November 24, 2014
The value of housing counseling has long been a hotly-debated topic in part because concrete data is limited on whether counseling is more effective than other methods of preparing borrowers to get a mortgage.
A growing number of studies support housing finance counseling's ability to boost loan performance. And advocates of housing counseling maintain borrowers benefit more from third-party resources that don't have an interest in whether a consumer ultimately gets a mortgage.
"Realtors and FHA lenders care a lot about borrowers, but it's a conflicted conversation because the Realtor and the lender want the deal to happen and they prefer a bigger deal to a smaller deal," said Ellen Seidman, a former director of the Office of Thrift Supervision.
But others argue alternatives exist that are just as effective at improving loan performance without the added time and expense of third-party resources. Edward Pinto, co-director of the International Center on Housing Risk at the American Enterprise Institute, has long believed a residual income test — like what's used to qualify borrowers for mortgages insured by the Department of Veterans Affairs — is a more cost-effective method of providing the true benefit of housing counseling.
"The VA uses residual income and it works great," said Pinto, noting that VA volumes have been one of the few loan sectors to consistently increase following the housing crash and perform better than FHA loans. "You collect the data, the underwriter underwrites it and you get your answer. It's pretty straightforward."
Fannie Mae and Freddie Mac require housing counseling (typically provided in conjunction with mortgage insurers) on higher-risk mortgages, like the low-down-payment products the government-sponsored enterprises plan to resume offering. And the Department of Housing and Urban Development is planning a pilot program to incentivize Federal Housing Administration borrowers with discounts on their mortgage insurance premiums if they receive counseling.
Lenders have mixed views on housing counseling.
Third-party counselors take an education-focused approach with consumers and play a key role in reducing loan-performance concerns, rather than the sales-based relationship that exists between loan officers and borrowers, said Clem Ziroli, president of Ontario, Calif.-based lender First Mortgage. "They understand the risks and are better equipped to cover all the bases with the borrower," he said of counselors.
Still, skeptics question whether available data on housing counseling really confirm that improvements in loan performance stem from third-party education, as opposed to the analysis of consumer budgets that goes along with it.
"Down payment and borrower reserves/residual income ensure that there's a better opportunity for the long-term performance of a loan," said Steve Calk, chairman and CEO of The Federal Savings Bank in Chicago.
And he questions whether there is enough quantitative research to prove a third-party counselor is central to that benefit.
"I want to see more statistical analysis," he said.
Limited Data is Optimistic
In detailing the rationale for its Homeowners Armed with Knowledge, or HAWK, pilot program, HUD cites numerous housing counseling studies, including one published by Freddie Mac in April 2013, which found serious delinquencies within the first three years of origination were lower when borrowers received housing counseling.
Between 2000 and 2008, loans with counseling had an average 90-plus-day delinquency rate of 11.8%, while nearly 21% of the loan sample without borrower counseling had serious delinquencies, according to the study. (The overall average delinquency rate is higher than historic norms because of the effect of the mid-2000s market downturn.)
The study also found that first-time homebuyers benefited more from counseling than repeat buyers. Delinquency rates also varied by the type of housing counseling that borrowers received.
Borrowers who received housing counseling either individually over the phone or one-on-one in person had delinquency rates of 8.05% and 9.34%, respectively. Borrowers who received counseling in either a classroom group setting or through self-guided home study had delinquency rates of 13.3% and 15.08%, respectively.
A Federal Reserve Bank of Philadelphia study — published in April 2014, but not cited in HUD's HAWK proposal — found individual counseling increased consumers' credit scores roughly twice as much as classroom instruction, said author Marvin Smith, a senior community development economic advisor.
Despite the promising results, both studies have their limitations. While the Freddie Mac study spans several years and adjusts for loan-to-value ratios in ways other studies haven't. But it has small sample sizes for certain time periods as well as self-selection bias.
The Philadelphia Fed study addressed the self-selection bias with random assignment. But it examines broader consumer credit performance relative to homeownership counseling, rather than mortgage performance specifically.
The research about counseling and loan performance can be improved upon, and some is mixed, said Peter Zorn, a vice president specializing in housing analysis and research at Freddie Mac, and one of the authors of the GSE's study. Academic research should continue, he said.
"There are a lot of people talking about this sort of thing, and it's an important public policy question," said Zorn.
But existing studies showing counseling improves loan performance are strong enough "for business purposes," he said.
For its HAWK initiative, HUD is proposing lowering its standard 175-basis-point upfront loan fee by 50 basis points and lowering its 135 basis point annual premium by 10 basis points at closing if a first-time borrower completes counseling requirements. If the loan is still performing after 18 months, the FHA will reduce the annual premium by another 15 to 110 basis points.
While HUD is confident in the available research showing the effectiveness of housing counseling, a key component of the HAWK pilot program will be to gather and analyze data, and HUD also routinely gathers more and better data on counseling, said spokesman Brian Sullivan said.
"I think that the body of research out there leaves no confusion in terms of the impact housing counseling has in improving loan performance," Sullivan said.
Footing the Bill
Housing counseling is funded through a mix of federal and state government funds, consumer and business expenditures. It also is a condition of and funded by several mortgage-related legal settlements, Sullivan said.
HUD's housing counseling assistance budget request for the 2015 fiscal year was $60 million, up 33% from FY 2014. HUD's total requested budget was up 2.6% to $47 billion — meaning general counseling assistance accounts for less than 13 cents out of every $100 of the HUD budget.
The general counseling line item in HUD 2015 budget does not include the HAWK program, said Sullivan, as HUD is currently retooling HAWK after reviewing feedback on the concept.
Another recipient of federal housing counseling funding is NeighborWorks America, which receives an annual appropriation for Congress. The group helps local communities establish public-private partnerships that are independent, tax-exempt nonprofits, and requested $182 million for the 2015 fiscal year; $132 million for core activities, plus $50 million for foreclosure prevention. That's down from FY 2014, when NeighborWorks requested $136.6 million for core activities and $67.6 million for foreclosure prevention
"Despite the decline in foreclosure, demand for foreclosure counseling is still strong. For each round of foreclosure counseling grants that we've made since 2008, the demand for money has exceeded the supply by more than two to one in many cases," said NeighborWorks spokesman Doug Robinson.
"Also, although there is a lot of talk about people not wanting to become first-time homebuyers, our homebuyer education and counseling classes are reaching more people, but the money to pay for classes and materials is not keeping up," he said.
Relative to existing agency mortgage requirements, demand for counseling has fallen short at times, said Freddie Mac's Zorn.
Some still question whether housing counseling gives taxpayers the best bang for their buck, particularly when public budgets come under strain.
"I'd rather err on the side of caution and do things that are going to directly reduce risk rather than these indirect, third-party interventions," said the AEI's Pinto.
"We know what works. Do an ability-to-repay based on residual income," he added. "That's going to work. It's going to protect the consumer at the same time."
Lender-provided residual income tests, like the ones used in VA originations, eliminate the additional cost of third-party counseling. But like counseling, the tests provide more extensive consumer budget analysis than standard underwriting, Pinto said.
VA loans typically perform better than FHA mortgages. While the residual income tests are just one contributor to VA loans performing better than FHA mortgages, it's an influential one, Pinto said.
The FHA does perform some residual income analysis in line with manual underwriting on certain loans, Sullivan noted.
But a more exhaustive, lender-initiated review of additional consumer financial obligations during the underwriting of an FHA mortgage would diminish options for the lower-income borrowers that the FHA aims to serve, said First Mortgage's Ziroli.
If a counselor reviews detailed budget information with a consumer, it's the basis for a choice the borrower makes. If a residual income test is an underwriting requirement that determines loan eligibility, the borrower doesn't have a choice in the matter, he said.
According to Seidman, third-party review of consumer budget data is valuable because counselors don't have the same conflict of interest with consumers that FHA lenders do. Seidman is a senior fellow at the Urban Institute's Center for Housing Finance Policy Center and co-author of a study entitled, "VA Loans Outperform FHA Loans. Why? And What Can We Learn?"
That's not to say lenders making mortgages outside the auspices of the VA program don't have any concerns about performance.
The FHA insures lenders against more risk than the VA program. But when loans don't perform well, the FHA has also been quick to go back to lenders for indemnification if there is the slightest exception in underwriting to challenge. Similarly, Fannie Mae and Freddie Mac have been quick to require loan repurchases on that basis.
The FHA and GSEs are working on measures aimed at alleviating lenders' concerns in these areas, but some mortgage companies and banks remain skeptical.
Nevertheless, requests for counseling in conjunction with loan programs that require it have increased slightly, said Ed Campbell, a vice president of operations at private mortgage insurer Radian.
Certain GSE loan products require third-party housing counseling, which is often paid for by PMI firms. But between 2010 and 2012, Radian went months without fielding any counseling requests for loans, Campbell said.
The following year, when a period of record-low rates ended and it became more difficult for lenders to make loans, the company began getting a handful of inquiries per month, he said. And those requests are only expected to increase as the GSEs roll out their new low-down-payment products, because those programs include counseling requirements.
Neither Campbell nor NeighborWorks' Robinson are aware of any PMI firms that have offered borrowers discounts on their coverage in exchange for receiving counseling like the HAWK program aims to do. And they said PMI firms typically do not track whether borrowers received housing counseling when analyzing the performance of their loan portfolios.
Counseling is particularly important for the Home Equity Conversion Mortgage program. For those loans, whether borrowers can pay taxes and insurance is central to avoiding defaults that have hurt the financial stability of the FHA's reverse mortgage program in the past.
A new financial assessment rule related to reverse mortgages takes effect in 2015, but counselors' role in this has not yet been determined, said Buz Zeman, who has been providing HECM counseling since the early 1990s.
Whether counselors' roles will change as a result of the new financial assessment rules will probably vary by provider since approaches to counseling differ, added David Rothstein, director of resource development and public affairs at Neighborhood Housing Services of Greater Cleveland.
"There are counseling outfits that do solid work spending an average of two hours per borrower. Others are doing it by phone in 30 minutes," said Atare Agbamu, president and CEO of the advisory firm ThinkReverse. He fears phone-based counseling has more consumer fraud risks than in-person counseling, and added that part of the challenge in maintaining quality control can be a lack of funding.
The quality of housing counseling by organizations or individuals is difficult to statistically measure, but it's an important question when establishing a counseling requirement as part of a loan program, said Zorn.
Freddie Mac once had a time-consuming face-to-face counseling requirement, but relaxed it somewhat to accommodate a shortage of available counselors, particularly in remote areas, he said.
Calk, of The Federal Savings Bank, is open to testing the MI discount proposed in the HAWK program, but also would like to see further efforts to develop more quantitative insight into whether third-party counseling is worth its cost. Still, he dismisses concerns about counseling requirements prolonging the origination process or whether face-to-face counseling creates an excessive inconvenience for borrowers.
"I'm not worried about the speed with which it takes for the buyer to get a loan," he said. "I'm worried about the accuracy."
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