Analysis of FHA Single-Family Default and Loss Rates

This analysis of FHA-insured loans from 1992, 1994, and 1996 examines the factors that influence both default probabilities and dollar loss rates, and considers whether minorities would fare better with a scorecard based, in part, on dollar losses. Previous studies of mortgage risk in the conventional and FHA sectors have focused on default behavior and the factors that lead to default. Recent extensions on FHA mortgage scoring have also focused solely on the default probability as a metric for risk. Little attention is given to other dimensions of loss and to the dollar value of losses in particular. Thus, little is known about dollar loss and its determinants. This focus on default in the mortgage-scoring context means that observable factors affecting the likelihood of default assume a primary role. Since minorities tend to have less attractive distributions of factors leading to default, mortgage-scoring systems tend to give minorities less favorable scores than nonminorities. Some observers, understandably concerned by this racial discrepancy in scoring outcomes, have suggested that minorities generate smaller dollar losses on average when they default, and thus a mortgage-scoring system relying on dollar losses rather than default alone might improve minorities’ lot. A mortgage-scoring system that recognizes both the probability of default and the dollar losses attendant upon default would provide a more complete, and thus superior, measure of risk that could be used for policy decisions as well as for underwriting.