Brian Chappelle is a founding partner of Potomac Partners in Washington.
Brian Chappelle is a founding partner of Potomac Partners in Washington.

Now that the FY 2014 Actuarial Review has confirmed that FHA is back on solid financial footing, it is time to focus on the only disappointment in the review of forward mortgages — FHA's volume decline and its implications for lower income and minority families who rely on FHA financing.

FHA's FY 2014 originations were 30% below what was projected in the FY 2013 Actuarial Review and that shortfall lowered FHA's economic value by $4.7 billion. FHA's purchase mortgage volume fell another 15% and now stands 46% below its 2010 level. Even more troubling is that FHA purchase mortgages are now 29% below its 2000 activity, a year viewed as a benchmark for normal market conditions.

Despite the weak purchase data, HUD's Annual Report to Congress notes that FHA still "accounted for approximately 47% of purchase mortgage financing loans for African-Americans and Hispanic" homebuyers. Unfortunately, market share statistics can be misleading, particularly when the total purchase market is "standing below levels as far back as 1993" according to the latest HMDA report.

A closer look at the numbers behind the market share data shows the breadth of the current problem. FHA purchase lending to African-American and Hispanic homebuyers has declined 44% and 38%, respectively, since 2009, according to HUD Annual Reports to Congress.

It is a similar story for first-time homebuyers. While first-time homebuyers comprise about 80% of FHA purchase loans, the number of FHA loans to first-time homebuyers has declined 44% since 2010 and is 30% below the level in 2000.

The bottom line is that many who rely on FHA financing are now being totally excluded from the home purchase market because FHA is too expensive and they are not being "served" by the conventional mortgage market. To address this problem, FHA could take the following three steps on its own. These actions would also accelerate FHA's achievement of the all-important 2% capital ratio.

First, FHA needs to restructure and lower its premium. While the upfront premium can be financed in the mortgage, the annual premium is paid monthly in the form of an interest rate surcharge. The annual premium has soared (145% since 2010) increasing a homebuyer's monthly payment by $117 on a typical FHA loan today ($175,000). As one mortgage executive recently said to me, the current annual premium is the No. 1 "overlay" in the FHA program.

FHA historically has always relied on a higher upfront premium (as high as 3.8% in 1991) and an annual premium of about 0.5%. If FHA raised the upfront premium to 3.5%, it could lower a homebuyer's monthly mortgage payment by $50 per month without affecting FHA's premium income.

It is one thing to increase premiums to protect the fund and the taxpayer. It is a totally different matter to raise the premium in a manner that makes it more difficult for lower income families to qualify for a mortgage.

FHA should also lower its total premium in light of the strong credit quality and performance of recent originations, which now comprise 80% of FHA's portfolio. These loans are now performing as well as any group of loans in over 40 years, yet many are being charged the highest premiums in FHA history.

Second, FHA should implement the Supplemental Performance Metric announced last May in its Blueprint for Access. Of all the changes that FHA has proposed, this is the one that would have an immediate impact on lender underwriting policies. Instead of comparing lender originations to industry averages, this additional calculation would compare originations in specific risk buckets to FHA acceptable default rates. Assuring lenders of an "apples to apples" comparison of loans with similar credit scores will encourage the origination of loans to more homebuyers.

In an effort to reduce lender overlays, FHA has been devoting considerable time and resources to the development of its new handbook and quality assurance process. While the new handbook should be an improvement, the jury is out on whether the quality assurance changes will prove to help or hinder more lending.

Unlike the recent FHFA changes to representations and warranties for the GSEs that are generating industry optimism, the FHA environment is more complicated. For one thing, there are more government entities involved in FHA enforcement actions (i.e., the Department of Justice and the HUD Inspector General).

Also while GSE repurchase activities are really a "housing crisis" phenomenon (i.e., started in 2009), lender "disagreements" with FHA have been an ongoing battle since Direct Endorsement was implemented in 1983. No matter how fair and equitable the new quality assurance process may ultimately be, it is going to take many months, if not years, for the industry to develop trust with this new approach.

Finally, FHA should re-institute the spot loan condominium program permitting the insurance of individual condominium loans without requiring comprehensive analysis of the entire project. Condominium activity has dropped from almost 100,000 loans per year in 2000 to less than 25,000 in the last 12 months. Equally important, condominium loans have the lowest seriously delinquent rate of any property type in FHA's portfolio.

FHA certainly deserves credit for strengthening the insurance fund. To do so, FHA doled out some tough medicine raising premiums and tightening requirements. It is now time for FHA to take steps that will provide access to homeownership for many creditworthy homebuyers who have been left out of the housing recovery and that will also bolster FHA's balance sheet.

Brian Chappelle is a founding partner of Potomac Partners in Washington.