Financial Assessment is still working. Now in its sixth year, FHA’s policy of requiring the financial assessment (FA) of borrowers’ ability to pay has cut tax and insurance (T&I) defaults by over 75% and serious defaults by over two-thirds. These results continue to validate the encouraging data we shared in previous years.
FHA’s objective for its Financial Assessment regulations was to reduce the persistent defaults, especially T&I defaults, plaguing the HECM program in 2009-2014. As FHA put it, “… an increasing number of tax and hazard insurance defaults by mortgagors led FHA to establish … a requirement for a Financial Assessment of a potential mortgagor’s financial capacity and willingness to comply with mortgage provisions.” Financial Assessment requirements became effective for HECMs with case numbers issued on or after April 27, 2015. Since then, HECM lenders make a financial assessment of borrowers’ ability to meet their obligations, including property taxes and home insurance. T&I and other defaults can lead to foreclosure and result in significant losses to FHA, HMBS issuers, and other HECM investors. Defaults rose steadily during the financial crisis and remained a thorn in the side of the program until Mortgagee Letters 2014-21, 2014-22, and 2015-06 were released.
It’s been five years since Financial Assessment began, so we can measure with increasing confidence the effect of this policy by comparing default rates of loans originated before and after the FA rule was implemented.
With this in mind, we looked at a data set of more than 200,000 HECM loans, comparing loans originated in the immediate 57 month post-FA period from July 2015 through March 2020 to loans originated in the 57 month pre-FA period from July 2010 through March 2015. After July 2015, there were few (if any) loans originated under pre-FA guidelines. As Financial Assessment took effect in April 2015, the second quarter of 2015 included a mix of FA and pre-FA loans.
The data show a very strong reduction in T&I defaults in the post-FA period. As of March 31, 2015, the pre-FA data set had a T&I default rate of 4.7%, and an overall serious default rate of 6.8%. As of March 31, 2020, the comparable post-FA data set shows a T&I default rate of approximately 1.1%, and an overall serious default rate of 2.2%. For the purpose of this analysis, we define serious defaults as T&I defaults plus foreclosures plus other “Called Due” status loans.
Over the past few years, FHA has taken a number of steps to reduce defaults in its HECM program. These include Mortgagee Letter 2013-27, which limits in certain cases the amount that can be lent in the first 12 months. Also, a series of Principal Limit Factor (PLF) reductions has reduced the amount lent even when the loan is fully drawn.
Given these results, we continue to give Financial Assessment high marks for reducing defaults. Previously, we referred to these results as a “mid-term grade that needs to be tested further as the post-FA portfolio ages.” After nearly 5 years of experience, it is clear the HECM program has graduated to a sounder credit footing. The coming months will show how well this reformed HECM program weathers a likely serious economic downturn.
(Editor’s note: The following was republished with permission from New View Advisors, which compiled this data from publicly available Ginnie Mae data as well as private sources.)