The most recent Annual Report on the Financial Status of the Mutual Mortgage Insurance Fund for FY 2017 was the proverbial tale of two programs: the forward program which is much larger and has an improving capital ratio, and the very troubled home equity conversion program (HECMs) with a whopping negative capital ratio of 19.84% – clearly a program in need of radical change or shuttering.
Yet even within the improving and important FHA (forward) single-family program there are some surprises. The share of total FHA insurance utilized for cash-out refinancing has increased, reaching 11.4 percent in FY 2017. This increasing percentage raises two red flags.
From a policy perspective, the first red flag is: the current federal policy for cash-out refis permits the home to serve as an unconstrained equity-stripping ATM backed by the government – and therefore, the taxpayers. This is not sound policy. To understand why, consider the well-understood premise that homeownership is one of the most important tools to building wealth. The difference in financial terms between a homeowner and a renter is staggering: a study earlier this decade indicates that the median net worth of a homeowner is $195,400 vs. $5,400 for a renter. The American dream of homeownership and the value of building equity over time has been, and remains, the core justification for the many benefits provided the housing sector in federal policy.
In that light, what is the federal policy justification for a cash-out refi policy that acts like a government-backed ATM? The FHA insurance program permits cash-out refis up to 85% of the value of the home (only to be outdone by the VA, which permits the veteran to take 100% of the home’s value out in cash). A cash-out refi for limited purposes, such as home improvement, medical or educational expenses can be justified, but currently cash-out refi is a program that acts as an unconstrained equity-stripping ATM, backed by the taxpayers. We’ve seen this story before – more than once, in fact – and it never ends well. Not for the borrower, and not for the housing finance system.
The second red flag is that from a risk perspective, the FHA loans that are being insured have more and multiple risk factors and a cash-out refi product is one more added to a stack of risk factors. So, attractive is this program that conventional loans are refinancing to FHA for cash-out refi. That is regress, not progress. Multiple stacked risk factors are clearly factors that increase the risk of a borrower defaulting on a loan.
I am concerned that these stacked risk factors lead to more defaults impacting the individual and neighborhoods, and damages the long-term health of the FHA fund. Cash-out refi, and particularly conventional to FHA, is an exposure to FHA that has absolutely nothing to do with the fundamental purpose of the FHA insurance fund: helping low and moderate-income individuals achieve homeownership.
In the aggregate, FHA purchase loans perform worse than refinance loans due primarily to their higher LTVs. However, conventional to FHA refinance loans not only perform worse than FHA to FHA refinances, they also perform worse than the aggregate FHA purchase loans.
The relative performance of cash-out conventional to FHA refinances is the worst performing refinance segment with serious delinquency rates of 5.22%, nearly twice the 2.79% delinquency rate of FHA to FHA cash-out refinances. This poor performance should cause great consternation considering that cash-out conventional to FHA refinances serve no policy purpose.
Conventional to FHA refinances also account for more than three times the share of non-streamline refinances compared to FHA to FHA. Furthermore, the share of the conventional to FHA cash-out refinances has steadily increased from 10.52% of FHA refinances in September 2015 to 12.16% in September 2017.
FHA remains a linchpin of federal housing policy, but cash-out refinance is something that should be left largely to the private market. Unfettered cash-out refinance for FHA and absolutely conventional refinance to FHA is a diversion that makes no sense. Cash-out refi, at 85% for FHA (let alone 100% for VA) is not enhancing equity or wealth-building and it is not core to FHA’s mission.
This year, hopefully, will be the year that Congress tackles mortgage finance reform. FHA’s mission should be an integral part of the discussions on mortgage finance reform, and unfettered cash-out refis not only do not fit into this mission, they are counter-productive to the goals that FHA is trying to achieve.