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Mortgage Market Woes: Federal Housing Administration Hopes

This year has been a year of ups and downs for the housing market. In our continuing series, we chronicle news affecting the housing market and its major players.

For months we’ve heard about the subprime market collapse, and the increasing effects in the mortgage market and the greater economy. We’ve heard about how more and more borrowers are having their dream of homeownership ripped away when foreclosure rears its ugly head. Lately, we’ve learned about an increasing credit crunch, where banks and other lenders have become leery of extending funds.

So what does this mean for a large number of Americans still looking to own a home, but with less than ideal credit histories?

The subprime market was developed specifically for this group, borrowers keen on building equity and owning a home but with a history of mistakes or insecure finances. Many of these borrowers looked to subprime loans as a way of correcting their credit, and providing a better future for themselves and their families. Unfortunately, subprime mortgages were unstable at best, predatory at worst, resulting in massive defaults and the infamous and ongoing subprime collapse. Now, subprime credit has been yanked by most lenders or otherwise dried up.

To keep options open for this group of potential borrowers, mortgage lenders are urging Congress to revamp the Federal Housing Administration (FHA) single-family loan program. Many lenders see the program as a way to provide safe and affordable financing for first-time buyers, and even a rescue rope for current subprime borrowers nearing trouble. Last week, almost 90 of these lenders pushed for FHA reform legislation.

The push for FHA reform has been led by the Department of Housing and Urban Development (of which the FHA is part) and the Bush administration for several years. Congressmen and women have been seeking reform legislation in various methods, and one bill, sponsored by House Financial Services Committee chair Barney Frank, is up for vote in September.

The FHA is a mortgage insurance program that provides single- and multifamily housing for low and moderate-income families. Established in 1934, the FHA was designed to provide liquidity and stability to the housing finance system, expanding homeownership and broadening availability of mortgages. The FHA was designed to give first-time homebuyers opportunities for mortgages for which they would otherwise not qualify.

Under the current system, FHA-insured mortgage loans require only a 3% down payment, have more relaxed credit standards and permit borrowers to carry more debt than typically allowed by private mortgage insurers. Approximately 7.3% of all homebuyers receive FHA loans annually. About 80% of single-family purchase loans go to first-time buyers and 37.2% to minorities.

Proposed reform measures vary, but often include eliminating the down payment requirement, giving flexibility to set insurance premiums commensurate with loan risk, increasing mortgage loan limits, and extending the mortgage payback to 40 years from the current 30.

Many industry players and reform backers say that a greater FHA presence in the mortgage market could have prevented recent market woes, and can offer simple solutions. Modernizing the FHA and increasing mortgages through the agency could provide stability in the market.

Opponents say that FHA loans are basically dressed-up subprime loans, with the same amounts of predatory components that mean high delinquency and foreclosures. Recent statistics point to some truth in this: In the first quarter, FHA loans had a 12.1% delinquency rate, and subprime loans had a 13.8% delinquency rate. However, FHA's foreclosure rate is 2.2%, compared to the 5.1% foreclosure rate on subprime loans.

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