Homeownership:

Potential Effects of Reducing FHA's Insurance Coverage for Home Mortgages

RCED-97-93: Published: May 1, 1997. Publicly Released: Jun 2, 1997.

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Pursuant to a congressional request, GAO provided information on the impact of a reduction in the Federal Housing Administration's (FHA) mortgage insurance coverage on: (1) home mortgage lenders, the home mortgage market, and the types of borrowers served by FHA; (2) the financial condition of FHA's insurance fund; and (3) the Department of Housing and Urban Development's (HUD) Government National Mortgage Association.

GAO noted that: (1) if FHA's insurance coverage is reduced and lenders become responsible for the risk associated with the uninsured portion of loans, lenders will likely make fewer and more costly FHA loans; (2) the general consensus of a HUD-sponsored lender focus group was that the number of FHA-insured loans would fall by 28 percent and that interest rates would increase by one-quarter to one-half of a percent; (3) although some decrease in volume and increase in interest rates would be likely, GAO's analyses indicate that the changes would likely not be as great as those that the focus group predicted; (4) nevertheless, any reduction in the volume of loans and increase in interest rates is likely to disproportionately affect higher-risk borrowers, low-income, first time, and minority borrowers and those individuals purchasing older homes, the types of borrowers frequently served by FHA; (5) although uncertainty is associated with any forecast, the federal government would likely improve the financial health of the Fund, by lowering its exposure to financial losses, if FHA's insurance coverage were reduced, according to GAO's analyses; (6) this would likely occur in part because FHA would be liable for only a portion of the losses on loans that go to foreclosure and therefore would suffer lower financial losses than it would under full insurance coverage; (7) decreasing FHA's insurance coverage would have an even greater positive impact on the Fund's capital reserve ratio if future economic conditions are worse than the conditions assumed in GAO's baseline scenario; (8) reducing FHA's insurance coverage might shift some losses from FHA to Ginnie Mae; (9) reducing FHA's insurance coverage might increase costs for Ginnie Mae if more lenders were unable to make payments to investors because they could not shoulder their portion of the losses on defaulted FHA-insured loans; and (10) however, if lenders respond to a reduction in FHA's insurance coverage by taking steps to maintain their financial position, such as targeting FHA-insured loans away from the riskiest borrowers and increasing interest rates, the impact on Ginnie Mae's losses would likely be lessened.

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