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AEI Report Calls Out FHA’s ‘Abusive Lending Practices’

A study from the ""American Enterprise Institute"":http://www.aei.org/ (AEI) asserts the ""Federal Housing Administration"":http://portal.hud.gov/hudportal/HUD?src=/federal_housing_administration (FHA) is inadvertently setting the country up for another housing collapse.

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In a report titled ""_How the FHA Hurts Working-Class Families and Communities_"":http://www.aei.org/files/2012/12/12/-how-the-fha-hurts-workingclass-families-and-communities_211636397460.pdf, AEI resident fellow and former Fannie Mae EVP Edward Pinto says an analysis of FHA's books for fiscal years 2009 and 2010 show the agency's ""lending practices are inconsistent with its mission and represent a disservice to American working-class families and communities.""

The problem, Pinto claims, began in the late 1950s and grew worse over time.

""Lulled by its early success, encouraged by a housing lobby grown dependent on increasing leverage, and faced with private-sector competition for the first time, the FHA [COLUMN_BREAK]

... moved further and further out the risk curve until a down payment of less than 5 percent, a loan term of 30 years, and a mortgage debt burden more than double the level in 1954 became the norm,"" he writes.

As a result, equity earned by borrowers fell at a significant clip (from 30 percent over four years to about 8 percent over the same time), giving FHA little cushion against claims payments.

Another source of trouble is FHA's dependence on increasing leverage, Pinto says. From 1954 to 2012, the average leverage on an FHA loan increased by a factor of 17--incidentally, FHA's foreclosure start rate increased by a factor of 19 at the same time. Excessive use of leverage led in turn to greater dependence on unearned equity (equity accrued from house price appreciation).

""Leverage is a double-edged sword. It creates a windfall of unearned equity for home buyers and reduced losses for the FHA when home prices are increasing rapidly. When prices rise more slowly or decline or when income drops, it exposes home buyers to foreclosure,"" the report reads.

Pinto even goes so far as to accuse the agency of abusive lending practices.

""The FHA's underwriting policies encourage low- and moderate-income families with low credit scores to make a risky financing decision-one combining a low score with a 30-year loan term and a low down payment,"" he writes. ""This sets up for failure the very families and communities it is the FHA's mission to help. As a result, too many low- and moderate-income borrowers see their hope for the American dream turned into a nightmare.""

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