- Key insight: The Federal Housing Finance Authority should use its influence to build longer-term climate risk assessments into loans.
- What’s at stake: Escalating flood and wildfire risks are already pushing up insurance costs and, in some areas, putting downward pressure on home values.
- Forward look: At a minimum, the GSEs should incorporate forward-looking insurance costs more explicitly into underwriting.
A recent op-ed in American Banker by a former colleague at the Federal Housing Finance Agency (
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Since the aftermath of the great financial crisis, most mortgage lending in the United States operates on an originate-to-distribute model. Banks and nonbank lenders largely follow the underwriting and pricing standards set by Fannie Mae, Freddie Mac, the Federal Housing Administration and the Department of Veterans Affairs. The FHFA, as conservator of the GSEs that guarantee over $7 trillion in mortgages and as the best-resourced government entity, sits at the center of this system. Climate risk is not being incorporated today because the system’s standard setters have not yet acted.
The core issue is a mismatch in time horizons. Government-backed mortgages are typically guaranteed or insured for 30 years. Property insurers, by contrast, write one-year contracts that are often repriced or withdrawn at renewal. As insurers respond to
Addressing this mismatch should be a central priority for the FHFA and the federal housing system. One approach is to better align property insurance and mortgage horizons. Moving immediately to 30-year insurance contracts is unlikely, but the system could begin by encouraging longer-term or guaranteed-renewability insurance products, for example, five-year policies or contracts with capped annual increases. These products will be more expensive upfront, but they would provide a more accurate signal of long-term affordability than today’s one-year “teaser” premiums. Actual dollar costs will be more tangible to borrowers and underwriters than any disclosure form.
At a minimum, the GSEs should incorporate forward-looking insurance costs more explicitly into underwriting. Mortgage qualification already depends on payment-to-income ratios that include insurance. Ensuring that these ratios reflect realistic future insurance costs, not just current premiums, would improve risk assessment without requiring lenders to build their own climate models.
The GSEs are also well positioned to coordinate with insurers on resilience and mitigation. Homeowners lack clear information about how specific investments, for example, elevating a home, translate into insurance savings. A standardized framework, supported by the GSEs, could make these trade-offs transparent and allow pricing to reflect measurable risk reduction.
Expecting individual lenders to solve these problems is unrealistic. First, lenders that attempt to incorporate granular geographic risk into pricing face significant fair lending constraints, particularly for loans that are sold into the secondary market. When lenders do not retain long-term credit risk, it is difficult to justify differential pricing as a business necessity. Second, most lenders lack the scale and data to develop credible climate risk models. Third, no individual lender has sufficient market power to influence insurance contract structures.
The U.S. mortgage market already relies on centralized standards set by federal actors. Climate risk will be addressed through those standards — either proactively or after an expensive taxpayer bailout. If policymakers are concerned about rising taxpayer exposure and the long-term stability of housing finance, the place to start is not with individual lenders, but with the institutions that define the rules of the system.