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A white paper on FHA refinancings.

The prepayment behavior of FHA refinancings yields insights about how various borrowers use refinancing as a financial management tool. FHA originations from 1988 to 1993 show 15-year loans were favored heavily by refinancing borrowers, yet the claims on such loans are low. Meanwhile 30-year FHA refinancings, especially ARMs, show much higher claim rate - suggesting these are the loans of choice for more financially distressed homeowners.

In the last few years the mortgage banking industry has learned how little it actually knows about prepayment behavior. Data on prepayments is crucial to understanding the primary asset underpinning the business of mortgage banking - servicing rights. FHA possesses a wealth of historical prepayment data on individual MMIF (Mutual Mortgage Insurance Fund) mortgages that can help bridge this knowledge gap. This FHA data can be used to help understand recent experience as well as to forecast future experience.

In this article, the prepayment propensity of FHA loans that result from refinancings is compared to that of FHA loans originated to purchase homes. Specifically, this work compares the cumulative termination experience through December 31, 1993, of refinanced Section 203(b) 15-year mortgages and 30-year-term mortgages (both fixed-rate and adjustable-rate) with those that are not refinancings. It also identifies the FHA field offices that have originated the largest numbers of refinancings and compares their experience with that of the entire United States.

The article presents data that shows that the cumulative claim termination rates of refinancings within individual field offices are highly correlated with the cumulative claim termination rates of prior origination years.

Identifying the refinancings

At the request of FHA's statistical and actuarial analysis staff, HUD's Office of Information Policies and Systems created a new data element, a "Re finance Code," to add to actuarial's quarterly extract tape from FHA's single-family insurance system (the A43 database). This element, coded as "0", "1", "2" or "3", attempts to identify those cases that represent refinancings as follows:
Code Explanation

0 No explicit refinancing

1 Non-streamlined refinancing

2 Streamlined refinancing
 with a nonrisk-based
 mortgage insurance premium

3 Streamlined refinancing
 with a risk-based MIP

The refinance code was first used widely for the 1988 origination year data. The refinance code is intended to allow FHA to do more refined analyses of its single-family insurance programs.

In the past, FHA field offices have used zero, 30 percent or 999.99 percent as fillers for the loan-to-value (LTV) ratio element of records on streamlined refinancings because streamlined refinancings do not require appraisals and thus lack easily calculable loan-to-value ratios. So, for this analysis, we will construe as streamlined refinancings those cases in the A43 database originated since 1988 that have loan-to-value ratios coded as zero, 30 percent or 999.99 percent. Hence, we have four categories of refinanced loans: those whose refinance code is equal to 1, 2 or 3, or those whose LTV is coded as zero, 30 percent or 999.99 percent.

The A43 database reflects the fact that numerous refinancings have been originated since January 1, 1988. Origination years 1986 and 1987, which generated a flood of refinancings due to a decrease in mortgage interest rates, have only a small number of cases coded as refinancings. Therefore, one can use the A43 database to identify only a portion of the actual refinancings originated since 1988. We suspect that there are more refinancings than the data indicates. Nevertheless, we can analyze the data in its present form, calculate termination rates, compare these rates among FHA field offices and compare the termination experience of refinancings to that of other types of originations. Here, we focus our attention on mortgages originated since 1988.

Figures 1 through 3 show the number of originations, by calendar year of origination, for 30- and 15-year-term, Section 203(b) fixed-rate mortgages and Section 203(b) adjustable-rate mortgages (ARMs), respectively.

Dramatic shifts in origination patterns

While the number of MMIF 30-year, fixed-rate mortgages originated annually remained in a narrow range - from 528,000 to 640,000-during origination years 1988-1993, the number of reported nonrefinancings declined sharply from a peak of 627,165 mortgages in 1990 to only 338,001 mortgages in 1993. At the same time, the number of reported refinancings rose from around 12,000 in both 1989 and 1990 to more than 236,000 in 1993. This could be a result of more-accurate coding of refinancings in the A43 system in more recent years, or it could be the result of falling interest rates that prompted borrowers to refinance their Section 203(b) mortgages.

Figure 2 shows that the number of MMIF 15-year-term mortgage originations rose dramatically, from fewer than 30,000 mortgages in each of origination years 1988 through 1991 to 55,163 in 1992 and about 100,000 in 1993, as mortgage interest rates fell to levels not seen since the 1960s.

Figure 3 shows that the number of MMIF ARMs originated jumped from 21,776 mortgages in calendar year 1988 to almost 106,000 in 1992. In contrast with the MMIF fixed-rate mortgages - especially those with a term of 15 years - a relatively small proportion of ARMs were recorded as refinancings.

Figure 4 shows the proportion of 15- and 30-year-term, Section 203(b) fixed-rate mortgages as well as ARMs that were refinancings for origination years 1988 to 1993.

For all three amortization plans, the proportion of loans that were refinancings increased dramatically from 1988 to 1993. The vast majority of 15-year-term loans originated in 1992 and 1993 were refinancings, with a staggering 88.62 percent of the 15-year mortgages originated in 1993 being refinancings.

15-year loans used heavily for refinancing

For each calendar year of origination during this period, the proportion of 15-year-term loans that are refinancings is greater than the proportion of 30-year-term loans that are refinancings. The proportion of 30-year, fixed-rate loans used for refinancing is, in turn, greater than the proportion of ARMs that are refinancings for each calendar year.

Many borrowers select a 15-year term when they refinance in order to take advantage of yet lower interest rates on these shorter-term mortgages and to pay off their mortgage before they retire or their children enter college. We conjecture that most Section 203 (b) ARMs originated in 1992 and 1993 were taken out by first-time homebuyers who were able to qualify for a larger loan with an ARM and its lower interest rate than with a fixed-rate mortgage. The precipitous decline in short-term interest rates during 1992 and 1993 finally made FHA ARMs, with their 1 percent cap on annual interest rate changes, an attractive vehicle for investors.

The interest rate factor

As interest rates decrease, a borrower's economic incentive to refinance a high-interest-rate loan increases. Figure 5 illustrates the dramatic decline in mortgage interest rates that occurred from 1981 to 1993.

Many mortgages originated between 1981 and 1985 were likely refinanced in 1986 and 1987. Other mortgages from the 1981 to 1985 origination years were probably refinanced between 1988 and 1993 because mortgage interest rates in 1993 dropped below 7 percent for the first time since the 1960s.

Figure 6 compares the activity levels of the MMIF 15-year-term mortgages to those of the fixed-rate, 30-year-term mortgages.

While the ratio of 15-year-term mortgages to 30-year, fixed-rate mortgages declined over the years among the nonrefinanced MMIF mortgages, for refinancings the proportion of 15-year-term mortgages increased dramatically, from 9.6 percent in 1988 to 37.2 percent in 1993. This occurred as the annual number of 15-year-term, Section 203 (b) originations neared 100,000 during 1993.

Cumulative claim termination rates

Figures 7 through 9 show the cumulative claim termination rates through December 31, 1993, for MMIF 30-year and 15-year, fixed-rate mortgages and ARMs, as well as the corresponding rates for each of the four types of refinancings.



Proportion of Section 203 (b) Mortgages That Are Refinancings

 Calendar Year of Origination
Type of Mortgage 1988 1989 1990 1991 1992 1993

30-Year Term 3.04% 1.95% 1.86% 11.14% 24.22% 41.18%
15-Year Term 5.70% 5.54% 6.44% 34.18% 76.77% 88.62%
ARM 0.30% 0.28% 0.32% 9.85% 14.08% 17.74%
Average Section 203 (b) Contract Interest Rate

Calendar Year Type of Mortgage
of Origination 30-Year Term Adjustable Rate 15-Year Term
 Fixed Rate Mortgage Fixed Rate

1981 14.17% 14.83%
1982 14.21% 12.01%
1983 12.17% 11.08%
1984 12.87% 12.39% 12.13%
1985 11.88% 9.64% 11.41%
1986 9.79% 8.84% 9.59%
1987 9.35% 8.19% 9.03%
1988 10.11% 8.86% 9.80%
1989 9.94% 9.04% 9.85%
1990 9.76% 8.46% 9.63%
1991 9.27% 7.13% 9.05%
1992 8.40% 6.30% 8.09%
1993 7.79% 5.84% 7.45%
Number of 15-Year Loans Divided By Number of 30-Year
Fixed-Rate Loans

 Calendar Year of Origination
Type of Mortgage 1988 1989 1990 1991 1992 1993

Nonrefinanced 4.98 3.55 3.59 3.94 3.20 3.34
Refinanced 9.59 10.47 13.01 16.31 33.06 37.1
Cumulative Claim Termination Rates For 30-Year Term Mortgages (in
percent) Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992

All Section 203 (b) 6.22 4.33 3.07 1.33 0.18
All Nonrefinancings 6.10 4.30 3.06 1.29 0.18
Nonstreamlined 10.20 5.46 3.53 1.17 0.16
Streamlined Non-RB 33.33 0.00 1.19 1.20 0.35
Streamlined RB MIP 0.00 0.00 0.00 0.00 0.08
Special LTV 8.69 7.57 2.99 2.17 1.02
All Refinancings 10.12 5.73 3.42 1.60 0.17
Cumulative Claim Termination Rates For 15-Year Term Mortgages (in
percent) Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992

All Section 203 (b) 2.53 1.73 1.18 0.44 0.05
All Nonrefinancings 2.55 1.74 1.19 0.57 0.12
Nonstreamlined 2.31 1.60 0.96 0.17 0.04
Streamlined Non-RB 0.00 0.00 0.00 0.16 0.07
Streamlined RB MIP 0.00 0.00 0.00 0.00 0.02
Special LTV 1.56 1.62 1.11 0.38 0.00
All Refinancings 2.22 1.59 0.97 0.18 0.03

Cumulative claim termination rates appear to be higher for refinancings than for other FHA loans. This is particularly true on 30-year MMIF loans. Cumulative claim termination rates on 15-year loans are low.

The higher claim rates for 30-year-term refinancings indicate that such refinancings were used by borrowers already in danger of defaulting, in hopes that a lower monthly payment might ease their difficulty. (This statement applies both to fixed-rate and ARM 30-year loans. However, there were relatively few FHA ARMs originated, particularly from 1988 through 1990.) Perhaps, due to refinancing, fewer mortgages resulted in claims than otherwise would have.

On the other hand, the cumulative claim termination rates are lower on 15-year-term refinancings than on 15-year-term nonrefinancings. This indicates that FHA 15-year-term refinancings were generally employed by financially stable borrowers whose goal was to take advantage of the lower interest rates of the shorter-term loans and/or to pay off their loans more rapidly. In general, the cumulative claim rates of 15-year-term loans are substantially less than those of the corresponding 30-year-term loans.

Cumulative nonclaim termination rates

Figures 10 through 12 show the cumulative nonclaim termination rates through December 31, 1993, for MMIF 30-year- and 15-year-term, fixed-rate mortgages and for ARMs.

Cumulative nonclaim termination rates are dramatically higher for refinancings than for nonrefinancings. Again, the difference is more pronounced for 30-year, fixed-rate loans than for 15-year, fixed-rate loans or for ARMs. Dixon and Herzog in a 1992 unpublished HUD study on "Mortgage Insurance Risk - Investors and Low-Downpayment Loans" showed that mortgages with larger face amounts tend to have higher nonclaim termination rates than do those with smaller face amounts.

15-year originations by FHA field office

Figure 13 summarizes the termination experience of 15-year-term MMIF mortgages originated during calendar year 1988 in the 10 FHA field offices doing the most 15-year-term refinancings. We observe from Figure 13 that during calendar year 1988, the Puerto Rico FHA field office originated 1,953 15-year-term nonrefinancings and refinancings - the most of any FHA field office. These 15-year loan refinancings from Puerto Rico have not produced any claim termination and have had cumulative non-claim termination rates well below the national average. The cumulative claim and nonclaim termination rates on these 15-year mortgages that are nonrefinancings from Puerto Rico also have been well below the national average.

The Phoenix field office accounted for the highest cumulative claim termination rate for the 1988 15-year originations, while Salt Lake City had the highest cumulative nonclaim rate and the lowest mortgage survival rate as of December 31, 1993.

30-year 1988 originations by field office

Figure 14 summarizes the termination experience of 30-year, fixed-rate mortgages originated during 1988 for the 10 FHA field offices with the largest number of refinancings.

The Denver and Phoenix field offices dominate the 30-year-term refinancing activity for the 1988 origination year.

The cumulative claim termination rates on refinancings tend to be higher than those on nonrefinancings in weak real estate markets but lower in strong markets. For example, for 1988 originations, the cumulative claim termination rate on refinancings in the weak San Antonio market was 26.51 percent, which was more than twice the rate of 11.90 percent on nonrefinancings. By contrast, the cumulative claim termination rate on refinancings in the strong District of Columbia market was only 1.06 percent compared with 3.22 percent on nonrefinancings. Thus, it appears that in weak markets, many borrowers may be employing the FHA streamlined refinancing program in a desperate attempt to avoid foreclosure by reducing their monthly mortgage payments. For some, this strategy is successful; for many others it is not.

A more rigorous test of the theories discussed earlier regarding what motivates borrower re financing strategies was undertaken using some statistical measures of association. In particular, we examined the relationships between the cumulative claim rates by FHA field office on 30-year-term refinancings originated during 1988 and the cumulative claim rates on all 30-year mortgages within the field office originated in prior years. These calculations were carried out for the 25 FHA field offices that had originated at least 200 refinancings during calendar year 1988. We found the cumulative claim rates on 19851987 originations to be excellent predictors of the cumulative claim rates on 1988 originations. Similarly, we found the cumulative claim rates on 1985 originations to be excellent predictors of the cumulative claim rates on 1989 originations.

The cumulative nonclaim termination rates vary widely among offices. For example, on the 1988 originations, offices such as Dallas, Fort Worth and San Antonio, all part of the hard-hit Texas market of that time, had relatively low nonclaim termination rates compared with the offices in more-prosperous markets such as Minneapolis, Santa Ana or the District of Columbia. (In fact, we found that there was a strong negative correlation between the cumulative claim rates and the cumulative non-claim rates through December 31, 1993 for the 10 field offices listed in Figure 14.)

This finding arises from the fact that borrowers whose property values have increased sufficiently are able to refinance their mortgages without paying any mortgage insurance premiums (whether it be FHA, VA or private mortgage insurance). This extra savings at closing provides additional incentive for borrowers in strong real estate markets to refinance, but the same incentive is notably absent from weak housing markets. In fact, there is a disincentive at work that often requires borrowers seeking to refinance in depreciating markets to put more money down to get their LTV to an acceptable level to close the loan on top of paying mortgage insurance.

1993 originations

The field office data shown in Figure 15 on 30-year, fixed-rate mortgages originated during 1993 suggests what has been confirmed by the Salt Lake City FHA field office. That office's experience confirmed that some lenders are much more aggressive in convincing borrowers to refinance their loans. For the market served by the Salt Lake City FHA office, 11.48 percent of the 30-year-term, fixed-rate refinancings originated during calendar year 1993 had resulted in nonclaim terminations prior to the end of 1993. This was almost four times the corresponding rate of 3.15 percent for the entire country.

As with the nonclaim termination rates, the survival rates (i.e., the proportion of originations still outstanding on December 31, 1993) vary widely by FHA field office. For example, the Salt Lake City FHA office had less than 30 percent of its calendar year 1988 originations outstanding on December 31, 1993, compared with 63.5 percent for San Antonio. The low survivor rates on originations out of the Salt Lake City region were due to the success of aggressive local Salt Lake City lenders in convincing borrowers to refinance their MMIF mortgages with FHA.

(For reasons of space, the performance data corresponding to Figure 13 for 15-year-term loans originated during 1989-1993 and corresponding to Figure 14 for 30-year-term loans originated during 1989-1992 is excluded from this article. However, it is available from the authors upon request.)

In summary, this analysis has clearly demonstrated what is already well known to mortgage lenders, that as mortgage interest rates decrease the number of refinancings increases. In addition, this particular FHA data documents the dramatic increase in refinancings that began in 1991 and continued through 1993.

The data examined in this article also indicates that borrowers experiencing difficulty making monthly payments will likely refinance as interest rates decrease in order to lower their monthly payments. This effort may prevent an insurance claim in some cases. However, refinancings do not always help borrowers avert a default, thus becoming an insurance claim. This latter scenario helps to explain the higher claim rates found on FHA refinancings compared with nonrefinancings.

In reviewing FHA originations from 1988 through 1993, the data shows that some borrowers refinance a 30-year-term mortgage into a 15-year-term mortgage to take advantage of even lower interest rates. The pre-payment experience on these loans shows that such borrowers are less likely to be experiencing financial difficulty, thus explaining the lower claim rates observed on 15-year-term FHA refinancings for these origination years.

The findings examined in this article will shed more light, it is hoped, on the prepayment patterns associated with various types of FHA mortgages. This kind of knowledge should help those trying to realistically price servicing in today's active servicing sales market. It may also provide lenders with valuable insights regarding production strategies that will produce the type of servicing that retains its value for an optimal length of time.
Cumulative Claim Termination Rates For ARMs (in percent)
Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992

All Section 203 (b) 6.54 5.11 1.92 0.70 0.15
All Nonrefinancings 6.54 5.07 1.91 0.66 0.15
Nonstreamlined 9.09 0.00 8.33 0.48 0.14
Streamlined Non-RB 0.00 0.00 0.00 0.26 0.55
Streamlined RB MIP 0.00 0.00 0.00 0.00 0.07
Special LTV 0.00 60.00 0.00 1.47 0.91
All Refinancings 7.69 18.75 7.69 1.11 0.19
Cumulative Nonclaim Rates For 30-Year Fixed-Rate Mortgages (in
percent) Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992 1993

All Section 203 (b) 45.03 43.83 42.67 30.95 10.55 1.78
All Nonrefinancings 44.51 43.39 42.22 26.69 7.22 0.83
Nonstreamlined 62.44 68.19 68.67 50.92 10.62 1.70
Streamlined Non-RB 44.44 68.00 50.00 55.63 36.08 4.91
Streamlined RB MIP 0.00 00.00 00.00 33.33 19.20 3.02
Special LTV 49.19 52.13 55.48 24.52 9.35 50.00
All Refinancings 61.65 66.09 66.35 41.07 20.98 3.15
Cumulative Nonclaim Termination Rates For 15-Year Term Mortgages
(in percent) Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992 1993

All Section 203 (b) 38.60 38.57 36.62 25.65 8.15 1.22
All Nonrefinancings 37.94 38.12 35.85 23.71 5.78 0.65
Nonstreamlined 50.14 46.52 48.76 30.21 7.66 0.75
Streamlined Non-RB 0.00 14.29 37.50 32.19 15.22 1.83
Streamlined RB MIP 0.00 0.00 0.00 50.00 7.38 1.34
Special LTV 44.79 45.95 44.65 11.97 9.16 25.00
All Refinancings 49.47 46.26 47.87 29.39 8.87 1.30
Cumulative Nonclaim Rates For ARMs (in percent)
Experience Through December 31, 1993

 Calendar Year of Origination
 1988 1989 1990 1991 1992 1993

All Section 203 (b) 33.73 31.14 17.21 8.08 3.96 0.72
All Nonrefinancings 33.76 31.16 17.16 7.81 3.19 0.52
Nonstreamlined 18.18 36.36 33.33 14.60 6.49 1.29
Streamlined Non-RB 0.00 0.00 0.00 26.29 24.05 2.00
Streamlined RB MIP 0.00 0.00 0.00 0.00 6.76 1.73
Special LTV 50.00 0.00 0.00 6.57 5.61 16.67
All Refinancings 23.08 25.00 30.77 10.55 8.71 1.67




Thomas N. Herzog, Ph.D., A.S.A., is director of the statistical and actuarial analysis staff at the Office of Housing, U.S. Department of Housing and Urban Development, Washington, D.C. James E. Laverty, A.S.A., is an actuary on the statistical and actuarial analysis staff at the Office of Housing, U.S. Department of Housing and Urban Development, Washington, D.C.
COPYRIGHT 1995 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1995 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Cover Report: Servicing; Federal Housing Administration
Author:Herzog, Thomas N.; Laverty, James E.
Publication:Mortgage Banking
Date:Feb 1, 1995
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