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History is Not Repeating Itself with FHA Loan Risk

Federal Housing Administration (FHA) mortgage loans have historically been riskier than conventional mortgage loans because borrowers on FHA loans typically have lower credit scores and high LTV ratios on their loans.

The surprising recent data shows, however, that FHA loans may not be as risky as they have been historically—and in fact, lately, have been less risky than conventional loans.

The First American Financial Corp. Loan Application Defect Index for August 2016 revealed that conventional loan risk is down 14.6 year-over-year, compared to a 17.7 percent decline for FHA/Veterans Affairs (VA)/U.S. Department of Agriculture (USDA) transactions for that same period. Also, the transactions involving FHA/VA/USDA loans were found to be 14.5 percent less risky than conventional mortgage loans. The Loan Defect Index is down by nearly a third (31.4 percent) since peaking in October 2013.

The loan application and defect risk on transactions involving FHA/VA/USDA loans has declined more in recent years than that of conventional mortgage loans, according to First American. Why are FHA loans less risky than conventional loans now, which is a reversal of history?

“While FHA loans continue to have higher credit risk relative to conventional loans, the big improvement in application and defect fraud risk is likely due the significant cost risk associated with non-compliance and defective mortgage documents that is unique to FHA loans,” First American Chief Economist Mark Fleming said.

Not only is the risk down for FHA/VA/USDA loans down compared with conventional mortgage loans, but the volume is up. The recently-released American Enterprise Institute/First American National Mortgage Market Index (NMMI) showed an increase of 9.2 percent in Q2 2016, compared with last year, and that the share of FHA-backed mortgage loans has increased relative to the volume of conventional loans.

“[W]e have observed an increase in the share of FHA loans in the market,” Fleming said. “While the share of FHA/VA/USDA loans is up, the loan application defect risk on them is down. This has had a positive impact on overall defect risk in the market and partly explains the large decline in defect risk we have seen in the past year.”

The Defect Index for refinance transactions and for purchase transactions both declined substantially over-the-year, by 18.1 percent and by 10.2 percent, respectively. For refi transactions, the Purchase Index has declined at a faster rate (41 percent) than for purchase transactions (24 percent) since both peaked in late 2013.

About Author: Seth Welborn

Seth Welborn is a Harding University graduate with a degree in English and a minor in writing. He is a contributing writer for MReport. An East Texas Native, he has studied abroad in Athens, Greece and works part-time as a photographer.
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