score thresholds, when introducing a new low or no down payment product. FHA is authorized to require an additional credit enhancement by sharing risk through co-insurance but does not currently use this authority. FHA has used stricter underwriting criteria but this has not included credit score thresholds.

section_title: Letter
paragraphs: Every year, the U.S. Department of Housing and Urban Development  (HUD), through its Federal Housing Administration (FHA), insures billions  of dollars in home mortgage loans made by private lenders, very often with  low down payments. FHA mortgage insurance helps homebuyers with  limited funds to obtain a home mortgage. Homebuyers with FHA-insured  loans need to make a 3 percent contribution toward the purchase of the  property and may finance some of the closing costs associated with the  loan. As a result, an FHA-insured loan could equal nearly 100 percent of the  property’s value or sales price—commonly called loan-to-value (or LTV)  ratio.  In recent years, various mortgage industry participants, such as  lenders, private mortgage insurers, and government-sponsored enterprises  (the Federal National Mortgage Association  and the Federal  Home Loan Mortgage Corporation ) have begun to support  mortgage products that require very little or no down payment. Among  these products, some allow third-party provision of gift down payment  assistance. Recently, in a HUD contractor study of a national sample of  FHA loans, of those loans that received down payment assistance, 29  percent received assistance from a nonprofit down payment assistance  provider. In addition, the FHA and others have proposed eliminating the  borrower contribution requirement for FHA-insured loans. At the same  time, the mortgage industry has moved toward greater use of automated  systems assessing the risk level of mortgages. These automated  underwriting systems rely, in part, on individuals’ credit scores or credit  history, and these systems have played an integral role in the provision of  low and no down payment mortgage products.
In light of recent changes in the composition of FHA-insured mortgage  products and the proposal to eliminate the borrower contribution  requirement for FHA-insured mortgages, you asked us to evaluate low and  no down payment lending. Specifically, this report examines (1) the key  characteristics and standards of mortgage products—supported by FHA  and others—that require low or no down payments; (2) what published  research indicates about the importance of variables such as LTV ratios and  credit scores in estimating the risk level associated with individual  mortgages; (3) the performance of low and no down payment mortgages  supported by FHA and others; and (4) what lessons FHA might learn from  others that support low and no down payment lending in terms of designing  and implementing such products.
To address the objectives we interviewed officials at FHA, the U.S.  Department of Agriculture (USDA), and U.S. Department of Veterans  Affairs (VA); and staff at selected conventional mortgage providers;  private mortgage insurers; two government-sponsored enterprises (GSE);  the Office of Federal Housing Enterprise Oversight (OFHEO); selected  state housing finance agencies; and nonprofit down payment assistance  providers. We reviewed descriptions of low and no down payment  mortgage products supported by selected mortgage industry participants  and compared the standards used by these entities. To determine what  published research indicates about the variables that are most important  when estimating the risk level associated with individual mortgages, we  reviewed recent and relevant papers that we identified through a  systematic search of economic literature. To describe the low and no down  payment performance of loans supported by FHA and others, we examined  the relationship among mortgage performance, LTV ratio, and credit score  using 4-year default rates for a special research sample of over 400,000  mortgages insured by FHA during 1992, 1994, and 1996 and for all  conventional loans originated in 1997, 1998, and 1999 and purchased by  Fannie Mae or Freddie Mac. We chose these years because, for FHA, these  data are the only significant data set of FHA-insured loans that includes  credit scores and that had at least 4 years of loan performance activity. For  Fannie Mae and Freddie Mac, in 1997, these institutions began purchasing  an increasing number of loans with the highest LTV ratios; loans originated  after 1999 would have less than 4 years of experience to analyze. The GSEs  provided us data that they considered to be proprietary. We did not disclose  information that could be considered proprietary, but this did not limit our  overall findings. We assessed the reliability of the FHA, Fannie Mae, and  Freddie Mac data by discussing the data with knowledgeable FHA officials  and Fannie Mae and Freddie Mac officials; reviewing recent audit reports  that evaluated the information systems at each entity; and comparing the  data with similar publicly available data. We determined that the data are  sufficiently reliable to use in our analysis of the performance of low and no  down payment mortgages. To determine what lessons FHA might learn  from others that support low and no down payment lending, we obtained  testimonial information from mortgage industry participants about the  steps they take to design and implement low and no down payment lending  products. We did not verify that these institutions, in fact, used these  practices.
We performed our audit work from January 2004 to December 2004 in  accordance with generally accepted government auditing standards.  Appendix I provides a full description of our scope and methodology.
subsections: section_title: Background
paragraphs: Mortgage insurance, a commonly used credit enhancement, protects  lenders against losses in the event of default. Lenders usually require  mortgage insurance when a homebuyer has a down payment of less than 20  percent of the value of the home. FHA, VA, the USDA’s Rural Housing  Service (RHS), and private mortgage insurers provide this insurance. In  2003, lenders originated $3.8 trillion of single-family mortgage loans, of  which more than 60 percent were for refinancing. Of all the insured loans  including refinancings originated in 2003, private companies insured about  64 percent, FHA insured about 26 percent, VA insured about 10 percent,  and RHS insured a very small number.  Private mortgage insurers generally  offer first loss coverage— that is, they will pay all the losses from a  foreclosure up to a stated percentage of the claim amount. Generally,  these insurers limit the coverage that they offer to between 25 percent and  35 percent of the claim amount. The insurance offered by the government  varies in the amount of lender incurred losses it will cover. For example, VA  guarantees losses up to 25 percent to 50 percent of the loan, while FHA’s  principal single-family insurance program insures almost 100 percent.   FHA plays a particularly large role in certain market segments, including  low-income and first-time homebuyers. During fiscal years 2001 to 2003,  FHA insured a total of about 3.7 million mortgages with a total value of  about $425 billion. FHA insures most of its mortgages for single-family  housing under its Mutual Mortgage Insurance Fund. To cover lenders’  losses, FHA collects insurance premiums from borrowers. These  premiums, along with proceeds from the sale of foreclosed properties, pay  for claims that FHA pays lenders as a result of foreclosures.
Fannie Mae and Freddie Mac are government-sponsored private  corporations with stated public missions chartered by Congress to provide  a continuous flow of funds to mortgage lenders and borrowers.  Fannie  Mae and Freddie Mac purchase mortgages from lenders across the country  and finance their mortgage purchases through borrowing or issuing  mortgage-backed securities that are sold to investors. They purchase  single-family mortgages up to the “conforming loan limit,” which for 2005  was set at $359,650. Their purchase guidelines and underwriting  standards have a dominant role in determining the types of loans that  primary lenders will originate in the conventional conforming market.
Members of the conventional mortgage market (such as private mortgage  insurers, Fannie Mae, Freddie Mac, and large private lenders) have been  increasingly active in supporting low and no down payment mortgage  products. Many private mortgage insurers will now insure a mortgage up to  100 percent of the value of the housing being purchased. Fannie Mae and  Freddie Mac, working together with the private mortgage insurers, have  become more aggressive in developing high LTV products that target  low-and moderate-income or first-time homebuyers while also developing  high LTV products designed for use by borrowers across the income  spectrum. Figure 1 shows the history of the introduction of low and no  down payment mortgage products at three LTV levels. FHA and VA have  been backing low and no down payment mortgages for many years, and  Fannie Mae and Freddie Mac permitted conventional lenders to sell them  mortgages with an LTV of 97 percent in 1994 and 1998, respectively. Freddie  Mac and Fannie Mae’s no down payment mortgage products were  introduced in 2000.
As shown in figure 2, a greater proportion of the FHA-insured and  VA-guaranteed mortgage loans had low down payments than was the case  for loans purchased by Fannie Mae and Freddie Mac. Further, the number  of loans FHA insured in 2000 that had LTVs greater than 95 percent  exceeded the total number of loans with such LTVs that were guaranteed  by VA and purchased by Fannie Mae and Freddie Mac combined.
While relatively few loans purchased by Fannie Mae or Freddie Mac had  low or no down payments, in recent years the GSEs have purchased  relatively more of these loans than in the past. As shown in figure 3, both  Fannie Mae and Freddie Mac, during the years 1997-2000, acquired a higher  proportion of mortgages with a high LTV than in previous years. To do this,  they increased the number of product options available to borrowers with  limited down payment funds.
The mortgage industry is increasingly using mortgage scoring and  automated underwriting. During the 1990s, private mortgage insurers, the  GSEs, and larger financial institutions developed automated underwriting  systems. Mortgage scoring is a technology-based tool that relies on the  statistical analysis of millions of previously originated mortgage loans to  determine how key attributes such as the borrower’s credit history, the  property characteristics, and the terms of the mortgage note affect future  loan performance.  Automated underwriting refers to the process of  collecting and processing the data used in the underwriting process. FHA  has developed and recently implemented a mortgage scoring tool, called  the FHA TOTAL Scorecard, to be used in conjunction with existing  automated underwriting systems. More than 60 percent of all mortgages  were being underwritten by an automated underwriting system, as of 2002, and this percentage continues to rise. The mortgage industry also uses  credit scoring models for estimating the credit risk of individuals—these  methodologies are based on information such as payment patterns.  Statistical analyses identifying the characteristics of borrowers who were  most likely to make loan payments have been used to create a weight or  score associated with each of the characteristics. According to Fair, Isaac  and Company sources, credit scores are often called “FICO scores”  because most credit scores are produced from software developed by Fair,  Isaac and Company. FICO scores generally range from 300 to 850 with  higher scores indicating better credit history. The lower the credit score,  the more compensating factors lenders might require to approve a loan.  These factors can include a higher down payment and greater borrower  reserves.
section_title: Characteristics and Standards of Low and No Down Payment Products Vary by Mortgage Institution
paragraphs: The characteristics and standards for low and no down payment mortgage  products vary among mortgage institutions. Standards to determine a  borrower’s eligibility differ from lender to lender. For example, one  mortgage institution might have a limit on household income where  another might not. Each of these mortgage products requires some form of  borrower investment. Most mortgage institutions use automated systems  to underwrite loans but differ on how they consider factors such as the  borrower’s credit score and credit history. Finally, mortgage institutions  also try to mitigate the increased risk associated with these products by  employing tools like prepurchase counseling and greater insurance  coverage.
subsections: section_title: Eligibility Standards Are Not Uniform throughout the Mortgage Industry
paragraphs: Each mortgage institution we studied limits in some way the mortgages or  the borrowers that may be eligible for their low and no down payment  products, but the specific limits and criteria differ among institutions.  Fannie Mae and Freddie Mac are constrained in the size of the mortgages  they may purchase.  Specifically, the Housing and Community  Development Act of 1980 requires a limit (conforming loan limit) on the  size of mortgages that can be purchased by either Fannie Mae or Freddie  Mac. In 2005, the conforming mortgage limit for Fannie Mae and Freddie  Mac is $359,650 for most of the nation. FHA is also limited in the size of  mortgages it may insure. The FHA loan limit varies by location and  property type, depending on the cost of homes in an area and the number  of units in a property. Thus, FHA’s loan limit may be as high as 87 percent of  the conforming loan limit, or $312,895 in 2005; or as low as 48 percent of  the conforming loan limit, or $172,632 in 2005. In addition, FHA also has  higher limits in Alaska, Hawaii, Guam, and the U.S. Virgin Islands because  these are considered to be high cost areas. Although VA does not have a  mortgage limit, lenders generally limit VA mortgages to four times the VA  guaranty amount, which is now set at 25 percent of the conforming loan  limit. Since the maximum guaranty currently is legislatively set at $89,913,  VA-guaranteed mortgages will rarely exceed $359,650.
Moreover, while FHA does not restrict eligibility to borrowers with certain  income, other mortgage institutions may limit eligibility by borrower  income and other measures.  Most state housing finance agencies target  their low and no down payment products to first-time homebuyers. Some  mortgage institutions providing affordable low and no down payment  products also limit the loans to households with income at or below area  median levels. For example, USDA’s RHS, in its section 502 Guaranteed  Loan program, does not guarantee loans to individuals with incomes  exceeding 115 percent of the area median income or 115 percent of the  median family income of the United States. We also found that Web sites of  many state housing finance agencies show that their mortgage products  include income limits as well as sales price limits and in some cases  designated “targeted areas” within a state. Table 1 illustrates some of the  major similarities and differences in the eligibility criteria of FHA and other  mortgage institutions.
Fannie Mae and Freddie Mac affordable mortgage products primarily target  low-to-moderate income and first-time homebuyers. Freddie Mac and RHS  allow a borrower to purchase a home containing one unit, while FHA, VA,  and Fannie Mae allow a borrower to purchase properties that have up to  four units with one mortgage. VA stipulates that if the veteran must depend  on rental income from the property to qualify for the mortgage, the  borrower must show proof that he or she has the background or  qualifications to be successful as a landlord and have enough cash reserves  to make the mortgage payments for at least 6 months without help from the  rental income. With regard to mortgage type, many mortgage institutions  permit 30-year fixed-rate mortgages. Some also permit adjustable rate  mortgages (ARM).
section_title: Most Low and No Down Payment Products Require Some Form of Borrower Investment
paragraphs: Most low and no down payment mortgage products require some form of  borrower investment, either a borrower contribution or cash reserve, as a  way of reducing risk and assuring that the borrower has a stake in the  property. Low down payment products offered by FHA, Fannie Mae,  Freddie Mac and private insurers require a cash investment of at least 3  percent from the borrower. No down payment mortgage products offered  by VA, RHS, Fannie Mae, Freddie Mac, and some private insurers require  either no down payment or a minimum amount (such as $500 in Fannie  Mae’s MyCommunityMortgage program).
Many institutions permit down payment assistance. FHA stipulates that the  gift donor may not be a person or entity with an interest in the sale of the  property, such as the seller, real estate agent or broker, builder, or entity  associated with them.  FHA mortgagee letters state that “gifts from these  sources (seller, builder, etc.) are considered inducements to purchase and  must be subtracted from the sales price.” However, FHA allows nonprofit  agencies that may receive contributions from the seller to provide down  payment assistance to the borrower.  In contrast, Fannie Mae, Freddie Mac,  and some of the private insurers generally do not allow down payment  funds, either directly or indirectly, from an interested or seller-related party  to the transaction. Fannie Mae and Freddie Mac officials told us that such  seller-related contributions could contribute to an overvaluation of the  price of the property.
Even where borrowers pay no down payment they very often must pay a  minimum percentage of closing costs from their own funds. FHA requires  that borrowers pay 3 percent of the total loan amount toward the purchase  of the home. This contribution may be used for down payment or closing  costs. Thus, FHA borrowers may finance closing costs, within limits. FHA  borrowers may also finance their insurance premium. Unlike FHA, some  mortgage institutions do not allow financing of the closing costs and the  insurance premiums in the first mortgage. VA generally allows payment of  all closing costs to be negotiated while restricting those that may be  charged to the borrower. VA allows borrowers to finance their insurance  premium, called the funding fee. In the section 502 Guaranteed Loan  program for RHS, borrowers may pay closing costs but they are not  required to do so and may be allowed to finance the closing costs and their  insurance premium, called the Guarantee Fee. Freddie Mac in its no down  payment product requires a 3 percent borrower contribution to be used for  closing costs, financing costs, or prepaids and escrows, all of which can  come from gifts or property seller contributions.
FHA, RHS, VA, Fannie Mae, and Freddie Mac differ somewhat in terms of  their maximum allowable LTV ratios and how they calculate this ratio. LTV  ratios are important because of the direct relationship that exists between  the amount of equity borrowers have in their homes and the likelihood of  risk of default. The higher the LTV ratio, the less cash borrowers will have  invested in their homes and the more likely it is that they may default on  mortgage obligations, especially during times of economic hardship.
The Omnibus Budget Reconciliation Act of 1990 (Pub. L. No. 101-508),  established LTV limits for FHA-insured mortgages of 98.75 percent if the  home value is $50,000 or less, or 97.75 percent if the home value is in  excess of that. However, because FHA allows financing of the up-front  insurance premium, borrowers can receive a mortgage with an effective  LTV ratio of close to 100 percent.
In table 2, we calculate the effective LTV ratio for selected low and no  down payment products. The example assumes a $100,000 purchase price  (appraisal value) and a 30-year fixed-rate mortgage. It also assumes  average closing costs of about 2.1 percent of sales price. FHA has a formula  to calculate the maximum loan amount based on a percentage of the  purchase price of the home. FHA does not have a down payment  requirement but instead has what FHA calls a minimum cash investment  requirement. This investment requirement can be used to pay either the  down payment and in some cases the closing costs. Not shown are the  actual out-of-pocket expenses to the borrower which could vary based on  the individual transaction and whether the investment requirement was  split among the closing costs and down payment, as well as whether the  borrower opted to finance their up-front premium.
In addition, some of the affordable conventional mortgage products allow  for subordinate financing in the form of secondary mortgages to pay for a  down payment and/or closing costs. These secondary mortgages allow for  a total effective LTV of up to 105 percent.
section_title: Some Underwriting Standards Differ between FHA and Other Mortgage Institutions
paragraphs: When underwriting mortgages, FHA and other mortgage institutions  require that lenders examine a borrower’s ability and willingness to repay  the mortgage debt. Lenders for low and no down payment mortgages may  use automated underwriting systems examining the borrower’s credit score  or creditworthiness, qualifying ratios, and cash reserves. In some cases,  they use manual underwriting to accommodate nontraditional credit  histories. By screening the majority of applications with automated  systems, underwriters have more time to review special cases with manual  underwriting.
Many mortgage institutions use credit scores in assessing mortgage  applicants through their automated underwriting systems. For standard  products, institutions tend to rely on automated underwriting, which  develops a mortgage score based on various factors including credit score  and, based on this, they make a decision on the loan. However, in some  instances, mortgage institutions set credit score minimums for some low  and no down payment products. In some instances, these credit score  minimums exist within the automated underwriting system. In other  instances, the credit score minimums exist only in products that are  underwritten using manual underwriting. FHA does not require a credit  score minimum, nor do VA and RHS. These three governmental agencies  examine the overall pattern of credit behavior rather than rely on one  particular credit score. All three agencies allow a good deal of judgment  and interpretation on the part of the underwriters in determining the  creditworthiness of the prospective borrower. Fannie Mae does not use  externally derived credit scores for its loan products that use automated  underwriting but instead relies on the credit history of the borrower. Based  on a review of Web sites of private mortgage insurers, products with no  down payment that are insured by these private mortgage insurers have  minimum credit score requirements ranging from 660 to 700. Individual low  and no down payment products that use credit score minimums use a  variety of cutoff scores. Many mortgage industry sources consider  borrowers with credit scores of 720 or higher as having excellent credit.  One study that focused on issues related to homeownership and cited  extensive interviews with leading experts in government and industry  found that mortgage applicants with scores above 660 are likely to have  acceptable credit. On the other hand, for applicants with FICO scores  between 620 and 660, mortgage institutions typically perform more careful  underwriting, scrutinizing many factors. FICO scores under 620 indicate  higher risk and are unlikely to be approved by conventional lenders unless  accompanied by compensating factors.
Some of these mortgage institutions may, under some circumstances,  accept a lower credit score, if the borrower provides additional  compensating factors (such as 2 months cash reserve) that would indicate  a lower risk on the part of the borrower. Mortgage institutions might also  accept a lower credit score if they were receiving additional compensation  for the risk, such as a mortgage originator receiving a higher interest rate or  a mortgage insurer getting a higher insurance premium.  Some mortgage  institutions state in their underwriting guidance that FICO scores together  with the LTV determine in part the borrower’s minimum contribution. For  example, one private mortgage insurer allows borrowers with credit scores  equal or greater than 700 to have a minimum borrower contribution of 0  percent on a 100 LTV loan. For this same insurer, a borrower with a credit  score between 660 and 699 would have a minimum borrower contribution  of 3 percent on a 100 LTV loan.
Many mortgage institutions use two qualifying ratios as factors in  determining whether a borrower will be able to meet the expenses involved  in homeownership. The “housing-expense-to-income ratio” examines a  borrower’s expected monthly housing expenses as a percentage of the  borrower’s monthly income, and the “total-debt-to-income ratio” looks at a  borrower’s expected monthly housing expenses plus long-term debt as a  percent of the borrower’s monthly income. Lenders who do business with  Fannie Mae or Freddie Mac place more emphasis on the  total-debt-to-income ratio. Total debt includes monthly housing expenses  and the total of other monthly obligations, such as auto loans, credit cards,  alimony, or child support.   The guidelines for manual underwriting are  discussed below; automated underwriting systems weight the qualifying  ratios, as well as numerous other factors, in assessing the borrower’s ability  to meet the expenses involved in homeownership.
Unless there are compensating factors, FHA monthly housing-expense-  to-income ratio is set at a maximum of 29 percent, while the monthly  “total-debt-to-income ratio” is, at most, 41 percent of the borrower’s stable  monthly income. The requirements set by Fannie Mae, Freddie Mac, and  the private insurers on the monthly housing expense-to-income ratio vary  greatly. Some have set lower thresholds, such as Freddie Mac, which uses  as a guideline that the monthly housing expense-to-income ratio should not  be greater than 25 percent to 28 percent, with exceptions for some  products. Others, such as some private insurers, have set higher thresholds  than FHA has set, such as 33 percent.
Some mortgage institutions set thresholds on the “total-debt-to-income”  ratio that are lower than FHA’s threshold. Conventional mortgages that are  manually underwritten to Fannie Mae or Freddie Mac standards are set at a  benchmark total-debt-to-income ratio of 36 percent of the borrower’s stable  monthly income, compared with FHA’s 41 percent. However, Fannie Mae  and Freddie Mac state that they occasionally specify a higher allowable  debt-to-income ratio for a particular mortgage loan if compensating factors  are present.
Cash reserves represent the amount of funds a borrower has after closing  on the loan. Generally the reserves required of borrowers are expressed in  terms of the numbers of monthly mortgage payments they may comprise.  Conceptually they represent the ability of the borrower to repay the  mortgage out of accumulated funds.  Many mortgage institutions including  FHA consider it a compensating factor that reduces the risk of delinquency.  FHA, unlike conventional lenders who do business with the GSEs and the  private insurers, does not require cash reserves for its low down payment  product. VA and RHS also do not require cash reserves. Generally the GSEs  and the private insurers with whom we spoke required cash reserves of  either 1 or 2 months of monthly mortgage payments for low and no down  payment products.
section_title: Mortgage Institutions Use Various Risk Mitigation Tools
paragraphs: Some of the mortgage institutions we spoke with used various tools to  mitigate risk. For example, most mortgage institutions offering affordable  low and no down payment mortgages to first-time homebuyers require  prepurchase counseling, and some require postpurchase counseling. These  include lenders working with Fannie Mae, Freddie Mac, private insurers,  and state housing finance agencies. Homeownership counseling for  first-time homebuyers takes a variety of forms. There are counseling  programs administered by government agencies, lenders, nonprofit  organizations, and the private insurers, among others. These programs are  delivered through many different avenues including classroom, home  study, individual counseling, and telephone. The content of the counseling  programs also varies significantly across each of these administrative and  delivery mechanisms, as does the timing of the counseling—which can be  either prior to closing or postpurchase (when the borrower becomes  delinquent on a payment).
More specifically, Freddie Mac in each of its Affordable Gold products  (intended for first-time homebuyers who generally earn 100 percent or less  of area median income) requires that at least one qualifying borrower in the  transaction must receive prepurchase counseling. Lenders must document  the organization that administered the counseling and how the counseling  was delivered. Freddie Mac exempts those borrowers who have cash  reserves after closing equal to at least two monthly mortgage payments  from the counseling requirement. Similarly, Fannie Mae in its  MyCommunityMortgage, requires prepurchase counseling for first-time  homebuyers when they are purchasing a one-unit property. If they are  purchasing a two to four unit property, landlord counseling is required.  Fannie Mae also requires postpurchase counseling for borrowers under  certain low down payment programs who become delinquent on their  payments early in the mortgage.
Some private insurers require pre- and postpurchase counseling, but some  only recommend it. For example, two private insurers require pre- and  postpurchase counseling with all of its affordable low and no down  payment products, and they provide most of this counseling themselves.  On the other hand, another private insurer recommends, but does not  require, prepurchase counseling for first-time homebuyers in its low and no  down payment products. However, this insurer’s underwriting guidance  states that prepurchase counseling is considered a positive underwriting  factor. It also recommends postpurchase counseling, particularly for  borrowers who are experiencing financial difficulties but have a good  chance of overcoming their financial problems and maintaining  homeownership.
FHA, unlike most low and no down payment mortgage institutions serving  affordable first-time homebuyers, does not require prepurchase counseling.  VA also does not require prepurchase counseling, but considers it to be a  compensating factor in improving creditworthiness. RHS encourages  lenders to offer or provide for homeownership counseling and lenders may  require first-time homebuyers to undergo such counseling if it is reasonably  available in the local area.
FHA, VA, RHS, and the private insurers also differ in the amount of  insurance or guaranty they provide to protect lenders against the losses  associated with mortgages that go to foreclosure. While FHA essentially  protects against almost 100 percent of the losses associated with a  foreclosed mortgage, VA, RHS and the private insurers protect against a  portion of the loss. Private insurers generally provide protection to  lenders for only a portion of losses. This protection is usually expressed as  a percentage of the claim amount. For example, an insurer may provide  insurance coverage of 30 percent. This means that the insurer will cover  losses up to 30 percent of the claim amount. In exchange for offering this  insurance, the insurer charges borrowers a premium.
Some of the insurers with whom we spoke, as well as the GSEs, noted that  they require higher insurance coverage for mortgages with lower down  payments. For example, one insurer said that the amount of insurance  coverage tends to be 35 percent for no down payment mortgages, in  contrast to 30 percent for low down payment mortgages. Private insurers  noted that they charge higher premiums or require more stringent  underwriting when they provide higher insurance coverage. For example,  one private insurer stated that its monthly premium rates to a borrower  increase about 15 percent for every 5 percentage point increase in  insurance coverage between 20 and 35 percent.
section_title: Research Shows LTV Ratio and Credit Score Are Important When Estimating Risk of Individual Mortgages
paragraphs: Economic research we reviewed indicated that LTV ratios and credit scores  are among the most important factors when estimating the risk level  associated with individual mortgages. We identified and reviewed 45  papers that examined factors that could be informative. Of these, 37  examined if the LTV ratio was important and almost all of these papers (35)  found the LTV ratio of a mortgage important and useful. Nineteen research  papers evaluated how effective a borrower’s credit score was in predicting  loan performance, and all but one reported that the credit score was  important and useful. In addition, a number of the papers reported that  other factors were useful when estimating the risk level. For example,  characteristics of the borrower—such as qualifying ratios—were cited in  several of the papers we reviewed. Finally, other research evaluated  additional factors; however, we identified very few papers that investigated  the same variables or corroborated these findings. Collectively, the  research we reviewed appeared to concur that considering multiple factors  was important and useful in estimating the risk level of individual  mortgages. For example, some of the papers (7) reported that considering  LTV ratio and credit score concurrently was important and useful when  estimating the risk level of individual mortgages.
subsections: section_title: LTV Ratio Helps Estimate Risk of Individual Mortgages
paragraphs: Many studies found that a mortgage’s LTV ratio was an important factor  when estimating the risk level associated with individual mortgages. In  theory, LTV ratios are important because of the direct relationship that  exists between the amount of equity borrowers have in their homes and the  likelihood of risk of default. The higher the LTV ratio, the less cash  borrowers will have invested in their homes and the more likely it is that  they may default on mortgage obligations, especially during times of  economic hardship (e.g., unemployment, divorce, home price  depreciation). And, according to one study, “most models of mortgage loan  performance emphasize the role of the borrower’s equity in the home in the  decision to default.” We identified 45 papers that examined the  relationship between default and one or more predictive variables; of these,  37 examined if LTV ratio was important and useful. Almost all of these  papers (35) determined that LTV ratio was effective in predicting loan  performance—specifically, when predicting delinquency, default, and  foreclosure. Several papers reported that there was a strong positive  relationship between LTV ratio and default. Specifically, one paper  reported that the default rates for mortgages with an LTV ratio above 95  percent were three to four times higher than default rates for mortgages  with an LTV ratio between 90 to 95 percent. Another paper found that, at  the end of 5 years, the cumulative probability of default risks for mortgages  with an LTV ratio less than 95 percent was 2.48 percent; however, the  cumulative probability of default for mortgages with an LTV ratio greater  than or equal to 95 percent was 3.53 percent. While the majority of the   empirical research found that LTV ratio mattered, 4 of the research efforts  did not find that LTV ratio is important when estimating the risk level  associated with individual mortgages. For example, one paper found that,  for subprime loans, delinquency rates were relatively unaffected by the LTV  ratio. Generally, subprime loans are loans made to borrowers with past  credit problems at a higher cost than conventional mortgage loans.  Additionally, some (7) research efforts examined the relationship between  the LTV ratio and severity (losses), and all found that there was a positive  relationship between the LTV ratio and severity. For a detailed list of the  economic research that addresses the relationship between LTV ratio and  mortgage performance, see appendix II.
section_title: Credit Score Helps Estimate Risk of Individual Mortgages
paragraphs: Despite the relatively recent use of credit score information in the  mortgage industry, several studies found that credit score was an important  and useful factor when estimating the risk level associated with individual  mortgages. In general, credit scores represent a borrower’s credit history.
Credit histories consist of many items, including the number and age of  credit accounts of different types, the incidence and severity of payment  problems, and the length of time since any payment problems occurred.  The credit score reflects a borrower’s historic performance and is an  indication of the borrower’s ability and willingness to manage debt  payments. Of the 45 papers we reviewed, 19 evaluated how effective a  borrower’s credit score was in predicting loan performance. Eighteen  research efforts evaluated how effective a borrower’s credit score was in  predicting delinquency, default, and foreclosure; all of these efforts found  that a borrower’s credit score was important. Generally, the papers  reported that higher credit scores were associated with lower levels of  defaults. Specifically, one study found that a mortgage with a credit score  of 728 (indicating an applicant with excellent credit) had a default  probability of 1.26 percent, while a mortgage with a credit score of 642 had  a default probability of 3.41 percent—or more than two times higher.   Additionally, four research efforts examined the relationship between  credit score and severity (losses), and three reported that there was a  negative relationship between credit score and severity.  For example, one  study found that credit scores were also helpful in predicting the amount of  losses resulting from foreclosed mortgages. In particular, the paper  reported the loss rate for defaulted mortgages with high credit scores was  lower than foreclosed mortgages with low credit scores. For a list of the  economic research, that we reviewed, that addresses the relationship  between credit score and mortgage performance, see appendix II.
section_title: Other Factors May Help in Estimating the Risk of Individual Mortgages
paragraphs: Many of the papers we reviewed identified factors that, in addition to LTV  ratios and credit scores, were important and useful determinants of credit  risk for home mortgages. Of these, the most widely analyzed  factor—accumulation of equity in the home—was a subject of 26 studies  we reviewed. Some factors were the subject of far fewer papers. Yet other  factors were the subject of a single paper only. The most widely assessed  factors included borrower characteristics such as accumulation of equity in  the home, qualifying ratios, and income. Additionally, characteristics of  the area in which the property was located included variables such as  unemployment rates and income levels. Finally, characteristics of the  mortgage included variables such as mortgage age and term of the  mortgage (e.g., 15 year vs. 30 year). The extent to which the authors agreed  on the importance of the other factors varied. For example, nearly all of the  papers that looked at equity accumulation (a factor which is not known at  the time of loan origination), the unemployment rate of the area in which  the property is located, and mortgage age, found that these factors were  important. However, the research was less certain as to the importance of  qualifying ratios and income. That is, several of the papers found that the  qualifying ratios and income were important in estimating risk; however,  some found that qualifying ratios and income were not an important factor.
The economic research we reviewed also indicated that considering factors  in combination was helpful in estimating the risk level of individual  mortgages. Of all 45 papers we reviewed, more than half conducted  multivariate analyses. For example, seven studies found that using credit  score information in combination with the LTV ratio was helpful in  estimating the risk level of individual mortgages. Specifically, one study  found that the “foreclosure rate is particularly high for borrowers with both  low credit scores and high LTV ratios—almost 50 times higher than that for  borrowers with both high credit scores and low LTV ratios.” Other studies  examined several aspects of a mortgage concurrently. For example, in one  study, the authors controlled for certain loan characteristics, such as credit  history and LTV, and they found that borrower income is useful in  estimating risk levels of mortgages. In another study, the authors  controlled for house price appreciation (10 percent) and unemployment  rates (8 percent) and examined loan performance—after 15 years—in  terms of LTV ratio and a borrower’s relative income. Regardless of income,  default was higher for zero down payment mortgages. Specifically, under  these conditions, the authors reported that zero down payment mortgages  of borrowers with incomes below 60 percent of the metropolitan statistical  area’s (MSA) median level would have cumulative default rates about twice  as high as mortgages that required a 10 percent down payment made to  borrowers with similar incomes. Similarly, the zero down payment  mortgages of borrowers with incomes greater than one-and-a-half times the  MSA’s median level would have cumulative default rates about 50  percentgreater than mortgages that required a 10 percent down payment  made to borrowers with similar incomes.
section_title: Our Analysis Indicated That Mortgages with Higher LTV Ratios and Lower Credit Scores Pose Greater Risks
paragraphs: Consistent with studies we reviewed, our analysis of FHA and conventional  mortgage data indicated that mortgages with high LTV ratios (smaller down  payments) and low credit scores generally are riskier than mortgages with  low LTV ratios and high credit scores. For example, FHA-insured  mortgages with LTV ratios greater than 80 percent and low credit scores  (below 660) had a default rate above the FHA average default rate.   Similarly, conventional mortgages with LTV ratios greater than 80 percent  and somewhat low credit scores (below 700) had a default rate above the  conventional average default rate. While this analysis is useful in  determining the extent to which LTV ratios and credit scores can help  predict the risk level associated with individual mortgages, care should be  taken when comparing the FHA with the conventional relative default. In  particular, the relative default rates are derived from different calendar  years (that is, a sample of FHA mortgages insured in 1992, 1994, and 1996  and conventional mortgages originated in 1997, 1998, and 1999 and  purchased by Fannie Mae or Freddie Mac). Also the average default rate for  FHA-insured mortgages is higher than the average default rate for  conventional mortgages.
subsections: section_title: FHA-Insured Mortgages with Higher LTV Ratios and Lower Credit Scores Are Riskier Than Other FHA-Insured Mortgages
paragraphs: When considering LTV alone, FHA-insured mortgages with higher LTV  ratios (smaller down payments) generally perform worse than FHA-insured  mortgages with lower LTV ratios. As figure 4 illustrates, our analysis  indicates that the incidence of default increases as LTV ratios increase.  When considering the LTV ratio alone, the default rate for sampled  FHA-insured mortgages, with an LTV of 70 percent or less, is no more than  half the average FHA default rate. In contrast, the default rate for  mortgages with LTV ratios greater than 90 percent, as a group, surpasses  the average FHA default rate. For the highest LTV ratio group—greater  than 97 to 100 percent—the default rate for these mortgages is about 1.75  times the average FHA default rate.
FHA-insured mortgages with lower credit scores generally perform worse  than FHA-insured mortgages with higher credit scores, regardless of LTV  ratio.  As figure 5 illustrates, our analysis indicated that the incidence of  default increases as credit scores decrease. Considering the credit score,  the default rate for sampled FHA-insured mortgages with credit scores 700  and above is no more than half the average FHA default rate for all sampled  mortgages. The default rate for mortgages with a credit score below 660, as  a group, surpasses the average FHA default rate. For the lowest credit  score group—less than 620—the default rate for these mortgages is almost  twice the average FHA default rate.
As expected, FHA-insured mortgages with both high LTV ratios (smaller  down payments) and low credit scores generally perform worse than  mortgages with both low LTV ratios and high credit scores. Our analysis  indicates that the incidence of default increases as LTV ratios increase and  credit scores decrease. As figure 6 illustrates, mortgages with lower LTV  ratios and higher credit scores (those at the bottom of the figure) have  lower default rates than mortgages with higher LTV ratios and lower credit  scores (at the top of the figure). FHA-insured mortgages with LTV ratios  greater than 80 percent and low credit scores (below 660) had a default rate  above the FHA average default rate. FHA-insured mortgages, with LTV  ratios greater than 90 percent and credit scores below 620, had a default  rate more than double the FHA average.
section_title: Conventional Mortgages with Higher LTV Ratios and Lower Credit Scores Are Riskier Than Other Conventional Mortgages
paragraphs: Generally, the performance relationships that exist for FHA-insured  mortgages also exist for conventional mortgages originated in the late  1990s. As figure 7 illustrates, our analysis indicates that conventional  mortgages with higher LTV ratios (smaller down payments) generally  perform worse than conventional mortgages with lower LTV ratios. When  considering LTV ratio alone, the default rate for the group of conventional  mortgages with LTV ratios below 80 percent was no more than half the  average conventional default rate. Generally, the default rates then increase  with higher categories of the LTV ratio. In fact, the default rate for  conventional mortgages with an LTV ratio greater than 90, but less than 97  percent, as a group, is more than twice the average conventional default  rate. One notable exception to this general pattern is that conventional  mortgages in the highest LTV ratio category (that is, greater than 97 to 100  percent) appear to have a lower risk of default than do conventional  mortgages in some of the lower LTV ratio categories. According to GSE  officials, this may be explained by a number of possible factors. The GSEs  had just begun to purchase an increasing number of mortgages with very  high LTV ratios during the late 1990s and the GSEs took steps to limit the  risks associated with these mortgages. For example, some of these loans  were part of negotiated deals with individual lenders. These negotiated  transactions may have required the use of manual underwriting and  minimum credit scores, and the GSEs may have used specific servicers for  these loans. GSE officials told us that lenders and servicers operating as  part of negotiated deals with them tend to be more conservative in their  approach to these loans. GSE officials also told us that the borrowers  during this time period would have been the very best segment of the  applicant pool. Agency officials indicate that, for more recent loans where  volumes are higher and lenders are reaching deeper into the applicant pool,  default rates on loans in these categories are higher than they were in the  1997–1999 period and are now consistent with the relationship we would  expect between LTV and default rates.   We discuss these practices in  greater depth later in the report.
When considering credit score alone, conventional mortgages with lower  credit scores generally perform worse than conventional mortgages with  higher credit scores. As figure 8 illustrates, our analysis indicates that the  incidence of default generally increases as credit scores decrease. The  average default rate for mortgages with credit scores of 740 and higher is  no more than 20 percent that of the average default rate for conventional  loans and loan performance declines for each lower category of credit  score. In fact, the default rate for mortgages with a credit score below 700,  as a group, surpasses the average default rate. Ultimately, the average  default rate for the lowest credit score category (below 620) is more than 4  times the average conventional default rate.
As expected, conventional mortgages with both high LTV ratios (smaller  down payments) and low credit scores generally perform worse than  mortgages with both lower LTV ratios (larger down payments) and higher  credit scores. Our analysis indicates that the incidence of default generally  increases as LTV ratios increase and credit scores decrease. As figure 9  illustrates, mortgages with lower LTV ratios and higher credit scores (those  at the bottom of the figure) have much smaller default rates than mortgages  with higher LTV ratios and lower credit scores (at the top of the figure).
Specifically, as a group, mortgages with LTV ratios greater than 80 percent  and credit scores below 700 have default rates greater than the average  conventional default rate. Further, conventional mortgages with LTV ratios  greater than 80 percent and credit scores below 660 had a default rate more  than twice the conventional average.
One notable exception to this general pattern is that the group of  conventional mortgages with the highest LTV ratios (that is, greater than 97  to 100 percent) appears to have a lower risk of default than do the group of  conventional mortgages with lower LTV ratios for loans originated during  these years. For example, of conventional loans with credit scores of 740  and higher, those that had LTV ratios greater than 97 percent, as a group,  performed better than those with LTV ratios greater than 90 to 97 percent.  Similarly, of conventional loans with credit scores below 620, those with  the highest LTV ratio performed better than those with LTV ratios greater  than 90 to 97 percent. This anomaly, where the highest LTV mortgages  appear to perform better than the lower LTV loans, may reflect that the  GSEs had just begun to purchase an increasing number of mortgages with  very high LTV ratios in the years we analyzed and that the GSEs took steps  to limit the risks associated with these mortgages. Likewise, lenders may  perform more rigorous underwriting when first originating a new loan  product.
While this analysis is useful in determining the extent to which LTV ratios  and credit scores are helpful in predicting the risk level associated with  individual mortgages insured by FHA and for mortgages purchased by the  GSEs during specific years, there are several reasons why care should be  taken when comparing the FHA with the conventional relative default  rates. The relative default rates are derived from different years (that is,  FHA mortgages insured in 1992, 1994, and 1996; and conventional  mortgages originated in 1997, 1998, and 1999 and purchased by Fannie Mae  or Freddie Mac). Also, the actual average default rate for FHA-insured  mortgages is higher than the actual average default rate for conventional  mortgages. Finally, the distribution among LTV categories for FHA-insured  loans and conventional loans differs. Generally, over half of the loans that  the GSEs purchase have LTV ratios at or below 80 percent.  In comparison,  loans insured by FHA generally have LTV ratios greater than 95 percent.
section_title: Several Practices Mortgage Institutions Use in Designing and Implementing Low and No Down Payment Products Could Be Instructive for FHA
paragraphs: Mortgage institutions we spoke with used a number of similar practices in  designing and implementing new products, including low and no down  payment products. Some of these practices could be helpful to FHA in its  design and implementation of new products. When considering new  products, mortgage institutions focused their initial efforts on identifying  other products with similar enough characteristics to their new product so  that data on these products could be used to understand the potential  issues and performance for the proposed product. Some mortgage  institutions, including FHA, said they may acquire external loan  performance data and other data when designing new products. Moreover,  mortgage institutions often establish additional requirements for new  products such as additional credit enhancements or underwriting  requirements. FHA has less flexibility in imposing additional credit  enhancements but it does have the authority to seek co-insurance, which it  is not currently using. FHA makes adjustments to underwriting criteria and  to its premiums, but is not currently using any credit score thresholds.  Mortgage institutions also use different means to limit how widely they  make available a new product, particularly during its early years. FHA does  sometimes use practices for limiting a new product but usually does not  pilot products on its own initiative, and FHA officials question the  circumstances in which they can limit the availability of a program and told  us they do not have the resources to manage programs with limited  availability. According to officials of mortgage institutions, including FHA,  they also often put in place more substantial monitoring and oversight  mechanisms for their new products including lender oversight, but we have  previously reported that FHA could improve oversight of its lenders.
subsections: section_title: Mortgage Institutions Initially Analyze the Risk of Products Similar to the Product They Are Seeking to Develop
paragraphs: Mortgage institutions, such as Fannie Mae, Freddie Mac, the private  mortgage insurers, and FHA first identify what information, including data,  they already have that would allow them to understand the performance of  a potential product. When these institutions do not have sufficient data,  they may purchase external data that allows them to conduct their own  analysis of loans that are related to a type of loan product that they are  considering. For example, Freddie Mac purchased structured transactions  of Alt A and subprime loans in order to learn more about the underwriting  characteristics and performance of high LTV and low credit score loans.   Freddie Mac officials reported that these data were very helpful to them in  considering how to best structure some of their high LTV products.  Moreover, the accounting standards related to the Federal Credit Reform  Act of 1990, which requires federal agencies to estimate the budget cost of  federal credit programs, suggest that federal agencies making changes to  programs should consider external sources of data. FHA officials told us  that FHA has purchased such loan performance data. According to FHA  officials, FHA relies more heavily on data that it has collected internally  from the approximately 1 million loans it endorses each year and its  single-family data warehouse, which contains data on approximately 30  million loans. FHA officials stated that, when possible, they use these  internal data to create a proxy for how a loan product with certain  characteristics might perform. FHA officials said they used these data to  create a “virtual zero down loan” when FHA was considering how it might  implement a proposed no down payment product.
The mortgage institutions with whom we spoke noted that any loan  performance data they develop or produce when implementing new  products are also used to enhance their automated underwriting systems.   The data improve the statistical models used in their automated  underwriting systems. In May 2004, FHA implemented a statistical model  for evaluating mortgage risk that may be used in lenders’ automated  underwriting systems, called the FHA TOTAL Scorecard.  In developing the  TOTAL Scorecard, FHA purchased external data (credit score data), which  they merged with their existing FHA data to try to better understand the  loan performance of FHA-insured loans.
section_title: Mortgage Institutions Require Additional Credit Enhancements or Stricter Underwriting for New Low and No Down Payment Products
paragraphs: Some mortgage institutions require additional credit  enhancements—mechanisms for transferring risk from one party to  another—on low and no down payment products and set stricter  underwriting requirements for these products. Mortgage institutions such  as Fannie Mae and Freddie Mac mitigate the risk of low and no down  payment products by requiring additional credit enhancements such as  higher mortgage insurance coverage. Fannie Mae and Freddie Mac require  credit enhancements on all loans they purchase that have LTVs above 80  percent. Typically, this takes the form of private mortgage insurance.  Fannie Mae and Freddie Mac also require higher levels of private mortgage  insurance coverage for loans that have higher LTV ratios. For example,  Fannie Mae and Freddie Mac require insurance coverage of 35 percent for  loans that have an LTV greater than 95 percent. This means that, for any  individual loan that forecloses, the mortgage insurer will pay the losses on  the loan up to 35 percent of the claim amount. Fannie Mae and Freddie Mac  require lower insurance coverage for loans with LTVs below 95 percent.  Fannie Mae and Freddie Mac believe that the higher-LTV loans represent a  greater risk to them and they seek to partially mitigate this risk by requiring  higher mortgage insurance coverage.
Although FHA is required to provide up to 100 percent coverage of the  loans it insures, FHA may engage in co-insurance of its single-family loans.  Under co-insurance, FHA could require lenders to share in the risks of  insuring mortgages by assuming some percentage of the losses on the loans  that they originated (lenders may use private mortgage insurance). FHA  has used co-insurance before, primarily in its multifamily programs, but  does not currently use co-insurance at all. FHA officials told us they tried  to put together a co-insurance agreement with Fannie Mae and Freddie  Mac and, while they were able to come to agreement on the sharing of  premiums, they could not reach agreement on the sharing of losses and it  was never implemented.
FHA could also benefit from other means of mitigating risk such as stricter  underwriting or increasing fees. Fannie Mae officials also stated that they  would charge higher guarantee fees on low and no down payment loans if  they were not able to require the higher insurance coverage. Fannie Mae  and Freddie Mac charge guarantee fees to lenders in exchange for  converting whole loans into mortgage-backed securities, which transfer the  credit risk from the lender to Fannie Mae or Freddie Mac. Within statutory  limits, the HUD Secretary has the authority to set up-front and annual  premiums that are charged to borrowers who have FHA-insured loans. In  fact, in the administration’s 2005 budget proposal for a zero down payment  product, it included higher premiums for these loans. The Secretary has the  authority to establish an up-front premium, which may be up to 2.25  percent of the amount of the original insured principal obligation of the  mortgage. Within statutory limits, the Secretary may also require payment  of an annual premium. Under the Administrative Procedures Act, the  Secretary would generally follow a process in which the change to  premiums would include issuing a proposed rule, receiving public  comments, and then issuing a final rule.
Additionally, mortgage institutions such as Fannie Mae and Freddie Mac  sometimes introduce stricter underwriting standards as part of the  development of new low and no down payment products (or products  about which they do not fully understand the risks). Institutions can do this  in a number of ways, including requiring a higher credit score threshold for  certain products, or requiring greater borrower reserves or more  documentation of income or assets from the borrower. Freddie Mac  officials stated that they believed limits on allowing ARMs or multiple-unit  properties were also reasonable, at least initially. Once the mortgage  institution has learned enough about the risks that were previously not  understood, it can change the underwriting requirements for these new  products to align with its standard products.  Although FHA sometimes has  certain standards set for it through legislation, there exists some flexibility  in how it implements a newly authorized product or changes to an existing  product. The HUD Secretary has latitude within statutory limitations in  changing underwriting requirements for new and existing products and has  done this many times. Examples included the decrease in what is included  as borrower’s debts and an expansion of the definition of what can be  included as borrower’s effective income when lenders calculate qualifying  ratios. In the context of the new zero down product, the Federal Housing  Commissioner at HUD has stated that all loans being considered for a zero  down loan would go through FHA’s TOTAL Scorecard, and borrowers  would be required to receive prepurchase counseling.
section_title: Before Fully Implementing New Products, Some Mortgage Institutions May Limit Their Availability
paragraphs: Fannie Mae and Freddie Mac sometimes use pilots, or limited offerings of  new products, to build experience with a new product type or to learn  about particular variables that can help them better understand the factors  that contribute to risk for these products. Freddie Mac and Fannie Mae also  sometimes set volume limits for the percentage of their business that could  be low and no down payment lending. Fannie Mae and Freddie Mac  officials provided numerous examples of products that they now offer as  standard products but which began as part of underwriting experiments.   These include the Fannie Mae Flexible 97® product, as well as the Freddie  Mac 100 product. FHA has utilized pilots or demonstrations as well when  making changes to its single-family mortgage insurance but generally does  this in response to legislation that requires a pilot and not on its own  initiative. One example in which FHA might have opted to do a pilot, or  otherwise limited volumes, for a product is with allowing nonprofit down  payment assistance. Concerns have been raised about the performance of  FHA loans  that have down payment assistance. FHA might have benefited  from setting some limits on this type of assistance such that they could  study its implications before allowing its broader use.
FHA’s Home Equity Conversion Mortgage (HECM) insurance program is an  example of an FHA program that started out as a pilot. HECM was initiated  by Congress in 1987 and is designed to provide elderly homeowners a  financial vehicle to tap the equity in their homes without selling or moving  from their homes. Homeowners borrow against equity in their home and  receive payments from their lenders (sometimes called a “reverse  mortgage”). Through statute, HECM started out as a demonstration  program that authorized FHA to insure 2,500 reverse mortgages. Through  subsequent legislation, FHA was authorized to insure 25,000 reverse  mortgages, then 50,000, and then finally 150,000 when Congress made the  program permanent in 1998. Under the National Housing Act, the HECM  program was required to undergo a series of evaluations and it has been  evaluated four times since its inception. FHA officials told us that  administering this demonstration for only 2,500 loans was difficult because  of the challenges of selecting only a limited number of lenders and  borrowers. FHA ultimately had to limit loans to lenders drawn through a  lottery.
The appropriate size for a pilot program depends on several factors. For  example, the precise number of loans needed to detect a difference in  performance between standard loans and loans of a new product type  depends in part on how great the differences are in loan performance. If  delinquencies early in the life of a mortgage were about 10 percent for  FHA’s standard high LTV loans, and FHA wished to determine whether  loans in the pilot had delinquency rates no more than 20 percent greater  that the standard loans (delinquency no more than 12 percent), a sample  size of about 1,000 loans would be a sufficient size to detect this difference  with 95 percent confidence. If delinquency rates are different, or FHA’s  desired degree of precision were different, a different sample size would be  appropriate. FHA officials with whom we spoke told us they could use  pilots or otherwise limit availability when implementing a new product or  making changes to an existing product, but they also questioned their  authority and the circumstances under which they would do so. FHA  officials also said that they lacked sufficient resources to be able to  appropriately manage a pilot.
Some mortgage institutions may also limit the initial implementation of a  new product by limiting the origination and servicing of the product to their  better lenders and servicers, respectively. Mortgage institutions may also  limit servicing on the loans to servicers with particular product expertise,  regardless of who originates the loans. Fannie Mae and Freddie Mac both  reported that these were important steps in introducing a new product and  noted that lenders tend to take a more conservative approach when first  implementing a new product. FHA officials agreed that they could, under  certain circumstances, envision piloting or limiting the ways in which a  new or changed product would be available but pointed to the practical  limitations in doing so. FHA approves the sellers and services that are  authorized to support FHA’s single-family product. FHA officials told us  they face challenges in offering any of their programs only in certain  regions of the country or in limiting programs to certain approved lenders  or servicers. They generally offer their products on a national basis and,  when they do not, specific regions of the county or lenders may question  why they are not able to receive the same benefit (even on a demonstration  or pilot basis). These officials did, though, provide examples in which their  products had been initially limited to particular regions of the country or to  particular lenders, including the rollout of the HECMs and their TOTAL  Scorecard.
section_title: Mortgage Institutions Establish Enhanced Monitoring and Oversight for New Low and No Down Payment Products and Make Changes Based on What They Learn
paragraphs: Mortgage institutions, including FHA, may take several steps related to  increased monitoring of new products and then make changes based on  what they learn. Fannie Mae and Freddie Mac officials described processes  in which they monitor actual versus expected loan performance for new  products, sometimes including enhanced monitoring of early loan  performance. FHA officials told us they also monitor more closely loans  underwritten under revised guidelines. Specifically, FHA officials told us  that FHA routinely conducts a review of underwriting for approximately 6  to 7 percent of loans it insures. FHA officials told us that, as part of the  review, it may place greater emphasis on reviewing those aspects of the  insurance product that are the subject of a recent change. Some mortgage  institutions, such as Fannie Mae, told us that they may conduct rigorous  quality control sampling of new acquisitions, early payment defaults, and  nonperforming loans. Depending on the scale of a new initiative, and its  perceived risk, these quality control reviews could include a review of up to  100 percent of the loans that are part of the new product.
Fannie Mae and Freddie Mac also reported that they conduct more regular  reviews at seller/servicer sites for new products. In some cases, Fannie  Mae and Freddie Mac have  staff who conduct on-site audits at the sellers  and servicers to provide this extra layer of oversight. FHA officials also  reported that they have staff that conduct reviews of lenders that they have  identified as representing higher risk to FHA programs. However, we  recently reported that HUD’s oversight of lenders could be improved and  identified a number of recommendations for improving this oversight.    Mortgage institutions may issue a lender bulletin, announcement, or  seller/servicer guidelines to clarify instructions for new products or  changes to existing products.  FHA does this through the mortgagee letters  it issues to all of its approved lenders. Mortgage institutions may also issue  a lender bulletin, announcement, or seller/servicer guidelines to  communicate required additional controls, practices, procedures,  reporting, and remitting. Importantly, changes can be made to the structure  of a product, including the automated underwriting systems used to  approve individual loans, based on information learned from monitoring of  new products or from other sources.
FHA officials told us that they routinely analyze the changing performance  of loans they insure as part of the annual process for estimating and  re-estimating subsidy costs. The Federal Credit Reform Act of 1990  requires that federal government programs that make direct loans or loan  guarantees (including insuring loans) account for the full cost of their  programs on an annual budgetary basis. Specifically, federal agencies must  develop subsidy estimates of the net cost of their programs that include  estimates of the net costs and revenues over the projected lives of the loans  made in each fiscal year. FHA’s Mutual Mortgage Insurance Fund has  historically been self-sufficient (not requiring subsidy). When preparing  cost estimates for loan guarantee programs, agencies are expected to  develop a plan to establish the appropriate information, models, and  documentation to better understand the new product and to be able to  make changes based on what they learn. FHA officials state that they have  a process in which changes to their model are made to reflect the  incorporation of new programs and policies and that they review the  performance of a new program in the context of their annual development  of subsidy estimates, as well as their annual actuarial study.
section_title: Conclusions
paragraphs: While credit score is an effective predictor of default, LTV remains an  effective predictor of default. Loans with lower or no down payments carry  greater risk. Without any compensating measures such as offsetting credit  enhancements and increased risk monitoring and oversight of lenders,  introducing a new FHA no down payment product would expose FHA to  greater credit risk. The administration’s proposal for a zero down product  included increased premiums to help compensate for an increase in the  cost of the FHA program, and the Federal Housing Commissioner stated  that borrowers would be required to go through prepurchase counseling.  The extent to which increased cost for one program could effect the overall  performance of FHA’s Mutual Mortgage Insurance (MMI) fund depends, in  part, on the scale of any new product, its relative cost, and how the new  product affects demand for FHA’s existing products.
Although FHA appears to follow many key practices used by mortgage  institutions in designing and implementing new products, several practices  not currently or consistently followed by FHA stand out as appropriate  means to manage the risks associated with introducing new products or  significantly changing existing products. Moreover, these practices can be  viewed as part of a framework used by some mortgage institutions for  managing the risks associated with new or changed products. The  framework includes techniques such as limiting the availability of a new  product until it is better understood and establishing stricter underwriting  standards—all of which would help FHA to manage risk associated with  any new product it may introduce. For example, FHA could set volume  limits or limit the initial number of lenders participating in the product.  Further, changes in FHA’s premiums, an important practice used by FHA,  within statutory limits, permits FHA to potentially offset additional costs  stemming from a new product that entails greater risk or not well  understood risk.
FHA officials believe that the agency does not have sufficient resources to  implement products with limited volumes, such as through a pilot program.  However, when FHA introduces new products or makes significant  changes to existing products with risks that are not well understood, such  actions could introduce significant risks when implemented broadly.  Products that would introduce significant risks can impose significant  costs. We believe that FHA could mitigate these costs by using techniques  such as piloting.
section_title: Matters for Congressional Consideration
paragraphs: If Congress authorizes FHA to insure no down payment products or any  other new single-family insurance products, Congress may want to  consider a number of means to mitigate the additional risks that these  loans may pose. Such means may include limiting the initial availability of  such a new product, requiring higher premiums, requiring stricter  underwriting standards, or requiring enhanced monitoring. Such risk  mitigation techniques would serve to help protect the Mutual Mortgage  Insurance Fund while allowing FHA the time to learn more about the  performance of loans using this new product. Limits on the initial  availability of the new product would be consistent with the approach  Congress took in implementing the HECM program. The limits could also  come in the form of an FHA requirement to limit the new product to better  performing lenders and servicers as part of a demonstration program or to  limit the time period during which the product is first offered.
section_title: Recommendations for Executive Action
paragraphs: If Congress provides the authority for FHA to implement a no down  payment mortgage product or other products about which the risks are not  well understood, we recommend that the Secretary of HUD direct the  Assistant Secretary for HUD-Federal Housing Commissioner to consider  the following three actions:   incorporating stricter underwriting criteria such as appropriate credit  score thresholds or borrower reserve requirements,  piloting the initial product or limiting its initial availability and asking  Congress for the authority if HUD officials determine they currently do  not have this authority, and  utilizing other techniques for mitigating risks including use of credit  enhancements and prepurchase counseling.
Regardless of any new products Congress may authorize, when making  significant changes to its existing products or establishing new products,  we recommend that the Secretary of HUD direct the Assistant Secretary for  HUD-Federal Housing Commissioner to consider the following two  actions:  limiting the initial availability of the product and when doing so, the  Commissioner should establish the conditions under which piloting  should be used, the techniques for limiting the initial availability of a  product, and the methods of enhanced monitoring that would be  connected to predetermined measures of success or failure for the  product.; and  asking Congress for the authority to offer its new products or significant  changes to existing products on a limited basis, such as through pilots, if  HUD officials determine they currently lack sufficient authority.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to HUD, Fannie Mae, Freddie Mac, USDA,  and VA. We received written comments from HUD, which are reprinted in  appendix III. We also received technical comments from HUD, Fannie Mae,  Freddie Mac, and USDA, which have been incorporated where appropriate.  VA did not have comments on the draft.
HUD stated that it is in basic agreement with GAO that all policy options,  implications, and implementation methods should be evaluated when  considering or proposing a new FHA product. HUD also stated that in  designing its zero down payment program it considered the items that we  recommended it consider, including piloting. HUD stated that it adopted  the prepurchase counseling requirement as a component of a proposed  zero down program and that it determined that structuring the mortgage  insurance premium in such a way as to minimize risk represents the most  appropriate tool for managing the risk of this proposed program.
However, it is not clear under what circumstances HUD believes that  piloting or limiting the availability of a changed or new product would be  appropriate or possible. As we noted in our draft report, HUD officials told  us that they face challenges in administering a pilot program because of the  difficulty of selecting only a limited number of lenders and borrowers. HUD  officials also held that they may not have the authority to limit products  and that they lacked sufficient resources to adequately manage products as  part of a pilot or with limited volumes.
We believe that HUD needs to further consider piloting or limiting volume  of new or changed products because, as we state in the report, it is a  practice followed by others in the mortgage industry and could assist HUD  in mitigating the risks and costs associated with new or changed products,  while still allowing HUD to meet its goal of providing homeownership  opportunities. Difficulties in selecting a limited number of lenders and  questions about a lack of authority could both be addressed by seeking  clear authority from Congress on these matters, if HUD officials determine  they currently lack sufficient authority. As we note in our report, when  considering the resources necessary to implement products with limited  volumes, if FHA does not use pilots or limit the availability of certain new  or changed products, FHA may face costs due to the significant risks that  can be associated with products that are implemented broadly and about  which the risks are not well understood. We do not believe that  implementing products with initial limits is appropriate or necessary in all  cases. To ensure that piloting or limiting the initial availability is given  sufficient consideration, we continue to recommend that HUD consider  establishing the conditions under which piloting should be used and the  techniques for limiting the initial availability of a product, as well as the  methods of enhanced monitoring that would be connected to  predetermined measures of success or failure for the product.
As agreed with your office, 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 of this report to the  appropriate Congressional Committees and the Secretaries of Housing and  Urban Development, Agriculture, and Veterans Affairs. We also will make  copies available to others upon request. In addition, the report will be  available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact me at (202) 512-8678 or shearw@gao.gov or Mathew Scirè,  Assistant Director, at (202) 512-6794 or sciremj@gao.gov. Key contributors  to this report are listed in appendix IV.
section_title: Scope and Methodology
paragraphs: To describe key characteristics and standards of mortgage products, we  interviewed officials at the Federal Housing Administration (FHA), U.S.  Department of Agriculture (USDA), and U.S. Department of Veterans  Affairs (VA); as well as staff at a conventional mortgage providers (Bank of  America); private mortgage insurers (for example, The PMI Group, Inc.;  Mortgage Guarantee Insurance Corporation); government-sponsored  enterprises (GSE) (such as Fannie Mae and Freddie Mac); Office of Federal  Housing Enterprise Oversight (OFHEO); various state housing finance  agencies; and nonprofit down payment assistance providers (for example,  Nehemiah Corporation of America and Ameridream, Inc.). We reviewed  descriptions of various mortgage products and compared the standards  used across entities including FHA, USDA, and VA regulations and program  guidance and the GSEs seller/servicer guides. We reviewed Web sites of  state housing finance agencies and if we identified zero down payment  programs, we corroborated some of the Web site information through  interviews of agency officials. To report on the volume of mortgage  products, we reviewed relevant reports including reports from the U.S.  Department of Housing and Urban Development (HUD).
To determine what economic research indicates about the variables that  are most important when estimating the risk level associated with  individual mortgages, we conducted a literature search. To identify recent  and relevant papers, we used various Internet search engines (such as  Online Computer Library Center, FirstSearch: EconLit; HUD USER) and  inquired with various mortgage industry participants (for instance, FHA,  Fannie Mae, Freddie Mac, and Nehemiah). Research we reviewed includes  articles, reports, and papers that were made available to us from economic  journals, the Internet, libraries, or were provided to us by various entities  (e.g., HUD, Fannie Mae, Freddie Mac). For the purposes of this report, we  refer to these documents as “papers.”
To facilitate the search we developed several criteria. For example, we  used the following search terms: mortgage, performance, default, LTV  ratio, credit score, and down payment assistance. We excluded the  following terms from our search: multifamily and commercial. We limited  our search to papers published or issued from 1999 to 2004; however, we  did include some papers relevant to our inquiry that were published or  issued prior to 1999 that we determined were significant to our research  objectives. We identified 151 papers. There may be some relevant research  that our search did not identify.
For the papers we identified, we conducted a multistep review. Initially, we  determined which papers to include in our analysis. Papers included in the  analysis were those that (1) were relevant to our inquiry, (2) included  empirical analysis, and (3) utilized satisfactory methodologies. Papers that  were not relevant were excluded from our analysis (for example, subject of  paper was off-point—car loans; or analysis of loans in foreign country).  Additionally, we determined if the paper included empirical analysis. If the  paper did not include empirical analysis, we did not include it. However, we  did review the paper to determine if it talked about papers that we had not  yet identified that appeared to have empirical analysis. If the paper did  identify an additional paper that appeared to be relevant to our inquiry, we  attempted to obtain it. Finally, we excluded papers with weak  methodologies. GAO economists conducted the evaluations of economic  models. During this review, we excluded 106 papers leaving 45 for the  second-stage review. Many of the papers we excluded were excluded for  lack of relevance or because they did not include empirical analysis. The  second review consisted of documenting the findings of the papers that  were relevant, had empirical analysis, and used satisfactory methodologies.  To facilitate this analysis, we developed and maintained an Access  database to document our analysis—cataloging the specific factors these  papers identified as being important to estimating the risk level associated  with individual mortgages. Finally, for these papers, we synthesized the  literature by determining how many papers found each variable to be  important. For a bibliography of the 45 papers included in our analysis, see  appendix II.
To examine the relationship between mortgage performance and two key  underwriting variables, loan-to-value (LTV) ratio and credit score, we  calculated 4-year default rates for several categories of mortgages with  various LTV ratios and credit scores. We selected 4-year default rates  because it best balanced the competing goals of having recent loans and  the greatest number of years of default experience. To perform this  analysis, we first obtained mortgage volume and performance data from  three mortgage institutions: FHA (government mortgages) and Fannie Mae  and Freddie Mac (conventional mortgages). The FHA mortgage data  consist of a stratified random sample of over 400,000 FHA-insured mortgages originated in calendar years 1992, 1994, and 1996. We used  these data because they are the only significant data set of FHA loans that  includes credit scores and that had at least 4 years of loan performance  activity. The data come from a sample built by FHA for research purposes.  The Fannie Mae and Freddie Mac data consist of all purchase-money  mortgages originated in calendar years 1997, 1998, and 1999 and purchased  by Fannie Mae or Freddie Mac. The data provided by Fannie Mae and  Freddie Mac exclude government-insured mortgages. We selected these  loan years because they include loans that aged at least 4 years and  because, during these years, the GSEs began to purchase an increasing  number of loans with higher LTVs. The GSEs provided us data that they  considered to be proprietary. Although we limited the reporting of our  analysis to that which was considered nonproprietary, this did not limit our  overall findings for this objective. A comparison of results from the FHA  and the conventional mortgage performance analysis should be done with  care, for a number of reasons because the data are from different years,  FHA and the GSEs calculated LTVs differently, and FHA’s average 4–year  default rate is higher than for the GSEs.
For this analysis, we used the LTV ratio contained in the data system for  each mortgage institution. FHA defines the LTV ratio as the original  mortgage balance, excluding the financed mortgage insurance premium,  divided by the appraised value of the house. For the GSEs, LTV ratio is  defined as the original mortgage balance divided by the lesser of the sale  price of the house or the appraised value of the house.
For this analysis, the credit score is the Fair Isaac score contained in each  institution’s data system. The mortgage institutions obtain credit scores in  various ways. FHA has only recently begun to collect credit scores in its  single-family data warehouse. However, for research purposes, FHA  purchased historic credit score information for the sample of mortgages  originated in 1992, 1994, and 1996. On the other hand, Fannie Mae obtains  credit score information in two ways. For some mortgages, the lender  obtained the borrower’s credit score information when it originated the  mortgage, and upon Fannie Mae’s purchase of the mortgage, the lender  provides this credit score information to Fannie Mae. In some cases,  however, lenders do not obtain borrower’s credit scores; when Fannie Mae  purchases the mortgage, it obtains a credit score for the borrower. For  some mortgages, the institutions indicated that a credit score for a  particular mortgage was unknown. Within the FHA data, about 8 percent of  the mortgages had unknown scores; within the GSE data, about 3 percent  of the mortgages had unknown scores. We included mortgages with  unknown credit scores in our analysis and presented the loan performance  results.
We carried out several actions to ensure that data provided by FHA, Fannie  Mae, and Freddie Mac were sufficiently reliable for use in our analysis. For  the FHA sample data, we met with FHA staff involved in generating the  sample data set. We also discussed data quality procedures with  appropriate FHA staff. Based on these discussions in which FHA officials  described their policies and procedures and the results of external audits of  their data systems, we determined that the FHA data were sufficiently  reliable to use in our analysis. FHA officials indicated that their data  systems contain data entry edit checks and that data submitted by lenders  was reviewed by FHA. FHA’s data system was audited by external auditors,  and no major issues concerning data quality were raised. We also discussed  data quality procedures with appropriate Fannie Mae and Freddie Mac  staff. These procedures included data entry edit checks, exception reports,  and checks for reasonableness. Additionally, we reviewed reports from  audits of Fannie Mae and Freddie Mac. These audits included an  assessment of the Fannie Mae information systems that generated the data  used in this report. The audits also assessed Freddie Mac information  systems that generated the data used in this report. We also compared the  data with similar publicly available data. Based on these discussions and  reviews of audit reports, we determined that the data Fannie Mae and  Freddie Mac provided were sufficiently reliable to use in our analysis.
With these data, we generated FHA and conventional 4-year default rates  for several combinations of LTV ratios and credit scores. To do this, we  defined default as a credit event that includes foreclosed mortgages, as  well as mortgages that did not experience foreclosure, but that would  typically lead to a credit loss, such as a “short sale” or a “deed-in-lieu of  foreclosure” termination of the mortgage;  selected six LTV ratio categories;  selected six credit score categories;  combined Fannie Mae and Freddie Mac mortgage volume and   combined mortgage volume and performance data for the sample (of  mortgages insured by FHA in 1992, 1994, and 1996; and conventional  mortgages originated in 1997, 1998, and 1999 and purchased by Fannie  Mae or Freddie Mac);   calculated the average 4-year default rate for FHA (weighted average)  and for all conventional loans separately by dividing the total dollar  amount of mortgages experiencing a credit event by the total dollar  amount of mortgages originated (for FHA) or purchased (for  conventional);   calculated the average 4-year default rates for sampled FHA loans and  for conventional loans that fell within each LTV ratio and credit score  category; and  calculated the relative 4-year default rates for each LTV ratio and credit  score categories for FHA loans and for conventional loans by dividing  the average 4-year default rate for each specific LTV and credit score  category by the average 4-year default rate for sampled FHA loans and  all conventional loans, respectively.
For example, if the merged average 4-year default rate for FHA loans within  a particular LTV ratio and credit score category was 3 percent, and the  average 4-year default rate for all FHA loans was 2 percent, the relative 4- year default rate for FHA loans within this particular category would be 3  divided by 2, or 1.5 times the average FHA default rate.
We do not present relative default rates for categories with small numbers  of mortgages because the performance information may not be reliable  when there are too few observations. In the figures, these instances are  noted as “N/A.” For the FHA analysis, we used a cutoff of about 1,000  mortgages to determine whether there were sufficient observations to  reliably measure the relative default rate. For the conventional analysis, we  used a cutoff of about 3,000 mortgages to determine whether the relative  default rate was reliable. We chose a higher cutoff for the GSE analysis  because the GSEs have a lower default rate, and analysis of less frequent  events requires a larger sample size.
To determine what lessons FHA might learn from others that support low  and no down payment lending we obtained testimonial information from  the mortgage industry (for example, FHA, GSEs, private mortgage insurers,  and a private lender) about the steps they take to design and implement  low and no down payment lending. We selected these entities based on the  parallels to FHA, as well as their significance in the mortgage industry.  Where available, we reviewed industry and academic information relevant  to these steps in carrying out low and no down payment lending.
We performed our audit work from January 2004 to December 2004 in  accordance with generally accepted government auditing standards.
section_title: Papers Identified in Literature Search and Included in Analysis
paragraphs: factor(s)
Brent W. Ambrose and Charles A. Capone. “The Hazard Rates of First and Second Defaults,”  Journal of Real Estate Finance and Economics, vol. 20 no. 3 (May 2000).
Brent W. Ambrose and Charles A. Capone. “Modeling the Conditional Probability of Foreclosure  in the Context of Single-Family Mortgage Default Resolutions,” Real Estate Economics, vol. 26  no. 3 (1998).
Richard Anderson and James VanderHoff. “Mortgage Default Rates and Borrower Race,” The  Journal of Real Estate Research, vol. 18 no. 2 (Sep/Oct 1999).
Robert B. Avery, Raphael W. Bostic, Paul S. Calem, and Glenn B. Canner.  “Credit Risk, Credit  Scoring, and the Performance of Home Mortgages,” Federal Reserve Bulletin (July 1996).
James A. Berkovec, Glenn B. Canner, Stuart A. Gabriel and Timothy H. Hannan. “Race,  Redlining, and Residential Mortgage Loan Performance,” Journal of Real Estate Finance and  Economics, vol. 9 no. 1 (July 1994).
Paul S. Calem and Susan M. Wachter. “Community Reinvestment and Credit Risk: Evidence  from an Affordable-Home-Loan Program,” Real Estate Economics, vol. 27 no. 1 (1999).
Paul S. Calem and James Follain. The Asset-Correlation Parameter in Basel II for Mortgages on  Single-Family Residences, a report prepared as background for public comment on the Advance  Notice of Proposed Rulemaking on the Proposed New Basel Capital Accord, November 6, 2003.
Paul S. Calem and Michael LaCour-Little. Risk-based Capital Requirements for Mortgage Loans,  November 2001.
Charles A. Calhoun and Yongheng Deng. “A Dynamic Analysis of Fixed- and Adjustable-Rate  Mortgage Terminations,” Journal of Real Estate Finance and Economics, vol. 24 no. 1/2 (Jan  2002).
Dennis R. Capozza, Dick Kazarian, and Thomas A. Thomson.  “Mortgage Default in Local  Markets,” Real Estate Economics, vol. 25 no. 4 (Winter 1997).
Richard L. Cooperstein, F. Stevens Redburn, and Harry G. Meyers. “Modelling Mortgage  Terminations in Turbulent Times,” AREUEA Journal, vol. 19 no. 4 (1991).
Robert F. Cotterman. Analysis of FHA Single-Family Default and Loss Rates, a report prepared  for the Office of Policy Development and Research, U.S. Department of Housing and Urban  Development, March 25, 2004.
Robert F. Cotterman. New Evidence on the Relationship Between Race and Mortgage Default:  The Importance of Credit History Data, a report prepared for the Office of Policy Development  and Research, U.S. Department of Housing and Urban Development, May 23, 2002.
Robert F. Cotterman. Neighborhood Effects in Mortgage Default Risk, a report prepared for the  Office of Policy Development and Research, U.S. Department of Housing and Urban  Development, March 2001.
Robert F. Cotterman. Assessing Problems of Default in Local Mortgage Markets, a report  prepared for the Office of Policy Development and Research, U.S. Department of Housing and  Urban Development, March 2001.
Amy Crews Cutts and Robert Van Order. “On the Economics of Subprime Lending.” Freddie Mac  Working Paper Series # 04-01(January 2004) (http://freddiemac.com/corporate/reports/).
X factor(s)
Ralph DeFranco.  “Modeling Residential Mortgage Termination and Severity Using Loan Level  Data.” (Ph.D diss., University of California, Berkeley, 2002).
Yongheng Deng, John M. Quigley. Woodhead Behavior and the Pricing of Residential  Mortgages, (December 2002).
Yongheng Deng and Stuart Gabriel. Enhancing Mortgage Credit Availability Among Underserved  and Higher Credit-Risk Populations: An Assessment of Default and Prepayment Option Exercise  Among FHA-Insured Borrowers, a report prepared for the U.S. Department of Housing and  Urban Development, August 2002.
Yongheng Deng and Stuart Gabriel. Modeling the Performance of FHA-Insured Loans:  Borrowers Heterogeneity and the Exercise of Mortgage Default and Prepayment Options, a  report submitted to the Office of Policy Development and Research, U.S. Department of Housing  and Urban Development, May 2002.
Yongheng Deng, John M. Quigley, and Robert Van Order. “Mortgage Terminations,  Heterogeneity and the Exercise of Mortgage Options,” Econometrica, vol. 68 no. 2 (March 2000).
Yongheng Deng, John M. Quigley, and Robert Van Order, Mortgage Default and Low  Downpayment Loans: The Costs of Public Subsidy, National Bureau of Economic Research:  Working Paper No. 5184 (Cambridge, Mass.: July 1995).
Peter J. Elmer and Steven A Seelig. “Insolvency, Trigger Events, and Consumer Risk Posture in  the Theory of Single-Family Mortgage Default,” Journal of Housing Research, vol. 10 no. 1  (1999).
Robert M. Feinberg and David Nickerson. “Crime and Residential Mortgage Default: An  Empirical Analysis.” Applied Economics Letters, vol. 9 (2002).
Dan Feshbach and Michael Simpson.  “Tools for Boosting Portfolio Performance,” Mortgage  Banking, October 1999.
Dan Feshbach and Pat Schwinn.  “A Tactical Approach to Credit Scores,” Mortgage Banking,  February 1999.
Gerson M. Goldberg and John P. Harding. “Investment Characteristics of Low- and Moderate- Income Mortgage Loans,” Journal of Housing Economics, vol. 12 (2003).
Government Accountability Office. Mortgage Financing: Changes in the Performance of FHA- Insured Loans, GAO-02-773. Washington, D.C. July 10, 2002.
Government Accountability Office. Mortgage Financing: FHA’s Fund Has Grown, but Options for  Drawing on the Fund Have Uncertain Outcomes, GAO-01-460. Washington, D.C. February 28,  2001.
Valentina Hartarska, Claudio Gonzalez-Vega, and David Dobos.  Credit Counseling and the  Incidence of Default on Housing Loans by Low-Income Households, a paper prepared as part of  a collaborative research program between Ohio State University and Paul Taylor and Associates,  of Columbus, Ohio. (February 2002).
Abdighani Hirad and Peter M. Zorn (corresponding author).  A Little Knowledge Is a Good Thing:  Empirical Evidence of the Effectiveness of Pre-Purchase Homeownership Counseling, May 22,  2001.
The Department of Housing and Urban Development, Office of Inspector General.  Follow-up of  Down Payment Assistance Programs Operated by Private Nonprofit Entities. 2002-SE-0001,  Seattle, Washington, September 25, 2002.
X factor(s)
The Department of Housing and Urban Development, Office of Inspector General.  Final Report  of Nationwide Audit: Down Payment Assistance Programs (Office of Insured Single Family  Housing), 2000-SE-121-0001, Seattle, Washington, March 31, 2000.
Michael Lacour-Little and Stephen Malpezzi. “Appraisal Quality and Residential Mortgage  Default: Evidence From Alaska,” Journal of Real Estate Finance and Economics, vol. 27 no. 2  (2003).
Andrey D. Pavlov. “Competing Risks of Mortgage Termination: Who Refinances, Who Moves,  and Who Defaults,” Journal of Real Estate Finance and Economics, vol. 23 no. 2 (September  2001).
Anthony Pennington-Cross. “Credit History and the Performance of Prime and Nonprime  Mortgages,” Journal of Real Estate Finance and Economics, vol. 27 no. 3 (2003).
Anthony Pennington-Cross. “Subprime and Prime Mortgages: Loss Distributions.”   Office of Federal Housing Enterprise Oversight Working Paper Series 03-01   (May 27, 2003).
Anthony Pennington-Cross. “Patterns of Default and Prepayment for Prime and Nonprime  Mortgages.” Office of Federal Housing Enterprise Oversight Working Paper 02-1 (March 2002).
Roberto G. Quercia, Michael A. Stegman, Walter R. Davis, and Eric Stein. Community  Reinvestment Lending: A Description and Contrast of Loan Products and Their Performance, a  report prepared for the Joint Center for Housing Studies’ Symposium on Low-Income  Homeownership as an Asset-Building Strategy, September 2000.
Roberto G. Quercia, George W. McCarthy, and Michael A. Stegman. “Mortgage Default Among  Rural, Low-Income Borrowers,” Journal of Housing Research vol. 6 no. 2 (1995).
Stephen L. Ross. “Mortgage Lending, Sample Selection and Default,” Real Estate Economics,  vol. 28 no. 4 (Winter 2000).
Robert A. Van Order and Peter M. Zorn. The Performance of Low Income and Minority  Mortgages: A Tale of Two Options, August 2001.
Robert Van Order and Peter Zorn. Performance of Low-Income and Minority Mortgages, a report  prepared for the Joint Center for Housing Studies’ Symposium on Low-Income Homeownership  as an Asset-Building Strategy, September 2001.
Robert Van Order and Peter Zorn. “Income, Location, and Default: Some Implications for  Community Lending,” Real Estate Economics, vol. 28 no. 3 (2000).
Economic Systems Inc., ORC Macro, and The Hay Group.  Evaluation of VA’s Home Loan  Guaranty Program: Final Report. A report prepared for the Department of Veterans Affairs.  (July  2004).
section_title: Comments from the Department of Housing and Urban Development
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those individuals named above, Anne Cangi, Rudy Chatloss,  Bert Japikse, Austin Kelly, Marc Molino, Andy Pauline, Roberto Piñero, and  Mitch Rachlis made key contributions to this report.