Subprime Alternative: FHA Reform Deal Close

Lawmakers say they're optimistic that they'll be able to send a bill to President Bush for his signature by April.
3/10/2008

NEW YORK (CNNMoney.com) -- By early April, both chambers of Congress are likely to tie the bow on a bill that would expand the reach of the Federal Housing Administration (FHA), which aims to provide safe loan alternatives to subprime mortgages and make homeownership more accessible.

Different versions of the FHA modernization bill passed in the House and the Senate last year, and both Senate Banking Committee Chairman Christopher Dodd (D-Conn.) and House Financial Services Chairman Barney Frank (D-Mass.) said last week that the differences between the chambers could be resolved in short order.

"I think we are fairly close to having an FHA reform bill that we will be able to adopt very quickly," said Dodd on the Senate floor last week.

The FHA program is intended for mortgage borrowers with weak credit or little or no cash who may not be able to get an affordable mortgage elsewhere.

Borrowers get FHA loans from a private lender just as they would any other mortgage. But they pay a small premium to the FHA every month.

The FHA, in turn, uses those premiums to cover the lender in the event of foreclosure and requires lenders to pursue viable ways to help borrowers avoid foreclosure if they become delinquent. That gives borrowers a better chance of keeping their homes should they fall on hard times. If a lender does have to foreclose, the FHA will pay the lender the unpaid principal on the loan, foregone interest and a portion of the foreclosure costs.

FHA loans typically have better rates than other subprime mortgages and don't carry prepayment penalties.

And since most FHA mortgages are 30-year fixed rate loans, the lender won't make the loan unless he has proof the borrower will be able to make the monthly payments. One of the reasons for the subprime mess is that lenders didn't require proof that borrowers could make their payments or only required that they could make the payments at the low initial rate of an adjustable-rate mortgage (ARM).

Taxpayer dollars don't directly support the FHA loan insurance program - the premiums paid by homeowners with FHA loans do. But taxpayers could end up footing the bill if too many FHA loans go south.

Lawmakers have been working on legislation to reform the FHA to modernize its standards so that they reflect changes to the housing market in the past 30 years. Among the changes on tap, lawmakers will:

• Permanently raise loan limits. The economic stimulus bill passed in February temporarily increased the limit on loans eligible to be FHA-insured. The ceiling until Dec. 31,2008 is now $729,750, up from the normal $362,790 for single-family homes. Those are the ceilings for high-cost areas. The ceiling is lower in low-cost housing markets.

• Reduce down payment requirements. Homeowners would no longer be required to have 3% equity or the cash equivalent to get an FHA-insured loan. The House bill would allow borrowers to get an FHA-insured loan with 0% down if they can show they can afford the mortgage payments. The Senate bill requires 1.5%.

• Make it easier for borrowers in high-cost loans to refinance. The House bill would let some homeowners in default or at risk of default refinance into an FHA-insured loan.

The changes to the FHA are intended modernize the loan program, which, like a lot of low- and middle-income people, had essentially been priced out of many housing markets. In 2005, there were roughly 5,000 FHA loans made, down from 109,000 in 2000.

"There's been a desire to push FHA in the market and make it a much more viable product, especially in high-cost markets," said Janis Bowdler, a senior housing policy analyst of National Council of La Raza, a Latino civil rights and advocacy group.

While FHA loans are intended to help low- and moderate-income families who may not have any other loan options available, anyone can get an FHA-insured loan if they meet the eligibility requirements. But for those who are capable of putting down 20% on a home and have very good credit, they might find they get a better deal going with another type of mortgage product for which they don't have to pay insurance premiums, Bowdler said.

FHA modernization is a welcome move by politicians and community advocates alike. But Dodd, Bowdler and others caution that reform is not the last word on easing the strains from the subprime crisis.

Said Bowdler, "My concern is that this will be seen as a panacea to the current foreclosure crisis. It's really not. It's one good tool going forward."

By Jeanne Sahadi, CNNMoney.com senior writer
First Published: March 10, 2008: 12:45 PM EDT

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