Homeownership: Results of and Challenges Faced by FHA's Single-Family
Mortgage Insurance Program (Testimony, 03/25/99, GAO/T-RCED-99-133).

Pursuant to a congressional request, GAO discussed the Federal Housing
Administration's (FHA) single-family mortgage insurance program,
focusing on: (1) the activities of FHA's home mortgage insurance
program, including the extent to which home buyers use FHA insurance,
the characteristics of these home buyers--including whether they were
first-time home buyers--and how many of them might also qualify for
private mortgage insurance; (2) comparing the insurance terms available
through FHA's principal single-family mortgage insurance program with
private mortgage insurance and guaranties from the Department of
Veterans' Affairs (VA); and (3) examining the challenges FHA faces in
ensuring the financial health of its Mutual Mortgage Insurance Fund.

GAO noted that: (1) FHA is a major participant in the single-family
housing market--overall as well as for some specific market segments,
particularly lower-income and other homebuyers who may have less cash
for a down payment but are otherwise able to afford the loan; (2) in
1997, FHA insured over 33 percent of the loans for which lenders
required mortgage insurance; (3) in 1996, FHA insured a greater
percentage of the home loans made to low-income homebuyers than did
either the VA or the private market; (4) this also held true for loans
to minorities--FHA insured 30 percent of these loans in 1996, with
private companies insuring 14 percent and VA insuring 6 percent; (5)
two-thirds of the loans FHA insured in 1995 probably would not have
qualified for private mortgage insurance on the basis of the
loan-to-value and qualifying ratios of the loans FHA insured; (6) the
FHA and VA programs allow borrowers to make smaller down payments and
have higher total-debt-to-income ratios than do private mortgage
insurers; (7) FHA's program differs from both the private mortgage
insurers' and VA's programs in that FHA allows borrowers to finance
closing costs in the mortgage; (8) FHA insures loans only up to a
maximum amount of $208,800, while VA-guaranteed loans generally cannot
exceed $203,000; (9) private mortgage insurers will insure larger loans
than either FHA or VA; (10) FHA provides nearly full insurance coverage
to lenders, while VA and private insurers do not; and (11) while FHA's
Mutual Mortgage Insurance Fund is financially healthy and has surpassed
the legislative target for reserves, FHA faces challenges in reducing
the losses it incurs on foreclosed properties and maintaining its
financial self-sufficiency in the face of economic and other factors
that could adversely affect future program costs.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-99-133
     TITLE:  Homeownership: Results of and Challenges Faced by FHA's 
             Single-Family Mortgage Insurance Program
      DATE:  03/25/99
   SUBJECT:  Mortgage programs
             Mortgage loans
             Government guaranteed loans
             Comparative analysis
             Foreclosures
             Federal aid for housing
             Minorities
             Lending institutions
IDENTIFIER:  Mutual Mortgage Insurance Fund
             FHA Single-Family Mortgage Insurance Program
             VA Home Loan Guaranty Program
             
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Cover
================================================================ COVER


Before the Subcommittee on Housing and Transportation,
Committee on Banking, Housing, and Urban Affairs,
U.S.  Senate

For Release
on Delivery
Expected at
2:00 p.m.  EST
Thursday
March 25, 1999

HOMEOWNERSHIP - RESULTS OF AND
CHALLENGES FACED BY FHA'S
SINGLE-FAMILY MORTGAGE INSURANCE
PROGRAM

Statement of Stanley J.  Czerwinski, Associate Director,
Housing and Community Development Issues,
Resources, Community, and Economic Development
Division

GAO/T-RCED-99-133

GAO/RCED-99-133T


(385798)


Abbreviations
=============================================================== ABBREV

  HUD -
  FHA -
  LTV -
  VA -
  HMDA -
  MICA -
  HUD -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are here today to discuss the single-family mortgage insurance
program of the Department of Housing and Urban Development's (HUD)
Federal Housing Administration (FHA).  FHA insured over 1 million
mortgages, representing over $90 billion in single-family mortgage
insurance during fiscal year 1998ï¿½ending the fiscal year with a total
of about $380 billion in single-family mortgage insurance
outstanding.  Many changes have occurred in the single-family housing
finance system since FHA was established in 1934 to insure housing
loans made by private lenders.  These changes include the advent of
modern private mortgage insurance, the development of a secondary
mortgage market, and the emergence of a number of public- and
private-sector initiatives designed to expand affordable housing
opportunities for homebuyers.  Given these developments, an ongoing
debate has centered on FHA's role in today's single-family housing
finance system.  Critics of FHA contend that other housing finance
players, such as private mortgage insurers, are filling the need once
filled exclusively by FHA.  Supporters of FHA argue that its
single-family program, which has insured at least 24 million home
mortgages since its inception, remains the only way for some families
to become homeowners and should be expanded. 

My statement today is based primarily on reports we have issued over
the last 3 years\1 and will (1) discuss the activities of FHA's home
mortgage insurance program, including the extent to which home buyers
use FHA insurance, the characteristics of these home buyersï¿½including
whether they were first-time home buyersï¿½and how many of them might
also qualify for private mortgage insurance; (2) compare the
insurance terms available through FHA's principal single-family
mortgage insurance program with private mortgage insurance and
guarantees from the Department of Veterans' Affairs (VA); and (3)
examine the challenges FHA faces in ensuring the financial health of
its Mutual Mortgage Insurance Fundï¿½the insurance fund supporting most
FHA-insured single-family mortgages. 

In summary: 

  -- FHA is a major participant in the single-family housing
     marketï¿½overall as well as for some specific market segments,
     particularly lower-income and other homebuyers who may have less
     cash for a down payment but are otherwise able to afford the
     loan.\2

In 1997, FHA insured over 33 percent of the loans for which lenders
required mortgage insurance. 

In 1996, FHA insured a greater percentage of the home loans made to
low-income homebuyers than did either the VA or the private market. 
This also held true for loans to minoritiesï¿½FHA insured 30 percent of
these loans in 1996, with private companies insuring 14 percent and
VA insuring 6 percent. 

Two-thirds of the loans FHA insured in 1995 probably would not have
qualified for private mortgage insurance on the basis of the
loan-to-value and qualifying ratios of the loans FHA insured. 

  -- The FHA and VA programs allow borrowers to make smaller down
     payments and have higher total-debt-to-income ratios than do
     private mortgage insurers.  FHA's program differs from both the
     private mortgage insurers' and VA's programs:  Only FHA allows
     borrowers to finance closing costs in the mortgage.  FHA insures
     loans only up to a maximum amount of $208,800,\3 while
     VA-guaranteed loans generally cannot exceed $203,000.  Private
     mortgage insurers will insure larger loans than either FHA or
     VA.  FHA provides nearly full insurance coverage to lenders,
     while VA and private insurers do not. 

  -- While FHA's Mutual Mortgage Insurance Fund is financially
     healthy and has surpassed the legislative target for reserves,
     FHA faces challenges in reducing the losses it incurs on
     foreclosed properties and maintaining its financial
     self-sufficiency in the face of economic and other factors that
     could adversely affect future program costs. 

Before I discuss these issues in greater detail, let me briefly
explain the reasons for mortgage insurance programs like FHA's and
how the programs decide which loans they will insure. 


--------------------
\1 Homeownership:  FHA's Role in Helping People Obtain Home Mortgages
(GAO/RCED-96-123, Aug.  13, 1996); Mortgage Financing:  FHA Has
Achieved Its Home Mortgage Capital Reserve Target (GAO/RCED-96-50,
Apr.  12, 1996); Homeownership:  Potential Effects of Reducing FHA's
Insurance Coverage for Home Mortgages (GAO/RCED-97-93, May 1, 1997). 

\2 ï¿½Low-incomeï¿½ refers to a borrower with an income no greater than
80 percent of the median income in the Metropolitan Statistical Area
where the borrower is located. 

\3 Alaska, Hawaii, Guam, and the Virgin Islands may have even higher
loan limits because the Congress has designated these states and
territories as special high-cost areas, allowing FHA to set its loan
limits there up to 50 percent higher than the limits applicable
elsewhere. 


   FHA'S SINGLE-FAMILY MORTGAGE
   INSURANCE PROGRAM
---------------------------------------------------------- Chapter 0:1

Lenders typically require mortgage insurance when a homebuyer has a
down payment of less than 20 percent of the value of the home.  In
these cases, the loan-to-value (LTV) ratio of the mortgage is higher
than 80 percent.  Most lenders require mortgage insurance for these
loans because they are more likely to default than are loans with
lower LTV ratios.  If a loan with mortgage insurance defaults, the
lender may foreclose on the loan and collect all or a portion of the
losses from the insurer.  In 1996, lenders required mortgage
insurance for nearly 40 percent (or about 1.5 million) of the 3.8
million mortgages borrowers took out, according to information
collected by banking regulatory agencies through requirements
contained in the Home Mortgage Disclosure Act (HMDA).\4

Private mortgage insurers, FHA, and VA provide virtually all
single-family mortgage insurance.  In general, private insurers
operate standard programs for typical borrowers and special
affordable programs for qualified borrowers who have fewer down
payment funds and need increased underwriting flexibility.\5 FHA
provides most of its single-family mortgage insurance through the
Section 203(b) program.  This program has not required any federal
funds to operate because FHA has collected enough revenue from
insurance premiums and foreclosed property sales to cover claims and
other expenses.  FHA also operates some smaller, specialized
single-family mortgage insurance programs.  A primary goal of FHA's
single-family programs is to assist households that may be
underserved by the private market.  VA provides insurance through its
Home Loan Guaranty Program only to U.S.  veterans and their families. 

FHA, VA, and private mortgage insurers provide lenders with
guidelines for deciding whether or not a mortgage is eligible for
mortgage insurance.  In addition, the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage
Corporation (Freddie Mac) establish their own guidelinesï¿½including
requirements for mortgage insurance under certain circumstancesï¿½for
the loans they will purchase in the secondary mortgage market.\6 A
borrower's ability to repay the mortgage is often evaluated by
computing the ratios of the borrower's total debt burden and housing
expenses to his/her income (known as ï¿½qualifying ratiosï¿½).  The
ï¿½total-debt-to-income ratioï¿½ compares all of the borrower's long-term
debt payments, including housing expenses, with his or her income. 
The ï¿½housing-expense-to-income ratioï¿½ compares the borrower's
expected housing expenses with his or her income. 

The HMDA database contains information on mortgages insured through
FHA's principal single-family mortgage insurance programï¿½the Section
203(b) programï¿½in addition to loans insured through FHA's smaller
single-family mortgage insurance programs but does not distinguish
between them.  Consequently, my testimony today on FHA's market
share, the characteristics of FHA borrowers, and the borrowers who
may have qualified for private mortgage insurance pertain to all
single-family loans FHA has insured. 


--------------------
\4 This figure is based on mortgages reported by lenders pursuant to
the HMDA requirements.  However, the number of mortgages written in
1996 is somewhat higher because HMDA collects information on most,
but not every, mortgage. 

\5 Underwriting is the process of analyzing a borrower's willingness
and ability to repay a loan. 

\6 Fannie Mae and Freddie Mac are government-sponsored enterprises
that provide a secondary market for many home mortgages.  Because
most mortgage lenders want to sell some or all of the loans they make
in the secondary market, they apply Fannie Mae's and Freddie Mac's
underwriting standards to the loans they issue. 


   FHA SINGLE-FAMILY MORTGAGES
---------------------------------------------------------- Chapter 0:2

FHA has been a major player in single-family home financing for over
60 years, and it remains so todayï¿½particularly in certain market
segments.  Between 1986 and 1990, FHA was the largest insurer of
single-family mortgages.  The factors contributing to FHA's large
market share during these years include an increase in FHA's maximum
loan limit in 1988 and the economic downturns in some areas of the
country that decreased the availability of private mortgage
insurance.  Except for FHA's loan limit, the terms under which FHA
and VA mortgage insurance are available, such as the maximum LTV
ratio, generally do not vary across different geographic locations.\7
However, private mortgage insurance 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. 

Throughout the 1991 through 1997 period, private mortgage insurers
had a greater share of all insured single-family mortgages than FHA
or VA.  In 1997, private mortgage insurers' share was 54.2 percent,
FHA's was 33.3 percent, and VA's was 12.5 percent.  This change may
be a result, in part, of the increased premiums for FHA insurance
implemented pursuant to the Omnibus Budget Reconciliation Act of 1990
(P.L.  101-508).  Premiums were increased because a 1990 independent
actuarial study of the FHA Fund indicated it would eventually have a
negative net worth if its reserves for covering future losses were
not replenished. 


--------------------
\7 FHA's loan limit may differ among geographic areas to reflect
differentials in the cost of housing. 


      FHA IS AN IMPORTANT SOURCE
      OF MORTGAGE INSURANCE IN
      CERTAIN MARKETS
-------------------------------------------------------- Chapter 0:2.1

In reporting on FHA's role,\8 we found that in 1994, FHA is a
particularly important source of mortgage insurance for low-income,
minority, and first-time homebuyers.  In addition, we estimated that
66 percent of FHA's borrowers in 1995 might not have qualified for
private mortgage insurance for the loans they received, based on the
loan-to-value and qualifying ratios of FHA's borrowers that year. 
However, it is important to note that, as with home buyers in
general, most low-income and minority homebuyers who obtained
mortgages in fiscal year 1996 did not have insured mortgages because
they made down payments of 20 percent or greater.  Data for 1996 from
HMDA, the Mortgage Insurance Companies of America (MICA), and HUD
showed that FHA-insured loans are concentrated to a greater extent on
borrowers with these same characteristics than are loans insured by
private mortgage insurers.  Specifically, we estimate the following
on the basis of HMDA, MICA, and HUD data for loans in 1996:\9

  -- FHA insured a greater percentage of the home loans made to
     low-income homebuyers than did either the VA or the private
     insurers.  Specifically, of the 984,495 home loans made to
     low-income homebuyers, FHA insured 23 percent, VA insured 5
     percent, and private companies insured 14 percent; the remaining
     loans to low-income homebuyers were not insured.  For just FHA,
     low-income homebuyers received about 39 percent of FHA-insured
     loans. 

  -- FHA insured 30 percent of all loans made to minority homebuyers,
     and such homebuyers represented about 31 percent of FHA-insured
     loans.  FHA insured a higher percentage of loans for minority
     borrowers in 1996 than did private mortgage insurers (14
     percent) and substantially more than did the VA (6 percent). 

  -- About 74 percent of FHA-insured loans in 1996 were made to
     first-time homebuyers.  FHA insured a higher percentage of loans
     for first-time homebuyers than its overall share of the insured
     home purchase market. 

  -- While 63 percent of FHA-insured loans made in 1996 had LTV
     ratios exceeding 95 percent, only about 7 percent of
     conventional loans below the maximum FHA loan limit had LTV
     ratios exceeding 95 percent in 1997. 


--------------------
\8 Homeownership:  FHA's Role in Helping People Obtain Home Mortgages
(GAO/RCED-96-123, Aug.  13, 1996). 

\9 We adjusted HMDA data for our comparisons with Mortgage Insurance
Companies of America data on private mortgage insurers' loans.  HMDA
data include approximately 93 percent of all FHA-insured home
purchase loans.  The mortgage insurance companies' data, however,
include nearly all loans insured by private mortgage insurers.  To
determine the relative share of the market of loans in the HMDA
database held by FHA and private mortgage insurers, HMDA data were
increased by a relevant percentage.  Also, we deleted some mortgage
insurance companies' and HMDA data that were not valid or were of
poor quality. 


   SINGLE-FAMILY MORTGAGE
   INSURANCE TERMS OFFERED BY FHA,
   PRIVATE INSURERS, AND VA ARE
   DIFFERENT
---------------------------------------------------------- Chapter 0:3

In our 1996 report on FHA's role, we reported that the FHA, private
mortgage insurers, and VA mortgage insurance programs differed in
terms of maximum LTV ratios and mortgage amounts, the financing of
closing costs, and the amount that each will pay lenders to cover the
losses associated with foreclosed loans.  Specifically, we reported
the following: 

  -- While both FHA and VA could insure loans with LTV ratios that
     exceed 100 percent (because of the financing of closing costs or
     other fees), private mortgage insurers did not offer insurance
     for loans with LTV ratios greater than 97 percent.  Following
     our 1996 report, both Fannie Mae and Freddie Mac announced the
     introduction of conventional 97-percent LTV mortgage products
     that offer many of the advantages of FHA's single-family
     program.  Both programsï¿½Fannie Mae's ï¿½Flexible 97 Mortgageï¿½ and
     Freddie Mac's ï¿½Alt 97 Mortgageï¿½ï¿½allow down payments as low as 3
     percent that can be funded through gifts, unsecured loans from
     relatives, or grants from nonprofit organizations or local
     governments. 

  -- FHA allows borrowers to finance most closing costs, but private
     mortgage insurers and VA do not.  Both FHA and VA allow
     borrowers to finance their insurance premiums. 

  -- FHA may insure loans only up to a maximum that varies depending
     on local housing costs, ranging from $115,200 for much of the
     country to $208,800 for certain areas with higher housing costs. 
     VA-guaranteed loans generally cannot exceed $203,000, while
     private mortgage insurers will insure larger loans than either
     FHA or VA. 

  -- While FHA protects lenders against nearly 100 percent of the
     loss associated with a foreclosed mortgage, private mortgage
     insurers and VA limit their coverage to a portion of the
     mortgage balance.  Private mortgage insurers generally cover
     only 20 to 35 percent, and VA covers only 25 to 50 percent, of
     the mortgage balance plus other costs, even if a loss exceeds
     that amount. 


   FHA'S SINGLE-FAMILY MORTGAGE
   INSURANCE FUND FACES CHALLENGES
---------------------------------------------------------- Chapter 0:4

While FHA's Mutual Mortgage Insurance Fund is financially healthy and
has surpassed the legislative target for reserves, FHA faces
challenges today, including reducing the losses it incurs on
foreclosed properties and maintaining financial self-sufficiency in
the face of economic and other factors that could adversely affect
future program costs.  To the extent that FHA can improve the
efficiency of its lending operations, it will improve its ability to
maintain financial self-sufficiency in an uncertain future and meet
the needs of lower-income borrowers by either increasing the number
of borrowers served or reducing the cost of their mortgage insurance. 


      FHA'S INSURANCE FUND EXCEEDS
      STATUTORY RESERVE TARGETS
-------------------------------------------------------- Chapter 0:4.1

One of the challenges FHA's single-family mortgage insurance program
has faced successfully has been restoring the financial health of the
Fundï¿½the insurance fund supporting 91 percent of the dollar value of
FHA-insured single family mortgages outstanding at the end of fiscal
year 1997.  At the end of fiscal year 1990, Price Waterhouse
estimated that the Fund's economic value/reserves\10 was a negative
$2.7 billion.  However, as of September 30, 1998,
PricewaterhouseCooper's recent actuarial study\11 reported that the
Fund's economic value/reserves had reached $11.4 billion, an
improvement of about $14 billion.  Over time, insurance premiums and
other income have more than covered costs.  The recent study also
reported that the Fund's capital reserve ratio (economic
value/reserves as a percentage of value of outstanding loans) was
2.71 percent, surpassing the legislative target for reserves (a
2-percent capital ratio) in advance of the legislatively set target
date of November 2000.  PricewaterhouseCoopers estimated that the
Fund's capital ratio will be 3.40 and its economic value/reserves
about $14.6 billion by fiscal year 2000.\12


--------------------
\10 The current assets available to the Fund, plus the net present
value of all future cash inflows and outflows expected to result from
mortgages insured under the Fund. 

\11 An Actuarial Review for Fiscal Year 1998 of the Federal Housing
Administration's Mutual Mortgage Insurance Fund, Final Report, March
1, 1999, PricewaterhouseCoopers LLP.  As a result of a merger with
another firm, Price Waterhouse was renamed PricewaterhouseCoopers. 

\12 The Omnibus Budget Reconciliation Act of 1990 (P.L.  101-508)
required the Secretary of Housing and Urban Development to endeavor
to ensure a capital ratio of 2 percent by November 2000 and maintain
that ratio or a higher one at all times thereafter. 


      LOSSES INCURRED BY FHA ON
      FORECLOSED SINGLE-FAMILY
      PROPERTIES ARE LARGE
-------------------------------------------------------- Chapter 0:4.2

Each year, mortgage lenders foreclose on a portion of the FHA-insured
mortgages that go into default and file insurance claims with HUD for
their losses.  FHA has always received enough in premiums from
borrowers and other revenues to more than cover these losses.  The
Fund finances the losses it sustains, thereby ultimately reducing its
ability to withstand economic downturns and possibly resulting in
higher premiums for FHA borrowers.  The impact that foreclosures can
have on the financial health of the Fund was demonstrated during the
1980s.  Until that time, the Fund had been relatively healthy. 
However, in the 1980s, losses were substantial, primarily because
foreclosure rates were high in economically stressed regions,
particularly in the Rocky Mountain and Southwest regions.  In June
1990, HUD announced that, while the Fund was financially solvent, it
had been steadily eroding from a net worth in constant 1989 dollars
of $7.8 billion in 1980 to $2.6 billion in 1989.  By the end of
fiscal year 1990, the fund's economic value/reserves were estimated
at about a negative $2.7 billion.  If the Fund is unable to finance
program and administrative costs, the U.S.  Treasury would have to
directly cover lenders' claims and administrative costs. 

More recently, the claims FHA paid in fiscal year 1998 were higher
than expected.  Actual claim payments for single-family insured loans
totaled about $5.3 billion, much higher than the $2.2 billion
projected for fiscal year 1998 in the fiscal year 1999 budget. 
Similarly, actual property acquisitions, properties sold, and the end
of fiscal year 1998 inventory of HUD-owned single-family properties
were higher than projected.  Actual property acquisitions were about
$5.3 billion, compared with the $4.0 billion projected; properties
sold were about $4.5 billion, compared with the $4.2 billion
projected; and, the September 30, 1998 inventory of properties
totaled about $2.8 billion, compared with the $1.8 billion projected. 
Notwithstanding these unexpected financial results, given current
economic conditions, we would expect the financial position of FHA's
single-family mortgage insurance program to continue to improve. 

Annual audits of FHA's financial statements have identified
weaknesses in FHA's ability to manage the risks associated with
troubled single-family insured mortgages.\13 The annual audit of
FHA's fiscal year 1998 financial statements\14 ï¿½the most recent
availableï¿½continues to identify a material internal control weakness
applicable, in varying degrees, to both the single-family and
multifamily programs.  Specifically, the 1998 report states that FHA
must continue to place more emphasis on early warning and loss
prevention for insured mortgages by, among other things, using loss
mitigation tools for the single-family insured portfolio before
properties are foreclosed.  According to the report, FHA does not
have adequate systems, processes, or resources to effectively
identify and manage risks in its insured portfolios.  The timely
identification of troubled insured mortgages is a key element of
FHA's efforts to target resources on insured high-risk mortgages
because FHA must identify its troubled insured mortgages before it
can institute loss mitigation techniques that can reduce eventual
claims.  The report notes that FHA made significant progress in this
regard during fiscal year 1998, including increasing its lender
monitoring and enforcement activities, developing automated systems
to monitor insured loan performance, and expanding the use of loss
mitigation.  Though the report states that these steps represent
significant progress, their benefits have not yet been fully
recognized because they are relatively new or still being developed. 


--------------------
\13 The Chief Financial Officers Act of 1990 and the Government
Management and Reform Act of 1994 required HUD and some other
agencies to annually prepare and subject to audit organizationwide
financial statements.  These reports are submitted to the Congress
through the Office of Management and Budget.  HUD's Office of
Inspector General contracts with a public accounting firm to conduct
annual audits of FHA's financial statements. 

\14 Audit of the Federal Housing Administration's Fiscal Year 1998
Federal Basis Financial Statements, prepared by KPMG LLP for the
Office of Inspector General (99-FO-131-0002, Mar.  12, 1999). 


      OTHER FACTORS THAT COULD
      AFFECT THE FINANCIAL HEALTH
      OF THE FUND
-------------------------------------------------------- Chapter 0:4.3

As we have reported,\15 the Fund's ability to maintain the target
ratio depends on many economic, program-related, and other factors
that will affect the financial health of the Fund in the future. 
These factors include (1) economic conditions, (2) uncertainty
surrounding the projections of the performance of FHA's streamlined
refinanced\16 and adjustable rate mortgage loans, and (3) risks
associated with the demand for FHA's loans.  We also reported in May
1997\17 that reducing FHA's insurance coverage to the level permitted
for VA home loans would likely reduce the Fund's exposure to
financial losses, thereby improving its financial health. 

Estimates of economic value/reserves of the Fund are sensitive to
future economic conditions, particularly the appreciation rates for
house prices.  The Fund will not perform as well if the economic
conditions that prevail over the next 30 years replicate those
assumed in pessimistic economic scenarios.  PricewaterhouseCoopers'
estimate of the Fund's economic value/reserves for its pessimistic
economic scenario is about $2.7 billion (or 24 percent) less than its
estimate of $11.4 billion as of September 30, 1998, which would still
represent a significant turnaround from the Fund's position in 1990. 

Also, the substantial refinancing of FHA's loans and the growth in
the number of FHA's adjustable-rate mortgages insured in recent years
have created a growing class of FHA borrowers whose future behavior
is more difficult to predict than that of the typical FHA borrower's. 
FHA's streamlined refinanced mortgages and adjustable rate mortgages
accounted for about 32 percent of the dollar value of FHA's loans
outstanding at the end of fiscal year 1997:  Streamlined refinanced
mortgages accounted for about 15 percent of the value of the
outstanding loans and adjustable-rate mortgages for about 17 percent. 
FHA has had little experience with streamlined refinanced mortgages
and adjustable-rate mortgages and the tendency for such loans to be
foreclosed and/or prepaid. 

Because FHA-insured properties whose mortgages were streamlined
refinanced did not have to be appraised, the initial LTV ratio of
these loansï¿½a key predictor of the probability of foreclosureï¿½is
unknown.\18 The impact of these loans on the financial health of the
Fund is probably positive because they represent preexisting FHA
business whose risk has been reduced through lower interest rates and
lower monthly payments.  However, the lack of experience with these
loans increases the uncertainty associated with their expected
foreclosure rates.  In addition, new developments in the private
mortgage insurance and secondary mortgage markets may increase the
average risk of future FHA-insured loans.  Homebuyers' demand for
FHA-insured loans depends, in part, on the alternatives available to
them.  Some private mortgage insurers have begun offering mortgage
insurance coverage on conventional mortgages with a 97-percent LTV
ratio, which brings their terms closer to FHA's 97.75-percent LTV
ratio on loans for properties exceeding $50,000 in appraised value. 
In addition, Fannie Mae and Freddie Mac have announced the
introduction of conventional 97-percent LTV mortgage products that
offer many of the advantages of FHA's single-family loans. 

If Fannie Mae's and Freddie Mac's 97-percent LTV mortgages are
successful in attracting those lower-risk borrowers who can choose
between FHA and private insurance (because private insurers do not
require an up-front mortgage insurance premium), they may be drawing
away from FHA customers with better-than-average credit histories or
payment-to-income ratios.  In doing so, the remaining new FHA loans
may become more risky, on average.  If this effect is substantial,
the economic value/reserves of the Fund may be adversely affected,
and it may be more difficult for the fund to maintain a 2-percent
capital ratio. 

Lastly, FHA insures private lenders against nearly all losses
resulting from foreclosures on the single-family homes it insures. 
However, VA, under its single-family mortgage guaranty program,
covers only 25 to 50 percent of the original loan amount against
losses incurred when borrowers default on loans, leaving lenders
responsible for any remaining losses.  In our May 1997 report,\19 we
concluded that reducing FHA's insurance coverage to the level
permitted for VA home loans would likely reduce the Fund's exposure
to financial losses, thereby improving its financial health.  As a
result, the Fund's ability to maintain financial self-sufficiency in
an uncertain future would be enhanced.  However, reducing FHA's
insurance coverage does pose trade-offs that affect lenders and
borrowers as well as the very role FHA itself plays in stabilizing
markets.  The most likely affected borrowers would be low-income,
first-time, and minority homebuyers and those individuals purchasing
older homes. 

To illustrate the financial impact of reducing FHA's insurance
coverage, our report pointed out that if insurance coverage on FHA's
1995 loans were reduced to VA's levels and a 14 percent reduction in
FHA's lending volume assumed, the economic values of the loans we
estimate would be $52 million to $79 million greater than our
estimate, assuming no coverage and volume reductions.  Reducing FHA's
insurance coverage would likely improve the financial health of the
Fund because the reduction in claim payments resulting from lowered
insurance coverage would more than offset the decrease in premium
income resulting from reduced lending income.  The amount of savings
that would be realized by reducing FHA's insurance coverage would
depend on future economic conditions, the volume of loans made, the
relationship of the number of higher-risk and lower-risk borrowers
who would leave the program, and whether some losses may be shifted
from FHA to the Government National Mortgage Association. 


--------------------
\15 Mortgage Financing:  FHA Has Achieved Its Home Mortgage Capital
Reserve Target (GAO/RCED-96-50, Apr.  12, 1996). 

\16 FHA's streamlined refinanced mortgages are those for which an
FHA-insured mortgage loan has been repaid from the proceeds of a new
FHA-insured loan using the same property as security.  Borrowers
often refinance mortgage loans to lower their monthly principal and
interest payments when interest rates decline.  FHA does not require
appraisals and credit checks on these loans, and borrowers cannot
obtain cash from the transaction except for minor adjustments not
exceeding $250 at closing. 

\17 Homeownership:  Potential Effects of Reducing FHA's Insurance
Coverage for Home Mortgages (GAO/RCED-97-93, May 1, 1997). 

\18 Also, FHA's data do not indicate whether second mortgages exist
on these properties. 

\19 Homeownership:  Potential Effects of Reducing FHA's Insurance
Coverage for Home Mortgages (GAO/RCED-97-93, May 1, 1997). 


-------------------------------------------------------- Chapter 0:4.4

In closing, Mr.  Chairman, FHA's importance in the housing
marketï¿½particularly for segments of the market that might not be able
to buy homes without itï¿½is substantial.  It fills a role that the
private market might not completely cover if FHA were not thereï¿½and
it does so without needing federal funds.  Nonetheless, we recognize,
and FHA is certainly aware, that there is more it can do to better
secure its long-term financial outlook. 

Mr.  Chairman, this concludes my statement.  We would be pleased to
respond to any questions that you or Members of the Subcommittee may
have. 


*** End of document. ***