STATEMENT OF THE

NATIONAL ASSOCIATION OF REALTORS®

BEFORE THE

SUBCOMMITTEE ON HOUSING AND URBAN AFFAIRS

SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS

BY RICK ADAMS

VICE CHAIRMAN, REALTORS REAL ESTATE FINANCE COMMITTEE

April 3, 1992

Introduction

Owning a home, along with obtaining an education and steady employment, are the basic components of the "American Dream." These goals are what most people consider necessary for long-term financial security. However, the goal of homeownership probably is the most difficult to achieve.

Over the last decade, spiraling housing costs, coupled with lagging income growth, created a huge affordability gap for low- and moderate-income people. Many young households have been forced to delay homeownership indefinitely.

Throughout the past several months, low mortgage interest rates have helped improve housing affordability conditions. However, many prospective buyers are still falling through the cracks. They need access to the vital mortgage finance program provided by the Federal Housing Administration (FHA).

FHA's single-family mortgage insurance program represents the best, and in many cases, the only route first-time buyers can take to achieve homeownership. The crucial role FHA has played in fostering homeownership can be traced back to its creation in 1934. FHA was established in response to the general lack of private mortgage insurance during the Great Depression. Its mission was to insure mortgage loans and thereby encourage reluctant lenders to make mortgage funds available to homebuyers. FHA remained virtually the sole source of mortgage insurance until the establishment of the Veterans Administration's home loan guaranty program in 1945. Not until 1957 were private mortgage insurers authorized by the states to operate. In fact, until the 1970s, the main sources of mortgage insurance were FHA and VA. At that point, the volume of private mortgage insurance rose dramatically, due primarily to FHA's cumbersome operating procedures and the interest rate administered on FHA-insured mortgages.

In the 1980s, Congress crafted legislation to address some of the problems inherent in the FHA program. Major changes relative to the negotiation of interest rates, creation of the Direct Endorsement Program, and the upfront mortgage insurance premium (MIP) were instituted in 1983. Some of these changes, particularly the up-front MIP, contributed to the decreased viability of FHA's Mutual Mortgage Insurance Fund (MMIF).

With 1990 came the Cranston-Gonzalez National Affordable Housing Act (NAHA), and its subsequent implementation by the U.S. Department of Housing and Urban Development (HUD). Reforms were made that Congress believed would enhance the stability of the MMIF. Although housing industry groups were aware of the potential number of homebuyers who would be affected by the 1990 law, the FHA changes were accepted as necessary to insure the future viability of FHA. However, we believe HUD has gone far beyond the intent of Congress by imposing further constraints. In doing so, HUD has managed to create obstacles to homeownership that are definitely unnecessary at a time when our economy needs the lift that home buying activity can provide.

Since its creation, FHA has insured single-family homes for more than 17 million borrowers. The MMIF has never required taxpayer support to operate.

The NATIONAL ASSOCIATION OF REALTORS® is firmly committed to keeping FHA sound and viable. We believe a number of changes can be made to the program that will improve the financial position of the MMIF, and make the program more accessible to a large number of families who otherwise could not use the program.

Rescind the Restrictions on Financing Closing Costs

The FHA has historically played a pivotal role in helping Americans become homeowners. Recent changes in FHA underwriting guidelines have served to impede, rather than enhance, families' home-owning prospects. Specifically, these changes raised the down payment requirements and limited the amount of closing costs that can be financed.

We believe that HUD exceeded the intent of Congress when it implemented the restriction on financeable closing costs for FHA mortgages. Although there was considerable debate concerning the soundness of the MMIF at the original consideration of the National Affordable Housing Act, neither the statute nor the final conference report set forth any restrictions on financeable closing costs. The statutory provisions should have been given ample opportunity to work before further restrictions were imposed. We have three specific concerns: difficulty for lenders to meet Community Reinvestment Act (CRA) responsibilities; declines in FHA market share; and the increased burdens of obtaining and originating an FHA loan.

The recent FHA changes mandating higher fees and more restrictive lending standards are making it more difficult for lenders to meet CRA responsibilities and, more importantly, for marginal families to achieve the dream of homeownership. Historically FHA has been an extremely effective tool in serving marginal homebuyers. FHA provides homeownership opportunities for borrowers who have lower annual incomes, make smaller downpayments, and purchase lower value homes than homebuyers who utilize private mortgage insurance. The FHA program has been an invaluable source of home financing for lenders with CRA responsibilities. Since the CRA pressure has intensified and requires more flexible lending, Congress should rescind HUD's flawed policy to ensure FHA financing will take place in low-income communities.

Contrary to recent comments from HUD officials, there is information available to analyze the impact of the implemented changes to the FHA single-family mortgage program on FHA activity. The monthly NAR Home Sales terms-of-sale data (See Table I) shows that FHA activity

has declined significantly in every housing market we examined since HUD implemented the 57 percent closing cost restriction.

Table I presents the proportion of home sales, by metropolitan area, which were insured by FHA during the first six months of 1991 versus the proportion of FHA home sales transactions in the last six months of 1991. The important distinction of this data is that it is proportional market share data for the two time periods, and is irrespective of the reported volume of homes sales activity. Therefore, it cannot be argued, as HUD has done, that the current economic recession has distorted this measure of FHA activity. Table I shows that FHA has become less important in every market examined with the average decline in market share for these metropolitan areas more than 21 percent. Clearly, FHA has become far less attractive as an insurer since the reforms were implemented on July 1, 1991.

A major concern for NAR is that in addition to the increase in costs to potential FHA homebuyers, the implementation of the NAHA reforms by HUD has had the unintentional effect of making FHA-insured financing cumbersome and inefficient to acquire. Now, a REALTOR® is unable to advise potential homebuyers whether or not they can purchase a home with FHA insurance without knowing the details of the buyer-seller negotiation of who pays closing costs. Similarly, a mortgage lender cannot determine whether the prospective buyer can qualify for a loan without a detailed agreement between buyers and sellers on who pays what closing costs. In addition, the multiple calculations required to determine downpayment and maximum loan amount has resulted in a significant increase in both labor and time to apply for an FHA loan.

The result of moving from an efficient to an inefficient market has been to decrease the demand for FHA insurance from low-risk households. Lenders are steering consumers to the conventional, private mortgage insurance market if the potential homebuyer has any savings, rather than seeking an FHA insurance commitment as they might have in the past. It is quicker, less labor intensive, and just generally easier to go conventional. As we projected last year, FHA is losing low-risk borrowers. Contrary to assumptions in the original Price Waterhouse study of June, 1990, these borrowers are not selecting the FHA program. The net result is that FHA is currently insuring homebuyers post-reform with the same or higher loan-to-value (LTV) ratios than pre-reform, and the MMIF will continue to fail financially into the future. Whether the loss of the low-risk homebuyer is because of the increased costs of the program, or because the process has become regulatorily burdensome, is irrelevant. The MMIF has not been improved.

Financial Risk to GNMA is Increasing

NAR is increasingly concerned that this decline in FHA activity, a direct result of HUD's implementation of NAHA and the Omnibus Budget Reconciliation Act of 1990, is giving rise to serious risk within the Government National Mortgage Association (GNMA) program -- risk that would be borne by FHA, not GNMA. Not only is FHA losing new purchase money transactions (insurance on sales of new and existing homes), but also many existing FHA loans are being refinanced into conventional loans.

There is evidence that the total number of loans securitized in the GNMA single-family housing program is decreasing. This decrease began in December of 1991, and has continued through the first quarter of 1992. If this runoff continues, and it consists of loans being refinanced in the conventional mortgage market (good, low-risk loans), it is likely that the overall

GNMA portfolio, like the FHA MMIF single-family portfolio, will deteriorate as the poorer quality loans remain in the GNMA securities. Since September 1991, in fact, GNMA delinquency rates have increased substantially.

Changing the Premium Structure

Both the declining usage of the FHA single-family mortgage insurance program as well as the increasing proportion of existing GNMA securities with higher risk characteristics indicate that the reforms legislated in NAHA (and its implementation by HUD) are not working to lower risk in the MMIF. The philosophy of NAHA was sound -- lower the LTV of new FHA "books of business". This has not and is not occurring. The premium structure enacted in NAHA was and is troubling to NAR because it essentially requires future FHA homebuyers to pay for HUD's mortgage insurance pricing errors of the past. A number of other ways of lowering the LTV on new FHA business were debated during the crafting of NAHA. NAR strongly believes these alternatives would have addressed lowering LTV, while at the same time they would not have made the market inefficient through cumbersome underwriting criteria.

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The principal problem with FHA insurance is the premium structure the payment of mortgage insurance upfront (and financed in the loan) rather than the pay-as-you-go premium structure that existed prior to 1983. Price Waterhouse, in its original actuarial study of June 1990, proposed four premium structure options to reduce LTV. None were adopted by Congress. NAR feels strongly that a more appropriate mortgage insurance premium structure for FHA is a one percent, non-refundable, financeable up-front premium with a .5 percent annual premium. We feel this premium structure would have significantly reduced the LTV for new FHA business. The advantage of this structure is that a high upfront premium is not included in the loan amount and therefore the "true" LTV on each loan would be significantly reduced -- the espoused goal of NAHA. Additionally, it would be much easier to implement by HUD and would not have created an inefficient market.

Raise the Maximum Mortgage Limit

NAR reaffirms its long-standing position on raising the FHA mortgage loan limits. This position is based on three premises: first, it will make homeowning an option for many more families nationwide. Second, it will extend the program to stronger market areas, which will result in bringing even lower-risk loans into the FHA MMIF. Third, it significantly improves the reserves of the MMIF by raising premium income, reducing claims, and decreasing losses per claim.

We believe that the maximum loan the FHA is allowed to insure should be raised to keep pace with home price appreciation. FHA maximum mortgage limits have badly lagged behind increases in home prices in many areas, constraining the ability of moderate-income homebuyers to obtain financing for home purchases.

NAR has investigated the impact of existing FHA loan limits on our nation's 82.3 million households. Our research examined whether a household could qualify for a mortgage on a house priced at 95 percent of the median house price in their area. We first identified those families who cannot qualify for a conventional mortgage because they do not satisfy conventional underwriting criteria. We then identified the subgroup of families who can qualify for an FHA

mortgage. In other words, these are households who can afford a house priced at 95 percent of the median price in their area, but can purchase it only if they can take advantage of the relatively easier underwriting guidelines available through the FHA mortgage insurance program.

After identifying the households who qualify for an FHA mortgage, but not a conventional one, we examined how many of these families cannot use the FHA program because the mortgage they would need exceeds the FHA loan limit in their area. NAR found that 1.3 million families - or 1.6 percent of all households in the U.S. are kept from buying a home priced at 95 percent of their area's median price because of FHA loan limits.

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We next repeated our earlier analysis, but added consideration of the house price that cach family could afford under FHA underwriting guidelines. By examining each household's income, savings, and debt, we calculated the highest house price for which they can obtain an FHA mortgage. Finally, we examined how many of these families cannot buy a house they can afford because the mortgage they need exceeds the FHA loan limit in their area.

We determined that almost 7 million families throughout the U.S. cannot get an FHA mortgage on a house they can afford because of loan limits. That is, the maximum mortgage limits on FHA loans prevent 8.5 percent of all households throughout the country from buying homes they could otherwise afford.

It is unlikely, however, that all 7 million households would buy a home. Historically, twothirds of households are homeowners, suggesting that two-thirds of these 7 million "locked-out" families -- or 4.7 million potential homeowners nationwide -- are directly prevented by loan limits from becoming homeowners.

Families living in metropolitan areas are especially squeezed by rising house costs and low FHA loan limits. Table II presents the number of households in many of the larger metropolitan statistical areas (MSAs) who cannot buy a house that they can afford because of low FHA loan limits.

These households have been identified using the techniques just described. Looking at the table, consider the first entry in the second column. In the Boston metropolitan area, we have found that 475,808 families cannot buy homes because of FHA loan limits. These 475,808 are households who do not qualify for a mortgage using conventional underwriting criteria. But their financial position is sound enough to obtain an FHA mortgage. The one factor preventing them from purchasing their homes is that the mortgage they need exceeds the FHA loan limit for the Boston area. Even assuming that only two-thirds of these 475,808 families are likely to buy a home, 317,205 potential homebuyers in Boston are "locked out" of homes because of Boston's loan limit, as shown in the third column.

It should be pointed out that helping more households by raising the maximum mortgage loan limit will significantly strengthen the financial position of the MMIF, and reduce the likelihood that the MMIF will show net outlays in the future. A Price Waterhouse study completed for GAO in 1990 demonstrated that raising the loan limit would dramatically improve the reserves of the MMIF.