The Federal Housing Administration (FHA) provides mortgage insurance on loans made by FHA-approved lenders throughout the United States. These mortgages include those taken out for the purchase of single family and multifamily homes, including manufactured homes and hospitals. The FHA is the largest insurer of mortgages in the world.
FHA mortgage insurance protects lenders against losses incurred as the result of homeowners who default on their loans by paying a claim to the lender in the event of a foreclosure. Historically, FHA insured loans were meant to enable first-time homebuyers, minorities and low-income individuals and families to purchase homes. This meant FHA insured loans for a relatively low amount, so claims paid out to lenders upon buyer default were fairly reasonable.
Fast forward to the housing crisis of 2008 and things get more complicated. According to Dr. Robert Van Order, co-author of the FHA Assessment Report: The Role and Reform of the Federal Housing Administration in a Recovering U.S. Housing Market, the “FHA’s expansion played a major role in keeping the housing market afloat during the economic collapse of 2008 and 2009. However, we are now left with large loan limits that were set when home prices were at the top of the bubble. They don’t reflect current market conditions.” The study, released by George Washington University, reveals that current FHA loan limits are far larger than necessary to serve its target market of first-time and low to moderate income borrowers.
Pre-housing collapse, the FHA could insure loans of up to $362,790 in higher cost markets. In response to the 2008 housing crisis, FHA loan limits were revised to insure loans of up to $729,750 in these high cost markets. The Obama administration has proposed allowing the current law to lapse in October, which would result in a modest decrease to $629,500.
The problem with these high loan limits is twofold. These limits are unnecessary because low income and first time homebuyers are unlikely to purchase a property that requires such a large loan. In addition, the current market share is difficult for the FHA to manage, creating the potential for instability in the long standing institution.
In order to address the issues raised by high FHA loan limits, the Report suggests that Congress and the administration take the following actions, in order:
- Reduce the FHA’s loan limit in the lowest cost markets from the current $271,050 to $200,000
- Return the FHA’s loan limit in high cost markets from $729,750 to $363,000. To achieve this, the current FHA policy of insuring loans of up to 125 percent of the median home price in high cost markets needs to be reversed.
- Return to using current area median home prices in calculating the local loan maximum instead of using the 2008 median home price estimate.
The FHA Assessment Report suggests that an FHA limit of $350,000 in the high cost markets and a limit of $200,000 in the lowest cost markets is sufficient to satisfy more than 95 percent of FHA’s target market. According to the report, these reductions in loan limits would affect only three percent of loans endorsed in 2010.
The FHA Assessment Report: The Role and Reform of the Federal Housing Administration in a Recovering U.S. Housing Market is co-authored by Dr. Robert Van Order and Anthony Yezer. It is the second installment of the FHA Assessment Report, which is designed to analyze and interpret reforms to the FHA that are underway as well as other changes that may be considered in the future.