Slowing Price Declines Are Good News for FHA

Today’s release of the Federal Housing Finance Agency’s quarterly house price index showed a 1.2 percent decline in the price of homes purchased during the fourth quarter of 2009 compared to a year earlier. But compared to the third quarter, prices were only off 0.1 percent on a seasonally adjusted basis. Even though December’s levels showed a drop of 1.6 percent from the previous month (compared to November’s 0.4 percent increase of over October), it still marks a significant improvement over the fourth quarter 2008 data, which registered an 8.2 percent decline over the prior year. Despite the overall price drop at the national level, house price trajectories considerably varied across the country; FHFA reported today that prices rose over the past year in 19 states. The overall lesson here from the FHFA data is a reminder that local markets behave differently over time.

Price trajectories at the state and metropolitan level have very important implications for lenders’ and insurers’ balance sheets, particularly for the Federal Housing Administration. FHA insures mortgages that are then securitized and sold to investors with an explicit guarantee. Borrowers with FHA mortgages pay an upfront insurance premium as well as an annual premium. Those premiums go toward a fund that pays out claims when insured mortgages go through foreclosure. FHA’s losses are obviously a function of the number of loans that go through foreclosure, but the magnitude of those losses are driven by the current value of the properties on their books relative to the outstanding mortgage balances and the insurance premiums paid over the loan’s life.

FHA insured 3.2 million single-family mortgages in 2008 and 2009. Using the FHFA house price index to measure quarterly price changes at the metropolitan level, we estimate that 2.5 million of the FHA-backed homes are effectively above water on FHA’s books, accounting for the upfront premium but assuming no annual premiums paid. Fewer than 700,000 homes are currently worth less than their initial mortgage amounts, again adjusting for premiums paid. This translates into 21 percent of FHA properties currently underwater. These underwater properties pose potential costs to the FHA’s insurance fund, but it is worth noting that this figure is below the 24 percent of all mortgages that First American Core Logic has estimated are currently underwater.

FHA’s annualized foreclosure rate never exceeded 1.6 percent of their outstanding mortgages between January 2008 and August 2009, and a significant share of properties in foreclosure do not result in claims being paid. Nevertheless, FHA’s 2008 and 2009 activities would still be profitable even if every 2008 and 2009 FHA mortgage that is currently severely delinquent or in foreclosure were to generate claims against the FHA insurance fund (based on the state-level data for fixed- and adjustable-rate FHA mortgages reported by the Mortgage Bankers Association), and those properties were sold off at current market value.

We are currently working on an in-depth analysis of potential losses to FHA from loans insured in 2008 and 2009 that will include state and metropolitan level data. It is slated for release next month.

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Andrew Jakabovics is the Associate Director for Housing and Economics at American Progress.