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Study: FHA Underestimating Mortgage Risks

When it comes to creating sustainable homeownership, some economists are saying the ""FHA"":http://portal.hud.gov/hudportal/HUD?src=/federal_housing_administration is celebrating results it hasn't actually achieved.

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In a new ""study"":http://128.122.11.92/caplin/wp-content/uploads/2010/02/FHA-Sustainable-Homeownership-Revised-Final.pdf, New York University economics professor ""Andrew Caplin"":http://cess.nyu.edu/caplin/ investigates mortgage risk assessment and the FHA's actual progress toward creating sustainable homeownership. Caplin co-authored the report with Anna Cororaton, an economist for the ""Federal Reserve Bank of New York"":http://www.newyorkfed.org/index.html, and Joseph Tracy, EVP for the same institution.

In the report, Caplin and his co-authors conclude that the FHA measuring the wrong data and using flawed results to estimate mortgage risk.

Specifically, the study points to the FHA's measurement of mortgage outcomes where refinances are concerned.

""The FHA counts as successful any mortgage that is paid off without an insurance claim, even if this is just an internal refinance of one FHA mortgage into another,"" the study says. ""So a borrower who defaults after internally refinancing is treated by the FHA as creating one success (termination of the first mortgage) and one failure (default of the second mortgage).""

Fannie Mae and Freddie Mac operate the same way, the study notes.

Adding to the problem is the fact that most recent FHA loans have been for 98 percent of the home's value. As those values fall on many properties, the borrowers find themselves underwater, and because FHA's internal refinance program doesn't necessarily require a new appraisal, those borrowers could remain underwater even after refinancing.

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""Since many of the FHA borrowers refinancing are underwater, it will be difficult for them to exit the FHA system by either selling the house or refinancing into a non-FHA mortgage,"" the report says. ""As such, these borrowers may remain at risk of default for many years.""

Rather than studying the outcome of mortgage loans, Caplin and the other authors suggest assessors should focus on the borrowers' experiences, beginning with ""the initial exposure of the FHA fund through a purchase mortgage or a refinance from a non-FHA mortgage"" and ending with ""prepayment outside of the FHA or through default."" Rather than terminating risk, internal FHA refinances should carry the risk over, the report says.

Using data provided by CoreLogic, the researchers estimated that 6.4 percent of FHA borrowers since 2007 have ""successfully"" exited the FHA program-paid off their loans, in other words. Based on FHA's framework, the success rate would be 19.4 percent.

""This reflects the fact that a majority of terminated mortgages have in fact immediately been refinanced back into new FHA mortgages,"" Caplin and his co-authors write.

More than 15 percent of borrowers in the study have already been 90 or more days delinquent, with less than half that number going on to pay off their mortgages. The researchers project that the percentage of severely delinquent borrowers will rise above 30 percent in five years, with fewer than 15 percent ""graduating"" to sustainable homeownership.

The report acknowledges that its borrower-based structure is unlikely to resonate with risk assessors, largely because ""standard academic and industry practice to perform credit risk analysis at the mortgage level."" However, Caplin and the other authors suggest that following borrowers rather than mortgages would do more good overall.

""Even without making their data publicly available, the FHA and the GSE's could readily adopt the borrower-based data structure developed herein,"" the study says. ""Doing so may lead to higher loss estimates. Yet it would serve the cause of transparency and help policy-makers to determine these organizations' roles in the U.S. housing finance markets of the future.""

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