Purchasing a home is one of the greatest financial undertakings of most American families. In 1994, about 3.5 million families and individuals bought homes. Another 2.5 million families and individuals refinanced the mortgages on their existing homes. A variety of public- and private-sector institutions are involved in helping borrowers to obtain the mortgage credit they need to purchase homes. These institutions include mortgage insurers, who insure lenders against all or some losses on home mortgages. The primary mortgage insurers are private mortgage insurers (PMI), the Federal Housing Administration (FHA), and the U.S. Department of Veterans’ Affairs (VA). Mortgage insurance is required primarily for borrowers with limited down payment funds. Of the approximately 6 million mortgages reported through the Home Mortgage Disclosure Act (HMDA) for purchasing homes and refinancing existing mortgages in 1994, most (4 million) were not insured. In fact, 55 percent or more of the mortgages originated annually in 1984 through 1994 were uninsured. Uninsured mortgages reached their peak level in 1992 at 80 percent of all mortgages originated, as shown in figure 1.1. Many home buyers (42 percent) who financed the purchase of a home in 1994 required mortgage insurance. This percentage is substantially higher than the percentage of all mortgages taken out for refinancing in 1994 that were insured (19 percent). Mortgage insurance is generally used when a borrower makes a down payment of less than 20 percent of the value of the home (when the mortgage has a loan-to-value (LTV) ratio greater than 80 percent). If a borrower does not repay an insured mortgage loan as agreed, the lender may acquire the property through foreclosure and file a claim with the mortgage insurer for all or a portion of its total losses (the unpaid mortgage balance and interest, along with the costs of foreclosure and other expenses). If a borrower does not have mortgage insurance and fails to repay a mortgage, the lender may acquire the property through foreclosure and is responsible for the full amount of losses it incurs. While FHA and VA are federal entities, PMIs are privately-owned companies regulated at the state level. FHA is a government corporation operated within the U.S. Department of Housing and Urban Development (HUD). However, its primary single-family mortgage insurance program, the Section 203(b) program, is supported by the Mutual Mortgage Insurance Fund, which requires no federal funds to operate. The Mutual Mortgage Insurance Fund is required by law to meet or endeavor to meet statutory capital ratio requirements; that is, it must contain sufficient reserves and funding to cover estimated future losses resulting from the payment of claims on defaulted mortgages and administrative costs. Cash flows into the fund from insurance premiums and from the sale of foreclosed property. The cash reserves in the fund have always been more than enough to cover the expenses incurred. In 1995, the fund had a negative credit subsidy of $309 million. Negative credit subsidies occur when the present value of estimated cash inflows to the government exceeds the present value of estimated cash outflows. However, if the fund were to deplete its reserves, the U.S. Treasury would have to directly cover lenders’ claims and administrative costs. VA’s single-family mortgage guaranty program does require federal funds each year. In 1995, this program received a credit subsidy of $684 million. Many insured single-family mortgages are ultimately sold to investors through the secondary mortgage market. In 1995, virtually all FHA- and VA-insured mortgages were sold to investors with the help of the Government National Mortgage Association (Ginnie Mae), which, like FHA, is also a part of HUD. Ginnie Mae guarantees securities backed by pools of FHA- and VA-insured mortgages. Specifically, Ginnie Mae guarantees that investors in Ginnie Mae securities will receive timely principal and interest payments. Most privately insured mortgages are sold by lenders to the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac)—two government-sponsored enterprises (GSE) that sell securities backed by pools of mortgages to investors and hold other mortgages as investments. Like Ginnie Mae, Fannie Mae and Freddie Mac guarantee investors in their securities that they will receive their expected principal and interest payments. Fannie Mae and Freddie Mac’s charters require that loans they purchase with LTV ratios greater than 80 percent have some form of credit enhancement. Private mortgage insurance is the most common enhancement used for these high LTV loans. For an insured loan they have purchased, Fannie Mae and Freddie Mac assume the responsibility for foreclosure losses, if any, that a lender incurs above the amount of the claim paid by the PMI. Lenders use guidelines provided by the PMIs, FHA, and VA to determine whether a borrower is eligible for mortgage insurance through any of the insurers. These guidelines include maximum allowable LTV and qualifying ratios. Although some of the guidelines pertaining to FHA and VA mortgage insurance are set by the agencies, many are set by the Congress through legislation. Similarly, although some of the requirements for private mortgage insurance originate with the PMIs, others are set by Fannie Mae and Freddie Mac. When determining if a mortgage is eligible for private mortgage insurance, the requirements set by Fannie Mae and Freddie Mac are considered because many lenders want to sell insured mortgages through the secondary market. The requirements set by Fannie Mae and Freddie Mac include underwriting standards, insurance coverage requirements, and a maximum loan amount. In 1994, PMIs joined FHA and VA in offering insurance for mortgages with LTV ratios greater than 95 percent by creating special “affordable” programs. The affordable programs are for loans with LTV ratios of up to 97 percent. Generally, these affordable programs have more flexible underwriting than the standard program. Some PMIs also offer products through very specialized programs, sometimes administered in conjunction with another player, such as a state housing finance agency (HFA), with even more flexible terms than those available through the companies’ affordable programs. Between 1984 and 1994 (the latest year for which data are available), FHA’s share of all loans insured each year both for purchasing homes and refinancing existing mortgages has fluctuated between a low of 18 percent in 1984 and a high of 51 percent in 1987. PMIs’ share during the same period fluctuated between a low of 29 percent in 1987 to a high of 69 percent in 1984. VA’s share during this period stayed between 13 and 20 percent. The relative market shares of the mortgage insurers are shown in figure 1.2. Between 1986 and 1990, FHA was the largest insurer. The factors contributing to FHA’s large market share during these years may include an increase in FHA’s maximum loan limit in 1988 and economic downturns in some areas of the country. Except for FHA’s loan limit, the terms, such as maximum LTV ratio, under which FHA and VA mortgage insurance is available do not generally vary across different geographic locations, according to program guidelines. However, PMI companies may change the conditions under which they will provide new insurance in a particular geographic area to reflect the increased risk of losses in an area experiencing economic hardship. By tightening up the terms of the insurance they would provide, PMIs may have decreased their share of the market in economically stressed regions of the country. From 1990 through 1992, the share of the market insured by FHA fell. This decrease may be a result, in part, of increased premiums for FHA insurance implemented as a result of the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508). In 1992, the insurance premium for FHA mortgages decreased, which may have contributed to the rise in FHA’s market share that took place in 1992 through 1994. Throughout the period from 1991 through 1994, the PMIs had a greater share of all insured single-family mortgage originations than FHA or VA. In 1994, the PMIs’ share of all insured single-family mortgage originations was 48 percent, FHA’s was 35 percent, and VA’s was 17 percent. The federal government uses a variety of tools to promote homeownership, in addition to providing mortgage insurance through FHA and VA. As mentioned above, the secondary market institutions (Ginnie Mae, Fannie Mae, and Freddie Mac) help make capital available for mortgage lending. The Federal Home Loan Bank (FHLB) system also helps provide liquidity for lenders. The federal government insures deposits and provides advances to the thrifts and savings institutions that are members of the Federal Home Loan Bank system. Federal tax incentives, such as the home mortgage interest deduction that is available to homeowners of all income levels, also are designed to encourage homeownership. Federal programs and requirements that are designed to make homeownership affordable, particularly among households who may be underserved by the private market, are discussed in chapter 4. To obtain more information about the role of FHA’s single-family program in today’s housing finance system, the Chairman of the Subcommittee on Housing and Community Opportunity, House Committee on Banking and Financial Services, asked us to provide information on (1) the terms of products available through FHA’s Section 203(b) program in comparison with the terms of products available through the programs of the PMIs and VA; (2) FHA’s share of the home purchase mortgage market, the characteristics of home buyers using FHA mortgage insurance in comparison with other home buyers, and the portion of FHA borrowers who met certain qualifying ratios for private mortgage insurance; and (3) other federal programs and activities, besides FHA and VA, that promote affordable homeownership.