March 23, 2007 / 2:47 PM / 12 years ago

Subprime woes raise odds for FHA reform

WASHINGTON (Reuters) - One of the surprising winners in the fallout from the problems in U.S. subprime mortgage market could be the 72-year-old grandfather of government-backed mortgage finance.

Edna Tapia, her son Brian Cortez, 2, and daughter Edpa Cortez, 9, watch TV in their basement apartment in Addison, Illinois, March 21, 2007. Edna's husband Jose Cortez received a subprime loan on a home which may be subject to foreclosure, due to that, his family has moved back into his aunt's basement. REUTERS/John Gress

The Federal Housing Administration, a depression-era program that insures low-income home buyers, has for years lost business to private lenders catering to borrowers with damaged credit.

Between 1996 and the end of last year, the FHA’s share of new mortgages slipped from 9.1 percent to just 1.8 percent, according to the industry publication Inside Mortgage Finance.

Subprime lenders came to dominate the market for borrowers with damaged credit in those years, but a recent wave of mortgage delinquencies has raised concerns about subprime lending and increased calls for reform of the FHA.

The reform package would, in part, relax requirements for down payments and loosen loan limits, which are now pegged at 95 percent of the median home value in a local area.

By insuring loans on low-cost homes, the FHA helps borrowers get more affordable mortgage payments. Subprime lenders, on the other hand, charge higher rates for their loans.

The Department of Housing and Urban Development, which administers FHA, has become a leading reform proponent.

“Given recent concerns (about subprime loans), I think families need to know that there is a safe mortgage option that they can use,” HUD Secretary Alphonso Jackson said in an interview with Reuters.

Jackson said many borrowers have been “hijacked” by subprime loans and could be “saved if we move very quickly to get the FHA modernization legislation passed.”

Subprime lenders took business from the FHA by offering relaxed underwriting standards and quick approval, many brokers said.

Until recently, the FHA required a bulging “case binder” of home inspection and borrower paperwork before it would guarantee a loan.

For nearly two years, FHA Administrator Brian Montgomery has cut red tape tying up the $400 billion in mortgages insured by the FHA. New legislation would also raise the loan limit and allow nearly 100 percent financing.

Those steps would push more capital into underserved markets and help the FHA battle subprime lenders, said A.W. Pickel, a mortgage broker from Overland Park, Kansas.

“Quite frankly, in the cities, FHA loan limits are simply not high enough,” Pickel said. “Subprime loans have no limit. People can get as expensive a house as they want.”

A legislative reform bid failed late last year, but the unfolding subprime crisis “answers the argument” as to why reform is needed now, said Barney Frank, chairman of the House of Representatives’ Financial Services Committee.

Some lawmakers wanted to raise fees on all FHA borrowers to build a cushion against possible losses. Frank said he would rather raise fees on wealthier homeowners, and effectively subsidize less-affluent and riskier borrowers.

“What we have found is a way for the FHA to make money and recycle it,” Frank told Reuters in an interview.

Measures to help the venerable federal program make money are desperately needed.

According to a federal study, the FHA will run into deficit by 2008 if the system is not reformed. So far, the program has generated more revenue than it has cost, according to HUD.

Large banks have pushed FHA reform because it promises a federal backstop to the subprime loans they avoided during the housing boom.

Jose Cortez and his son Brian, 2, watch TV in a basement apartment in Addison, Illinois, March 21, 2007. Cortez received a subprime loan on a home which may be subject to foreclosure, due to that, he has moved back into his aunt's basement. REUTERS/John Gress

Effective reform could lead to the FHA reclaiming market share, but Allen Jones, Bank of America’s (BAC.N) chief of government mortgage lending, said: “I don’t think it will ever get back to double digits.”

According to Jones, at most, the FHA could hit 8.0 percent of the mortgage market, which is roughly the share of creditworthy borrowers shut out of the best mortgage terms.

“FHA is not there for what the private market can serve, but for some first-time homebuyers, minorities and the credit-impaired,” Jones said.

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