Situation
The Federal Housing Administration (FHA) is responsible for expanding and maintaining affordable homeownership opportunities, on an actuarially sound basis. FHA operates the Federal government’s largest single family mortgage insurance program, insuring more than $62 billion in mortgages in FY 2005. At that time, approximately 8% of the approved loans that HUD insured were to homebuyers with insufficient credit history to calculate a credit score. Loans approved without a borrower credit score experience a foreclosure rate of nearly twice the FHA portfolio average.
To understand the root causes of the situation, FHA engaged Concentrance to review the underwriting quality of approved loans without credit scores and to identify the relationship between the decision criteria used for loan approval and the performance of the loan.
Approach
The Concentrance team, comprised of experienced risk management professionals, reviewed a sample of loans that included performing loans, loans that prepaid prior to maturity and defaulted loans. The team then conducted a preliminary review of loans to identify and understand the types of information and documents used by underwriters to support approval of these mortgages – loans without credit scores – for FHA insurance. The results of this preliminary review served as the basis for the data collection framework that was applied in the analysis and review of the remaining loans. We coded and input the loan data into a Microsoft Access database developed by Concentrance.
During the file review, we looked for certain risk factors including borrower capacity to repay as evidenced by variables such as income, employment history and qualifying ratios, and credit character as evidenced by traditional credit experience and non-traditional credit experience. Our research led to a number of findings that showed the distinct differences between those loans with traditional credit and those without.
Outcome
Based upon the results of our analysis, we proposed several actions to mitigate risk to the insurance funds, while suggesting further study to identify additional policy changes that would align the performance of loans without credit scores with the performance of loans in the overall FHA portfolio. Based upon the outcomes of our study, FHA issued additional underwriting policy guidance to the industry.