FHA Single-Family Mortgage Insurance: Financial Status of the Mutual Mortgage Insurance Fund (MMI Fund)

Summary: The Federal Housing Administration (FHA) insures private lenders against losses on home mortgages that meet certain eligibility criteria. If the mortgage borrower defaults (that is, does not repay the mortgage as promised) and the home goes to foreclosure, FHA pays the lender the remaining principal amount owed. By insuring lenders against the possibility of borrower default, FHA is intended to expand access to mortgage credit to some households who might not otherwise be able to obtain affordable mortgages, such as those with small down payments.

Summary: When an FHA-insured mortgage goes to foreclosure, the lender files a claim with FHA for the remaining amount owed on the mortgage. Claims on FHA-insured home mortgages are paid out of the Mutual Mortgage Insurance Fund (MMI Fund), which is funded through fees paid by borrowers (called premiums), rather than through appropriations. However, like all federal credit programs covered by the Federal Credit Reform Act of 1990, FHA can draw on permanent and indefinite budget authority with the U.S. Treasury to cover unanticipated increases in the cost of the loans that it insures, if necessary, without additional congressional action.

Summary: Each year, as part of the annual budget process, the expected costs of mortgages insured in past years are re-estimated to take into account updated information on loan performance and economic assumptions. If the anticipated costs of insured mortgages have increased, then FHA must transfer funds from a secondary reserve account into its primary reserve account to cover the amount of the increase in the anticipated cost of insured loans. If there are not enough funds in the secondary reserve account, then the MMI Fund is required to take funds from Treasury using its permanent and indefinite budget authority in order to make the required transfer.

Summary: Separately from the budget re-estimates, FHA is required by law to obtain an independent actuarial review of the MMI Fund each year. This review provides a view of the MMI Fund's financial status by estimating the MMI Fund's economic value—that is, the amount of funds that the MMI Fund currently has on hand plus the net present value of all of the expected future cash flows on the mortgages that are currently insured under the MMI Fund. The actuarial review is used to determine whether the MMI Fund is in compliance with a statutory requirement to maintain a capital ratio of at least 2%. The capital ratio is the economic value of the MMI Fund divided by the total dollar amount of mortgages insured under the MMI Fund.

Summary: In the years following the housing and mortgage market turmoil that began around 2007, increased foreclosure rates, as well as economic factors such as falling house prices, contributed to increases in expected losses on FHA-insured loans. This put pressure on the MMI Fund and reduced the amount of resources that FHA had available to pay for additional, unexpected future losses. The capital ratio fell below 2% in FY2009 and remained below 2% for several years thereafter, turning negative in FY2012 and FY2013. Concerns about FHA's finances culminated at the end of FY2013, when FHA announced that it would need $1.7 billion from Treasury to cover an increase in anticipated costs of insured loans. This marked the first time that FHA needed funds from Treasury to make the required transfer of funds between the primary and secondary reserve accounts.

Summary: More recently, the financial position of the MMI Fund has improved. The capital ratio again exceeded the 2% threshold in FY2015 and has remained above 2% in the years since. The FY2018 actuarial review of the MMI Fund estimated the economic value of the MMI Fund to be positive $34.9 billion and the capital ratio to be 2.76%. This suggests that the MMI Fund would have about $34.9 billion remaining after realizing all of its expected future cash flows on currently insured mortgages. The FY2018 results represent an increase from FY2017, when the capital ratio was estimated to be 2.18% and the economic value was estimated to be $26.7 billion.

The Federal Housing Administration (FHA) was established by the National Housing Act of 1934 and became part of th e Department of Housing and Urban Development (HUD) in 1965. It insures private lenders against losses on certain home mortgages. If the borrower does not repay the mortgage and the home goes to foreclosure, FHA pays the lender the remaining amount that the borrower owes (that is, it pays a claim to the lender). FHA charges borrowers fees, called premiums, in exchange for the insurance.

FHA insurance is intended to encourage lenders to offer mortgages to some borrowers who otherwise might be unable to access mortgage credit at affordable interest rates or at all. For example, FHA requires a smaller down payment than many other types of mortgages, potentially making it easier for lower-wealth borrowers, first-time homebuyers, or others for whom a large down payment may present a barrier to homeownership to obtain a mortgage. To qualify for FHA insurance, both the borrower and the mortgage must meet certain criteria. For example, the principal balance of the mortgage must be under a certain dollar threshold. Lenders that originate FHA-insured mortgages must be approved by FHA.

This report describes certain measures of the financial health of the FHA insurance fund for home mortgages, the Mutual Mortgage Insurance Fund. The discussion in this report assumes a certain degree of familiarity with FHA-insured mortgages. For more information on the basic features of FHA-insured mortgages and FHA's role in the mortgage market, see CRS Report RS20530, FHA-Insured Home Loans: An Overview .

Most single-family mortgages insured by FHA are financed through an insurance fund called the Mutual Mortgage Insurance Fund (MMI Fund). Since FY2009, the MMI Fund has included FHA-insured reverse mortgages as well as traditional "forward" home mortgages. Much of the discussion in this report focuses only on traditional forward mortgages, rather than reverse mortgages. However, certain specified sections discuss both forward and reverse mortgages.

Money flows into the MMI Fund primarily from the mortgage insurance premiums paid by borrowers and from sales of foreclosed properties, and money flows out of the MMI Fund primarily from claims paid to lenders when FHA-insured mortgages default. The MMI Fund is intended to be self-supporting. It is meant to pay for costs related to insured loans (such as insurance claims paid to lenders) with money it earns on those loans (such as through premiums paid by borrowers), not through appropriations.

The MMI Fund is also required to maintain a capital ratio of 2% to help pay for any unexpected increases in losses on its insured mortgages, beyond the losses that it currently anticipates. (Capital in this context is defined as the assets that the MMI Fund currently has on hand, plus the net present value of future cash flows associated with the mortgages that it currently insures. The capital ratio is the ratio of capital to the total dollar amount of mortgages insured under the MMI Fund.) As will be discussed in more detail later in this report, the MMI Fund, like all federal loan and loan guarantee programs subject to the Federal Credit Reform Act of 1990, has permanent and indefinite budget authority to receive funds from the Department of the Treasury to cover increases in the costs of loan guarantees made in prior years.

FHA faces an inherent tension between facilitating the provision of mortgage credit to underserved borrowers and safeguarding the health of the MMI Fund. In the years following the housing and mortgage market turmoil that began around 2007, rising mortgage default rates and falling home prices put pressure on the MMI Fund. This resulted in the capital ratio falling below the required 2% threshold in FY2009 and then turning negative for a period of time. The capital ratio became positive again in FY2014 and regained the 2% threshold in FY2015.

The capital ratio falling below 2%, and then turning negative, raised concerns that the MMI Fund would not have enough money to cover all of its expected future losses on the loans that it was currently insuring. At the end of FY2013, the MMI Fund received $1.7 billion from Treasury using its permanent and indefinite budget authority to ensure that it was holding enough funds to cover expected future losses on insured loans. This represented the first time that the MMI Fund ever had to draw on its permanent and indefinite budget authority with Treasury for this purpose. The MMI Fund has not needed to draw such funds from Treasury in subsequent years.

Congress has expressed ongoing interest in the MMI Fund's financial status and its prospects for needing additional funds to pay for future losses on its insured loans. This report focuses on the financial position of the MMI Fund. It begins with a brief overview of some of the major factors that affect the MMI Fund's financial soundness. The remainder of the report focuses on (1) how the MMI Fund is accounted for in the federal budget and (2) the results of annual independent actuarial reviews that are mandated by Congress. The budgetary treatment of FHA-insured mortgages and the actuarial review are two different processes, but both examine how the loans insured under the MMI Fund have performed and are expected to perform in the future and the effect of this loan performance on the financial position of the MMI Fund. The annual actuarial review is the basis for determining the capital ratio. However, it is the annual budget process that determines whether or not the MMI Fund requires assistance from Treasury.

Major Factors Affecting the Stability of the MMI Fund

This section briefly describes some of the major factors that can affect the MMI Fund's financial position. These factors include default and foreclosure rates on FHA-insured loans and the average loss to FHA when a loan goes to foreclosure, the amount of the premiums charged by FHA, the volume of loans that FHA insures, and current and future economic conditions.

Foreclosures and Associated Loss Severities

Traditionally, when an FHA-insured mortgage goes to foreclosure, FHA pays the lender the remaining amount that the borrower owes on the mortgage and takes ownership of the property. The payment to the lender is called a claim . The loss to FHA is the claim amount paid plus any other foreclosure-related expenses (such as the cost of maintaining the foreclosed property), minus any amount that FHA can recoup by selling the foreclosed home. FHA's total losses related to defaults and foreclosures can depend on, among other factors, (1) the number of delinquencies, defaults, and foreclosures on FHA-insured loans; (2) the success of efforts to help borrowers avoid foreclosure on FHA-insured loans or to minimize the costs to FHA associated with a foreclosure; and (3) how much FHA can recoup by reselling foreclosed homes.

Number of Mortgage Delinquencies and Foreclosures

The number of FHA-insured mortgages that become delinquent on mortgage payments impacts FHA's financial status because higher numbers of delinquencies are likely to translate into higher numbers of foreclosures and more claims paid out by FHA. Not all delinquent or defaulted mortgages will necessarily result in completed foreclosures, but higher delinquency and default rates are more likely to lead to higher foreclosure rates.

During turmoil in the housing and mortgage markets starting around 2007, delinquency and foreclosure rates on all types of mortgages, including FHA-insured mortgages, increased, with FHA "serious delinquency" rates peaking in early 2012 at nearly 10%. (Seriously delinquent loans are generally defined as loans that are 90 or more days past due, in the foreclosure process, or in bankruptcy.) This increase in distressed mortgages put pressure on the MMI Fund. More recently, delinquency rates on FHA-insured mortgages have generally improved. As of December 2018, FHA reported that about 4% of its insured loans were seriously delinquent.

A number of factors contributed to elevated delinquency and default rates on FHA-insured mortgages in the aftermath of the housing market turmoil. Unfavorable economic conditions, such as decreases in home prices and increases in unemployment, affected many regions of the country, leading to more defaults and foreclosures on FHA-insured loans. Other factors, such as the credit quality of some loans, also contributed to increased default rates. Similarly, many factors contributed to the improvement in loan performance beginning in 2013. These factors included improving economic conditions and better credit quality of newly insured loans. FHA data show that the loans insured by FHA in the years since 2009 have generally performed better to date than the loans insured in the years immediately preceding 2009, based on a comparison of serious delinquency rates at the same number of months after loan origination.

Default and foreclosure rates can be affected by efforts to help borrowers avoid foreclosure, such as by offering mortgage modifications. Efforts to help borrowers avoid foreclosure and thereby mitigate the losses that the MMI Fund would experience due to a foreclosure are referred to as loss mitigation actions. When a borrower with an FHA-insured loan defaults, the servicer of the loan is required to evaluate whether the borrower is eligible for certain specified loss mitigation actions. If successful, these options can reduce the losses that FHA would otherwise bear on a troubled loan and help minimize losses to the MMI Fund. Some loss mitigation options are intended to result in a borrower keeping his or her home, such as loan forbearance or loan modifications. Other options will result in the borrower losing his or her home, but avoiding foreclosure, such as short sales and deeds-in-lieu of foreclosure.

FHA pays incentive payments and, in some cases, partial insurance claim payments to lenders in connection with loss mitigation actions. These costs are likely to be less to FHA than the cost of paying a claim after a foreclosure. However, if the borrower defaults on the mortgage again in the future and the loan then goes to foreclosure, FHA could end up paying the full claim amount. Therefore, the extent to which loss mitigation actions minimize losses to FHA will depend on whether borrowers who receive any type of loan workout remain current on their mortgages or default again in the future.

If a mortgage must ultimately go to foreclosure, FHA may be able to recoup some of the claim amount that it pays to the lender by selling the property. In general, the amount that it recoups will usually be less than the claim amount. FHA also incurs costs related to managing and marketing foreclosed properties before they are ultimately sold. The amount of money that FHA loses on a given claim as a share of the outstanding loan balance, after accounting for any amounts it recoups from selling the property, is referred to as its loss severity rate.

For the fourth quarter of FY2018, FHA reported that, on average, it lost about 41% of the unpaid principal balance of the loan when it paid insurance claims. (These rates can vary from quarter to quarter; for example, in FY2018 loss severity rates ranged from about 41% to about 46%; in FY2017 they ranged from about 46% to 54%.) FHA's loss severity rates have generally improved in recent years. For example, loss severity rates were 55% in the fourth quarter of FY2013 and 61% in the fourth quarter of FY2012, compared to about 41% in the fourth quarter of FY2018. This improvement has been driven in part by increased use of alternative methods of selling foreclosed properties, which have generally had lower loss severity rates than traditional foreclosures. However, the loss severity rates for traditional foreclosures have also decreased somewhat over time. A number of factors other than disposition methods can also affect loss severities, including home price appreciation or depreciation and the characteristics of the mortgages and properties in question.

FHA charges fees, or premiums, to borrowers who obtain FHA-insured mortgages. These premiums are intended to cover the costs of any claims that are paid out of the MMI Fund. Borrowers pay both an up-front premium and an annual premium. These fees represent the main source of revenue flowing into the MMI Fund.

The amount of premium revenue that comes into the MMI Fund depends on a number of factors, including the amount of the premiums charged, the number and dollar amount of outstanding mortgages on which borrowers are paying premiums, and how many of these outstanding mortgages are ultimately prepaid—through refinancing the mortgage, paying off the loan, or going to foreclosure—resulting in the borrower no longer paying premiums. Raising premiums can bring more money into the insurance fund and help to ensure that FHA is pricing its insurance high enough to adequately cover its risks. However, if premiums are raised too high, fewer borrowers might choose to take out FHA-insured mortgages, potentially affecting the overall amount of premium revenue that FHA earns. Furthermore, raising premiums too high could reduce the overall quality of the mortgages that FHA insures by potentially making FHA-insured mortgages a less attractive option for all but the borrowers who present the largest credit risk.

FHA raised the annual premiums that it charges multiple times in the years following the housing market turmoil before announcing a decrease in the annual premium in January 2015. The annual premiums that FHA is currently charging are lower than at any time since October 2010, though they are higher than the premiums that were charged prior to that date.

The number and dollar volume of loans that FHA insures plays a role in its economic stability. On the one hand, more loans insured by FHA could lead to more premium revenue coming into the MMI Fund as more borrowers pay premiums on their FHA-insured loans. On the other hand, more mortgages insured by FHA also increases FHA's liability for loan defaults. Ultimately, the quality of the loans insured and their future performance influence the overall impact of loan volume on the financial stability of the MMI Fund.

Economic and housing market conditions impact FHA's financial position in several ways. First of all, economic conditions can contribute to default and foreclosure rates. If more people become unemployed or underemployed, or if home prices fall such that people cannot sell their homes if they can no longer afford their mortgages, then more people may face default or foreclosure. Falling house prices also limit the amount that FHA can recoup when it sells a foreclosed property.

Projections of future economic conditions are also important factors in evaluating the health of the MMI Fund. The expected future paths of house prices and interest rates, in particular, play large roles in estimating how FHA-insured mortgages will perform in the future and, ultimately, how much money is expected to flow into and out of the MMI Fund. The future path of house prices is important because, as noted, house prices play a role in default and foreclosure rates and in how much FHA can recoup on foreclosures. Interest rates are important because they can affect home purchase activity as well as the decision by homeowners to refinance their mortgages, which affects how much premium revenue FHA expects to earn as well as affecting FHA's potential liability for future claims. If borrowers with FHA-insured mortgages refinance into new mortgages that are not insured by FHA, those borrowers will stop paying premiums to FHA, reducing the amount of revenue that FHA takes in. However, FHA's overall liabilities will also be reduced since it will no longer be responsible for repaying the lender if the borrower defaults on the mortgage.

If assumptions about future economic conditions and their impact on loan performance are not accurate, then current estimates of the MMI Fund's financial position may also not be accurate.

This section describes how FHA-insured mortgages are accounted for in the federal budget in the year that the loans are insured and in the years thereafter. It includes a discussion of the circumstances under which the MMI Fund would need an appropriation in order to cover the cost of insuring new single-family loans in an upcoming fiscal year (a situation which has never occurred), and the circumstances under which the MMI Fund can draw on permanent and indefinite budget authority with Treasury to reserve for higher-than-expected costs of loans insured in past years (an event that occurred at the end of FY2013).

Credit Reform Accounting and Credit Subsidy Rates

The Federal Credit Reform Act of 1990 (FCRA) specifies the way in which the costs of federal loan guarantees, including FHA-insured loans, are recorded in the federal budget. The FCRA requires that the estimated lifetime cost of guaranteed loans (in net present value terms) be recorded in the federal budget in the year that the loans are insured. The lifetime cost per dollar of loans guaranteed is reflected in the budget as a credit subsidy rate , and the credit subsidy rate multiplied by the total dollar volume of loans insured that year results in the total amount of credit subsidy for those loans.

When a loan guarantee program is estimated to have a positive credit subsidy rate, it requires an appropriation to cover the cost of new loan guarantees before it can insure any new loans in that fiscal year. When a loan guarantee program is estimated to have a negative credit subsidy rate, it means that the present value of the lifetime cash flows associated with the guaranteed loans is expected to result in more money coming into the account than flowing out if it. Rather than requiring an appropriation, a negative credit subsidy rate generates negative subsidy, resulting in offsetting receipts. In the case of the MMI Fund, these offsetting receipts can offset other costs of the HUD budget.

In accordance with the FCRA, each year as part of the President's budget request, FHA and the Office of Management and Budget (OMB) estimate the credit subsidy rate for the loans expected to be insured in the upcoming fiscal year. These estimates are based on factors such as projections of how much mortgage insurance premium revenue the loans insured in the upcoming year are expected to bring in, projections of how much FHA will have to pay in future insurance claims related to those loans, and projections of how much money FHA will be able to recover by selling foreclosed properties. These projections, in turn, rest on assumptions about the credit quality of the loans being made and assumptions about future economic conditions (including house prices and interest rates).

Since credit reform accounting was implemented, FHA's single-family mortgages have always been estimated to have negative credit subsidy in the year that they are insured. That is, over the life of the loans, the insured loans are projected to make money for the government rather than require an appropriation from the government to pay for their costs. (This applies only to the costs associated with the insured loans themselves; credit subsidy rates do not include the administrative costs of a program. FHA does receive appropriations for administrative contract expenses and for salaries. ) The original credit subsidy rate estimates for FHA-insured loans have ranged from a low of -0.05% in FY2009 to a high of -9.03% in FY2015. The total amount of money that FHA would expect to earn on loans insured in a given year depends on the total dollar amount of loans it insures in that year as well as the credit subsidy rate.

If FHA's single-family program were ever estimated to have a positive credit subsidy rate for the upcoming fiscal year, it would require an appropriation to cover the difference between the amount of money FHA expected to take in and pay out over the life of the loans. If funding was not appropriated to cover a positive subsidy rate, then FHA would not be able to insure new loans in that year. (For a brief discussion of a proposed change in the required method of calculating credit subsidy rates that could result in the MMI Fund having a positive credit subsidy rate, see the nearby text box, " FHA and "Fair Value" Accounting .")

In the President's FY2019 budget request, the credit subsidy rate for the MMI Fund, excluding reverse mortgages, was estimated to be negative 3.20% for FY2019. At an expected insurance volume of $230 billion, the budget estimated that the MMI Fund forward portfolio would earn about $7.4 billion in negative credit subsidy in FY2019.

CBO does its own credit subsidy estimates, and these estimates are the ones that are used during the appropriations process. For FY2019, CBO estimated that FHA's single-family programs (excluding reverse mortgages) would generate about $6.9 billion in negative credit subsidy. CBO's lower credit subsidy estimate, as compared to the budget request, results from slightly lower estimates of both the credit subsidy rate and overall loan volume for the FHA forward portfolio in FY2019.

The amount of money that loans insured by FHA in a given year actually earn for or cost the government over the course of their lifetime is likely to be different from the original credit subsidy estimates due to better or worse than expected performance of those loans. Federal credit reform accounting recognizes this, and provides permanent and indefinite budget authority to federal credit programs to cover any increased costs of loan guarantees in the future.

Each year, in consultation with OMB, FHA re-estimates each prior year's credit subsidy rates based on the actual performance of the loans and other factors, such as updated economic projections. Although the original credit subsidy rate for the single-family mortgage insurance program each year has historically been estimated to be negative, the credit subsidy rate re-estimates for the loans insured in several fiscal years are currently estimated to be positive, suggesting that FHA will actually pay out more money than it earns on the loans insured in those years.

Table 1 shows the original credit subsidy rate estimates and the most current re-estimated credit subsidy rates (as of the date of this report) for the loans insured in each fiscal year between 1992 and 2017. The first column shows the original credit subsidy rate. In all cases the original subsidy rate estimates were negative (shown in green), meaning that the loans insured in those years were originally expected to make money for the government. The second column shows the current re-estimated credit subsidy rate for each year. Re-estimated credit subsidy rates are shown in green if they remained negative (even if they are less favorable than the original estimate) and in red if they have become positive. (See the PDF version of this report to see the table in color.)

For most years, the current re-estimated credit subsidy rate is less favorable than the original estimate, although many of the re-estimated credit subsidy rates are still negative. A lower, but still negative, credit subsidy estimate suggests that the loans insured in that fiscal year will still make money for the government, but less than was originally estimated. In the years between FY2000 and FY2009, the re-estimates of the subsidy rates are positive (shown in red), meaning that the loans insured in these years are currently expected to lose money overall. In six years—FY1992, FY2010, FY2011, FY2012, FY2013, and FY2016—the current re-estimated subsidy rate is more favorable than the original estimated subsidy rate, meaning that the loans insured in those years are now expected to make more money than originally estimated.

The credit subsidy rate re-estimates affect the way in which funds are held in the MMI Fund. The MMI Fund consists of two primary accounts: the Financing Account and the Capital Reserve Account. The Financing Account holds funds to cover expected future losses on FHA-insured loans. The Capital Reserve Account holds additional funds to cover any additional, unexpected future losses. Funds are transferred between the two accounts each year on the basis of the re-estimated credit subsidy rates to ensure that enough is held in the Financing Account to cover updated projections of expected losses on insured loans. If the credit subsidy rate re-estimates reflect an aggregate increase in expected losses, funds are transferred from the Capital Reserve Account to the Financing Account to cover the amount of the increase in expected losses. If the credit subsidy rate re-estimates reflect a decrease in aggregate expected losses, funds are transferred from the Financing Account to the Capital Reserve Account.

Table 2 illustrates the changes in these account balances between FY2008 and FY2018. In the years following the housing market turmoil that began around 2007, the credit subsidy rate re-estimates showed aggregate increases in expected losses on FHA-insured loans, requiring large transfers of funds from the Capital Reserve Account to the Financing Account to cover these additional expected future losses. At the end of FY2008, the MMI Fund held $9 billion in the Financing Account and $19.3 billion in the Capital Reserve Account. The amounts needed in the Financing Account increased over the next several years and the amounts held in the Capital Reserve Account decreased, reaching zero at the end of FY2013 (when the MMI Fund received funds from Treasury to make a required transfer of funds to the Financing Account). By the end of FY2014, the MMI Fund had begun to rebuild its reserves, holding $7.3 billion in the Capital Reserve Account. As of the end of FY2018, the Capital Reserve Account held $27.2 billion.

Although the total resources held in these accounts have increased over the last several years, the total dollar volume of mortgages insured by FHA has also increased, from about $400 billion at the end of FY2008 to about $1.3 trillion at the end of FY2018.

Permanent and Indefinite Budget Authority

Recognizing the fact that estimating the lifetime cost of loan guarantees is inexact, the Federal Credit Reform Act of 1990 includes permanent and indefinite budget authority for federal loan guarantee programs to cover the cost of credit subsidy rate re-estimates. Therefore, if FHA ever needs to transfer more money than it has in the Capital Reserve Account to the Financing Account to cover an increase in expected losses on insured loans, it can draw on its permanent and indefinite budget authority to receive funds from Treasury to make this transfer without additional congressional action.

Any funds drawn from Treasury to make a required transfer of funds to the Financing Account are not spent immediately. Rather, they are held in the Financing Account, and used to pay claims to lenders only if the rest of the funds in the Financing Account are exhausted. If economic conditions and loan performance improve, or if loans insured in the future bring in enough money to both cover their own costs and pay for past loans that defaulted, it is possible that any money received from Treasury would never actually be spent. On the other hand, if future insured loans do not bring in enough funds to cover losses on past loans, or if economic conditions and loan performance do not improve, any funds received from Treasury could eventually be spent to pay actual claims.

When the President's budget request for FY2014 was released in April 2013, it included an estimate that the MMI Fund would need a mandatory appropriation of $943 million from Treasury during FY2013 in order to make a required transfer of funds from the Capital Reserve Account to the Financing Account. FHA had until the end of FY2013 to make the required transfer of funds, and there was a possibility that the MMI Fund would bring in enough additional funds through the negative credit subsidy it earned on loans that it insured in FY2013 to make the required transfer without depleting the Capital Reserve Account. However, due to reduced loan volumes in FY2013, the MMI Fund earned less than anticipated during the year.

At the end of September 2013, HUD announced that the MMI Fund needed about $1.7 billion to ensure that enough money was available in the Financing Account to cover all expected future losses on insured loans. It received these funds from Treasury using the permanent and indefinite budget authority provided under the FCRA. This amount was nearly twice what was anticipated in the President's budget, and represented the first time that FHA had ever needed funds from Treasury to make a required transfer of funds from the Capital Reserve Account to the Financing Account. FHA has not needed to draw additional funds from Treasury since that time.

Annual Actuarial Review and Annual Report to Congress on the Financial Status of the MMI Fund

Separately from the annual budget process, FHA is required by law to obtain an independent actuarial review each year that analyzes the financial position of the MMI Fund and to provide an annual report to Congress on the results of the actuarial review. This review traditionally analyzes the MMI Fund's financial position by reporting the amount of funds that it currently has on hand and estimating the net amount (in present value terms) that it expects to earn or lose in the future on loans that it currently insures. These numbers are added together to compute the "economic value" of the MMI Fund. The economic value is the amount of money that the MMI Fund would be projected to have on hand after all of the cash flows associated with its insured loans are realized, assuming that it does not insure any more loans going forward. The results of the actuarial review are presented in FHA's annual report to Congress on the financial status of the MMI Fund.

The budgetary treatment and the actuarial review of the MMI Fund are two different ways of looking at the same thing—namely, how the loans insured under the MMI Fund have performed and are expected to perform in the future, and the effect of this loan performance on the financial position of the MMI Fund. However, the annual actuarial review is separate from the federal budget process, and uses somewhat different economic assumptions than those used in the federal budget. This section describes the actuarial review and accompanying annual report to Congress along with important related concepts. It then discusses the results of the FY2018 actuarial review and annual report that were released in November 2018.

In the annual actuarial review, the independent actuary reviews the MMI Fund's financial information to estimate the MMI Fund's current financial position, including both forward and reverse mortgages insured under the fund. This usually includes reporting the amount of funds that the MMI Fund currently has on hand and estimating the cash flows that it expects in the future—such as premiums paid into the fund and claims paid out of the fund—on the loans that it currently insures. It uses economic modeling to project the MMI Fund's financial status for the current year and several years into the future under a "base case" scenario and several alternative economic scenarios. Some of the key terms used in the actuarial report and FHA's annual report on the financial status of the MMI Fund include the following:

Capital resources are the net assets (assets minus liabilities) that the MMI Fund currently has on hand that can be converted into cash to pay claims on defaulted mortgages or other expenses. Present value of future cash flows on outstanding business is the estimated amount that the MMI Fund is currently expected to gain or lose in the future, in present value terms, on the loans that it currently insures (this estimate does not take into account any new loans that might be insured in the future). Economic value or economic net worth is the MMI Fund's capital resources plus the present value of its future cash flows on outstanding business. It represents the amount of capital resources that the MMI Fund would have after expected future cash flows on currently insured loans are realized. In other words, it represents the amount that the MMI Fund could use to pay for any additional, unexpected losses on its outstanding loans.

The law also mandates that FHA meet a 2% capital ratio requirement, which means that the economic value of the MMI Fund must be at least 2% of the total dollar volume of mortgages that FHA currently insures. The capital ratio is calculated on the basis of the actuarial report. The capital ratio fell below this 2% requirement in FY2009 and remained below 2% for several years thereafter, turning negative in FY2012 and FY2013. The capital ratio was estimated to be positive again in FY2014 and was estimated to exceed 2% in FY2015 and each subsequent year to date.

The FY2018 annual actuarial review and FHA's accompanying annual report to Congress on the MMI Fund's financial status were released in November 2018. In its annual report, FHA reported the MMI Fund's total capital resources to be $49.2 billion. This is the amount of resources that FHA currently has on hand that can be converted into cash to pay claims. FHA estimated the present value of future cash flows on insured loans (including both forward and reverse mortgages) to be negative $14.4 billion. In other words, in net present value terms, the loans that FHA currently insures are expected to cost FHA about $14.4 billion over the remaining life of those loans. The economic value of the MMI Fund, therefore, was estimated by FHA to be approximately $34.9 billion ($49.2 billion-$14.4 billion), including both forward and reverse mortgages. The independent actuary separately estimated the present value of future cash flows on insured loans for the MMI Fund. While the actuary's estimate differed somewhat from FHA's, it found FHA's estimate to be reasonable.

The estimated economic value of $34.9 billion was an increase of about $8.1 billion compared to FY2017, when the MMI Fund was estimated to have an economic value of $26.7 billion.

In FY2012 and FY2013, the MMI Fund was estimated to have a negative economic value. A negative economic value means that the funds that the MMI Fund currently has on hand, plus the present value of the funds that it expects to earn in premiums on loans that it currently insures, would not be enough to pay for the present value of claims on the loans that are currently insured. For example, in FY2013 the MMI Fund was estimated to have an economic value of negative $1.3 billion. This meant that, based on the MMI Fund's capital resources and estimates of future cash flows on insured loans as of the time the report was prepared, FHA was expected to be short about $1.3 billion when all of its currently insured loans were eventually paid off. In contrast, the FY2018 economic value of positive $34.9 billion means that the MMI Fund would be estimated to have that amount left over after all of the expected future cash flows (including premium payments and insurance claims) on its currently insured mortgages were realized. This provides a "cushion" should future losses on insured mortgages be higher than currently anticipated.

The projections included in the actuarial report and the annual report to Congress rely on several assumptions. For one thing, the estimates of the MMI Fund's current status assume that FHA will not insure any more mortgages. In actuality, FHA will likely continue to insure loans, which will bring in additional resources in the form of premium revenues, but will also create new liabilities in terms of claims.

Furthermore, the actuarial review relies upon assumptions about future economic conditions. To the extent that actual future economic conditions differ from these assumptions, the estimates of the MMI Fund's value will also be different. Although FHA estimates that the MMI Fund's economic value in FY2018 is positive $34.9 billion, it notes that, under a variety of alternative future economic scenarios, the MMI Fund's economic value could be different, including potentially negative values in certain severe economic scenarios. Both the actuarial report and the annual report to Congress include an analysis of the MMI Fund's financial position under various alternative economic scenarios.

As noted earlier, the MMI Fund is also required by law to maintain a capital ratio of 2%. This is often referred to as the capital ratio requirement.

Brief History of the Capital Ratio Requirement

The capital ratio requirement for the MMI Fund was enacted in 1990 amid concerns about the solvency of the FHA single-family mortgage insurance program. At the time, the MMI Fund had a negative economic value. This meant that the expected future cash flows associated with the mortgages currently insured by the MMI Fund, when combined with the capital resources that the MMI Fund currently had on hand, were not expected to be enough to pay for all future claims on FHA-insured loans.

In response to these concerns, the Omnibus Budget Reconciliation Act of 1990 ( P.L. 101-508 ) mandated that, going forward, the MMI Fund's economic value must be at least 2% of the total dollar amount of loans that it is currently insuring. The capital ratio is an expression of the economic value of the MMI Fund as a percentage of the total dollar volume of loans insured by the MMI Fund. It is a measure of how much capital the MMI Fund will have available to pay for unexpected losses on currently insured loans, after the amounts estimated to be needed to cover expected losses are taken into account.

In addition to establishing the capital ratio requirement, P.L. 101-508 also directed FHA to make certain changes that were intended to improve the MMI Fund's financial condition. The changes that the law required included charging borrowers an annual mortgage insurance premium to go along with the existing premium that was paid upfront and suspending certain payments (known as distributive shares) that had previously been paid to borrowers under certain conditions. The law also established the requirement for the annual independent actuarial review of the MMI Fund. Some of these changes, such as the additional mortgage insurance premium, essentially meant that FHA would charge more to future borrowers to build up reserves to pay for losses on mortgages made to past borrowers.

As Congress considered the legislation prior to enactment, there was debate over the appropriate level for the capital ratio requirement. This debate highlights the ongoing tension that FHA faces between maintaining its financial soundness and carrying out its purpose of expanding access to affordable mortgage credit for underserved borrowers. The 2% threshold was adopted because it was viewed as being high enough to provide FHA with a cushion to withstand some unexpected losses, but without imposing an undue financial burden on future FHA-insured borrowers. A higher capital ratio requirement would have likely required FHA to charge higher premiums for FHA insurance. It was recognized that a 2% requirement would likely be high enough to withstand moderate future economic downturns, but would likely not be high enough to allow the MMI Fund to withstand a catastrophic economic downturn. According to testimony from the General Accounting Office (GAO, now the Government Accountability Office) from 2000:

Determining what constitutes an adequate reserve level is essentially a question of what kinds of adverse economic conditions—moderately severe or catastrophic—the reserve should be able to withstand.... In the actuarial review of the Fund conducted by Price Waterhouse for fiscal year 1989, the researchers concluded that actuarial soundness would be consistent with a reserve that could withstand adverse, but not catastrophic, economic downturns. They further concluded that the Treasury implicitly covers catastrophic risk.... By contrast, rating agencies have taken the position, when evaluating private mortgage insurers, that they should have enough capital to withstand catastrophic risk.... However, requiring FHA to hold capital equivalent to that held by private mortgage insurers would likely impair FHA's public purpose.

While the law requires the Secretary of HUD to ensure that the MMI Fund maintains a capital ratio of 2%, it does not currently specify consequences or specific actions that the Secretary must take if the capital ratio falls below that threshold. Furthermore, GAO has noted that the 2% capital ratio requirement does not take into account specific economic conditions the MMI Fund should be expected to withstand. It has suggested that Congress could consider enacting legislation to specify such conditions, and to require FHA to maintain a capital ratio that is based on the MMI Fund's ability to withstand those specific economic scenarios.

While the results of the actuarial review and the estimate of the capital ratio provide important information about the financial soundness of the MMI Fund, the results of the actuarial review and the capital ratio estimate do not determine whether or not FHA will need to draw on its permanent and indefinite budget authority with Treasury for funds to hold against expected future losses or to pay claims. That is determined as part of the re-estimate process that is done as part of the federal budgeting process each year, which is described in the " The MMI Fund in the Federal Budget " section of this report.

The capital ratio is reported in FHA's annual report to Congress on the financial status of the MMI Fund, using the actuarial report's numbers for both traditional single-family forward mortgages and reverse mortgages insured by FHA. In FY2018, the annual report estimated the economic value of the MMI Fund to be $34.9 billion. The total dollar volume of mortgages currently insured by the MMI Fund was $1.265 trillion, which means that the capital ratio was estimated to be 2.76% ($34.9 billion divided by $1.265 trillion). This represents an increase from FY2017, when the capital ratio was estimated to be 2.18%. The capital ratio remained above 2% for the fourth straight year; FY2015 was the first time the capital ratio had exceeded 2% since FY2008.

In FY2009, the capital ratio was estimated to be 0.53%. This was the first time that the capital ratio had fallen below 2% since the requirement was first met in FY1995. The capital ratio remained below 2% from FY2009 through FY2014, when the capital ratio was estimated to be 0.41%. In FY2012 and FY2013, the capital ratio was estimated to be negative 1.44% and negative 0.11%, respectively. FY2012 was the first time that the MMI Fund had been estimated to have a negative capital ratio since the early 1990s, when Congress enacted the series of changes aimed at ensuring the financial soundness of the MMI Fund, including the requirement for an independent annual actuarial review and the required capital ratio.

A negative capital ratio by itself does not trigger any special assistance from Treasury, although it suggests that such assistance could be needed at some point. Rather, any assistance from Treasury is triggered if the credit subsidy rate re-estimates described in the " Annual Credit Subsidy Rate Re-estimates " section show that FHA needs to transfer more funds than it has in its Capital Reserve Account into its Financing Account to cover increases in expected future losses. The amount of assistance required from Treasury is based on the credit subsidy rate re-estimates, not on the capital ratio or the economic value of the MMI Fund as reported in the actuarial report.

Table 3 shows the MMI Fund's financial position, including its economic value, dollar volume of insured mortgages, and capital ratio, as estimated by the independent actuary and FHA for each fiscal year between FY2006 and FY2018.

The drop in the capital ratio in the years after 2008 resulted from both a decrease in the numerator of the ratio (the MMI Fund's economic value) and an increase in the denominator of the ratio (total dollar volume of mortgages outstanding), which reflects the fact that FHA is insuring a greater volume of loans than it has in the recent past. The decrease in the MMI Fund's economic value, in turn, was mostly due to the fact that the present value of future cash flows became increasingly negative for a time, suggesting that FHA was expecting large net cash outflows over the life of the loans that it was currently insuring.

Selected Current Issues Related to the Financial Status of the MMI Fund

This section briefly describes selected current issues related to the financial status of the MMI Fund, and in particular certain issues that are often discussed in the context of the annual actuarial review and annual report to Congress. Namely, it discusses the inclusion of reverse mortgages in the MMI Fund, debate over the appropriate level for the premiums charged for FHA-insured mortgages, and certain trends in FHA-insured mortgage characteristics that FHA identified in its FY2018 annual report as worthy of monitoring.

Role of FHA-Insured Reverse Mortgages in the Annual Actuarial Review

FHA-insured reverse mortgages, known as Home Equity Conversion Mortgages (HECMs), were moved into the MMI Fund beginning in FY2009. In contrast to traditional forward mortgages, HECMs are FHA-insured reverse mortgages for elderly homeowners who are seeking to access their accumulated home equity. HECMs that were insured by FHA prior to FY2009 are obligations of a different FHA insurance fund, but HECMs insured in FY2009 or later are obligations of the MMI Fund.

The dollar amount of HECMs insured under the MMI Fund is much smaller than the amount of traditional forward mortgages: about $72 billion of the $1.3 trillion of insurance-in-force under the MMI Fund are HECMs. However, changes in the estimated value of HECMs can have a significant impact on the MMI Fund's overall economic value and on the capital ratio.

Estimates of HECM performance are particularly sensitive to economic assumptions, such as future house prices and interest rates, making the value of the HECM portfolio volatile. While the value of forward mortgages insured under the MMI Fund has consistently increased since FY2012, the value of HECMs has fluctuated between negative and positive values and has become increasingly negative in recent years.

The volatility in the HECM portfolio can be seen in the results of recent actuarial reviews and in the standalone capital ratios for the forward and HECM portfolios as reported by FHA. As shown in Figure 1 , the standalone capital ratio for the forward mortgage portfolio alone has steadily increased from negative 0.91% in FY2012 to positive 3.93% in FY2018. In comparison, the standalone capital ratio for HECMs has fluctuated during that time period, ranging from a high of positive 3.07% in FY2013 to a low of negative 18.83% in FY2018. (The capital ratio for the overall MMI Fund in FY2018 was estimated to be 2.76%.) Given the smaller overall insurance volume of the HECM portfolio, changes in the portfolio's economic value can have a larger impact on the HECM standalone capital ratio than a comparable dollar volume change in the larger forward portfolio would have on its standalone capital ratio. Nevertheless, the trends in the standalone capital ratios illustrate differences in the performance of the two portfolios.

The volatility of HECMs and their inclusion in the MMI Fund potentially raise some policy questions. In its FY2015 annual report on the status of the MMI Fund, FHA noted that including both HECMs and forward mortgages in the fund could make it more difficult to independently assess the financial health of the separate programs, particularly since the capital ratio for the entire MMI Fund is often used as a proxy for the performance of the much larger forward mortgage portfolio. Furthermore, including both types of mortgages in the same fund could impact policies related specifically to forward mortgages, such as the level of fees paid by borrowers, in response to instability in the MMI Fund driven by HECMs. For these reasons, some industry groups and other observers have argued that Congress should consider legislation to remove HECMs from the MMI Fund. However, GAO and others have noted that removing HECMs from the MMI Fund would involve tradeoffs.

The upfront and annual mortgage insurance premiums charged by FHA account for most of the revenue coming into the MMI Fund. As described earlier in the " Mortgage Insurance Premiums " section of this report, the levels of the premiums charged can impact the MMI Fund's status in several potentially conflicting ways. All else being equal, higher premiums should bring more money into the MMI Fund. However, higher premiums have the potential to negatively impact FHA's finances by leading to a reduction in FHA loan volume or impacting the credit quality of the loans that FHA insures. Higher premiums also increase the costs of FHA-insured mortgages for homebuyers, potentially making FHA-insured mortgages less affordable or pricing some potential homebuyers out of the market. Therefore, setting the appropriate levels for the mortgage insurance premiums requires striking a balance between maintaining affordability of FHA-insured mortgages and managing risk to the insurance fund.

In the years following the housing market turmoil that began around 2007, FHA increased the premiums that it charges for new FHA-insured forward mortgages several times. Most of these changes affected the annual premiums. Following several increases, FHA decreased the annual mortgage insurance premiums that it charges in January 2015. The current annual premiums are at their lowest levels since the beginning of October 2010, though they are higher than the premiums that FHA was charging previously.

In recent years, as the capital ratio has increased over 2%, some industry groups and housing advocates have called for FHA to further reduce the mortgage insurance premiums it charges for forward mortgages (or to reduce the amount of time that it charges the premiums ), arguing that the MMI Fund is strong enough to take such steps to increase the affordability of FHA-insured mortgages. The improvement in the MMI Fund's capital ratio in FY2018 again led to calls from some advocates and industry groups to decrease the mortgage insurance premiums. However, FHA has reportedly indicated that it is not likely to reduce the premiums in the near future.

Suspension of a Planned FHA Premium Decrease in 2017

On January 9, 2017, in the last weeks of the Obama Administration, FHA had announced that it would again decrease the annual mortgage insurance premiums charged to borrowers who took out new FHA-insured mortgages that closed on or after January 27, 2017. However, on the first day of the Trump Administration, before the new premiums had gone into effect, FHA announced that it was suspending the planned premium reduction. In its announcement, FHA indicated a need to further study the impact that the fee decrease could have on the insurance fund and the long-term financial viability of FHA.

In its FY2017 annual report to Congress on the financial status of the MMI Fund, FHA estimated that had the premium decrease gone into effect, the capital ratio for the MMI Fund would have been 1.76% in FY2017, below the statutorily mandated level of 2%. The lower capital ratio would have resulted from the combination of an estimated decrease of $3.2 billion in the net present value of expected future cash flows on insured mortgages (stemming from lower premiums that would have been paid on FHA-insured mortgages originated in FY2017, including some borrowers refinancing their existing FHA-insured mortgages into new mortgages with lower premiums) and an estimated increase of $45 billion in FHA's insurance-in-force (stemming from more people obtaining FHA-insured mortgages as a result of the premium decrease).

These estimated differences in the net present value of future cash flows and insurance-in-force also would have reduced the economic net worth and the capital ratio for the forward mortgage portfolio alone. However, based on the figures provided in the annual report, the estimated capital ratio for forward mortgages alone would still have remained above 2% if the premium decrease had gone into effect, even though the capital ratio for the MMI Fund as a whole (including both forward mortgages and HECMs) would have fallen below that threshold. The capital ratio for the MMI Fund as a whole is the only number that matters for the purposes of complying with the law. Nevertheless, the estimated impact that the premium decrease would have had on the forward portfolio alone may be relevant to the extent that some are concerned that the inclusion of HECMs in the MMI Fund may affect policy decisions related specifically to the forward portfolio.

FHA-Insured Mortgage Origination Trends Identified by FHA in the FY2018 Annual Report

In the FY2018 annual report to Congress, FHA identified several trends related to the credit quality of its forward mortgage insurance portfolio that it is monitoring due to their potential to increase risk to FHA. In particular, FHA noted the following five trends:

Cash-Out Refinances : 75 Cash-out refinances are refinance transactions in which the borrower can access equity in the home by taking out a new mortgage for a higher amount than the remaining principal balance of the existing mortgage. The share of cash-out refinances insured by FHA has been increasing in recent years, reaching 63% of all FHA-insured refinance mortgages, and 15% of all FHA-insured forward mortgages, in FY2018. The share of cash-out refinances may be increasing for several reasons; for example, rising home prices may lead to more cash-out refinances by increasing borrowers' equity in their homes, and continuing low interest rates may be depressing other types of refinancing activity (making cash-out refinances a larger share of all refinance mortgages). Nevertheless, cash-out refinances have the potential to pose a risk to FHA by increasing borrowers' leverage and reducing the equity they have in their homes. If home prices should fall in the future, it is possible that some borrowers with higher loan-to-value ratios due to cash-out refinances could have difficulty repaying their mortgages. Debt-to-Income Ratios : 77 Debt-to-income ratios for borrowers with new FHA-insured purchase mortgages have been increasing in recent years. In FY2018, the average debt-to-income ratio for a new purchase borrower was about 43%, compared to 42% in FY2017 and 40% in FY2008. The share of FHA-insured purchase mortgages with borrower debt-to-income ratios above 50% has been increasing as well, reaching nearly 25% in FY2018. Higher debt-to-income ratios could increase the risk that some borrowers might have problems repaying their mortgages if they encounter financial difficulties. Credit Scores : 78 The average credit scores of borrowers who obtain FHA-insured mortgages have been decreasing since FY2011. In FY2018, the average borrower credit score for FHA-insured mortgages was 670, compared to 676 in FY2017 and 701 in FY2011. This in part reflects a return of FHA to its traditional role in the mortgage market; in the aftermath of the housing market turmoil that began around 2007, FHA insured a greater share of mortgages as mortgage credit conditions tightened, including mortgages for borrowers with higher credit scores who traditionally may not have sought FHA-insured mortgages. As mortgage credit conditions have eased somewhat, more high-credit-score borrowers may find it easier to obtain other types of mortgages. However, lower borrower credit scores could potentially suggest increased risk associated with these mortgages, and FHA has said that it "will continue to monitor declining credit scores for new FHA endorsements for the risk they pose to the MMIF." Down Payment Assistance : 80 FHA has also been monitoring the increasing share of mortgages that have some form of down payment assistance, and in particular down payment assistance provided by a federal, state, or local governmental entity (rather than other sources, such as a family member). In FY2018, about 38% of FHA-insured purchase mortgages included some type of down payment assistance, compared to about 30% in FY2011. FHA has noted that mortgages with down payment assistance, and down payment assistance provided by a governmental entity specifically, tend to have somewhat higher default rates than other FHA-insured mortgages. FHA has also expressed some concerns about certain types of governmental down payment assistance programs and has suggested that it may be necessary to take action to provide more clarity about what types of down payment assistance are allowed. Non b ank Mortgage Originations : 83 The share of FHA-insured mortgages originated by nonbanks, rather than by traditional depository institutions, has been increasing in recent years. In FY2018, nonbank lenders originated nearly 87% of new FHA-insured mortgages. While all lenders that originate FHA-insured mortgages are required to meet certain standards, mortgages originated by nonbanks may pose different types of risks to FHA than traditional depository institutions. In its annual report, FHA stated that it "believes it needs to strike a better balance in doing business" with both nonbank and depository lenders.

There are several potential drivers of the trends identified by FHA, including, among other things, economic conditions and the availability of other types of mortgage credit. The overall impact of each of these trends on FHA loan performance and, by extension, its finances will depend on a variety of factors, and some of these trends may pose more of a potential risk to FHA than others.