Senate votes to expand mortgage program

WASHINGTON (Reuters) - The Senate on Friday overwhelmingly passed legislation to expand the nation's largest federal homeownership program in a move that could help struggling subprime borrowers avoid foreclosure.

The bill, which passed on a 93-1 vote, would loosen underwriting standards and raise the size of loans that may be insured by the Federal Housing Administration.

The FHA has said the changes should enable it to help 200,000 troubled borrowers save their homes.

The House of Representatives had already passed its own version of FHA reform. Now, a compromise between the two bills needs to be hammered out before a final vote in each chamber puts it before U.S. President George W. Bush to sign into law.

Separately, the Senate approved a bill to give tax relief to consumers who restructure their home loans to avoid foreclosure or who have lost their homes to foreclosure.

When a lender forgives or cancels a mortgage, under current law the financial relief is treated as income and the homeowner has to pay taxes on it.

"As these families struggle to reduce their home loan debt, they're hit by taxes due to debt forgiveness from the lender. It's right to offer them tax relief," said Sen. Charles Grassley.

The House approved the plan in October, but the Senate modified that bill to end the financial relief after three years. The altered measure now goes back to the House for approval.

During a five-year housing boom that ended in 2005, many borrowers turned to the easy terms and quick credit of subprime mortgages that have a built-in interest-rate spike. Many of these borrowers risk losing their homes as rates reset.

Supporters of the reform legislation say many of those distressed borrowers could save their homes if they are shepherded into fixed-rate FHA loans.

Alphonso Jackson, secretary of the U.S. Department of Housing and Urban Development, said the FHA could provide many homeowners with "a fairer, more affordable and more sustainable alternative to costly subprime loans."

More than 1.8 million borrowers are set to see their mortgage costs spike before the end of 2008. Mounting defaults have already led to a tightening of credit worldwide that some analysts fear could push the U.S. economy into recession.

Many of these troubled borrowers cannot benefit from the FHA program currently because their homes are valued higher than the current FHA loan limit of $362,000. The cap means FHA loans help very few borrowers in states like California that have high property values.

"Raising the loan limit cannot only help current homeowners refinance into a fixed-rate loan but it could jump-start the housing industry in California," said Dustin Hobbs, a spokesman for the California Mortgage Bankers Association.

The bill passed by the Senate would raise the current loan limit from $362,000 to at least $417,000, which is the same cap on loans that binds mortgage finance companies Fannie Mae and Freddie Mac. The House bill would lift it as high as $829,750 in some areas.

One question that could make a compromise difficult to reach is whether FHA should contribute to a new housing trust fund that would be established if provisions of the House bill hold. The Senate legislation has no such provision.

The FHA is a Depression-era program conceived in 1934 that was designed to insure the mortgage payments of low-income borrowers who might have trouble winning a loan.

(Reporting by Patrick Rucker; Editing by Diane Craft)