Substantial FHA Reform Before Congress

When the U.S. Senate reconvenes this week, mortgage lenders will be anticipating the most significant overhaul of Federal Housing Administration (FHA) lending in years.

Once one of the most important programs for credit-impaired and moderate-income borrowers, FHA has seen its market share dwindle from over 10% in the mid-1990s to about 3% due to aggressive subprime lenders with increasingly innovative loan products. A proposal before Congress could end that slide and make FHA competitive again. Indy mac

The House has already approved a bill (H.R.5121) authorizing FHA to use risk-based pricing, allow no- and low-down-payment loans, and increase its maximum loan amounts in high-cost areas.

While FHA has continued to charge all borrowers the same mortgage insurance premium, regardless of credit scores or down payment amounts, subprime lenders have used risk-based pricing to cherry-pick higher-quality borrowers. The resulting adverse selection has left FHA with lower-quality loans.

By using risk-based pricing, FHA could charge higher-risk borrowers a higher mortgage insurance premium, up to 3% upfront, compared to the current standard of 1.5%. Low-risk borrowers would be charged less.

A companion bill (S.3535) now sits before the Senate housing committee – specifically, the subcommittee chaired by Sen. Wayne Allard, R-Colo. The bad news for reformers is that Allard is seen as skeptical of government involvement in mortgage lending and friendly to private mortgage insurance companies, who may oppose FHA reform.

Allard has said he wants a government study of the reform proposals, says Erick Gustafson, vice president of government affairs for the Mortgage Bankers Association (MBA). ‘He's probably not the foremost advocate of FHA reform, but he's not been an obvious opponent.’

At a subcommittee hearing, Allard said, ‘I want to be absolutely clear that I do not oppose FHA reform. I simply want to be certain that the reform is done right. While I believe that FHA is in need of reform, we must first ensure that FHA is on solid financial footing and has the capacity to implement and manage any changes.’

The good news is that that there's another road to reform: through an appropriations bill. That road is more likely, Gustafson explains, pointing out that Congress needs an appropriations measure.

‘There's always two ways of doing something on Capitol Hill,’ he notes.

Reform chances

The Senate is scheduled to be in session only until Sept. 29. ‘That's certainly not a lot of time, but there will be a lame duck session after the election, and they need an appropriations bill,’ he says. ‘There's better than a 50-50 chance of some reform.’

Private mortgage insurance companies are concerned about risk-based pricing, but Gustafson says he sees middle ground. Instead of taking away business from mortgage insurance firms, reform would create new homeowners, especially in minority communities, he says.

Before the House approved H.R.5121, it included FHA reform in its appropriations bill, so it has effectively passed FHA reform twice. Plus, the overwhelming approval of the House bill – passed by a vote of 415-7 – helped boost chances of FHA reform by providing ‘an obvious statement’ of the representatives' stance, Gustafson points out.

The House bill would open FHA originations to brokers by allowing them to post surety bonds instead of submitting costly financial audits. But that language is not in the house appropriations bill, the version most likely to pass, Gustafson says. Some MBA members, concerned the change could open the door to lower-quality originators and weaken consumer protections, have reservations about that language, he adds.

While the bill before Allard's committee hasn't seen action, the Senate has already included limited reform in an appropriations bill. At this point, changes touch only reverse mortgages.

‘There are pretty sizeable differences between the House and Senate versions,’ Gustafson says.

Major supporters

Mortgage lenders have been major supporters of FHA reform. Part of the difficulty of lobbying for change is that lenders have become less concerned because its market share is now small. But MBA research indicates that lenders would use FHA if it was reformed.

Lenders see the lack of a zero-down-payment loan product as a major reason for the FHA's decline, according to an MBA study, ‘Lender Perspectives on FHA's Declining Market Share.’

‘Lenders see value in FHA, but there are barriers that FHA needs to overcome to allow it to provide additional options for borrowers and to be more user-friendly for lenders,’ says Doug Duncan, the MBA's chief economist and senior vice president of research and business development. Key findings from the study include:

� Over two-thirds of lenders surveyed believe that FHA's lack of product offerings was a major factor underlying its declining market share.

â�¢ Almost 70% of lenders report that the addition of a zero-down-payment product to FHA's product line would result in a ‘significant’ or ‘major’ increase in the number of FHA loans that they originate. Indy mac

â�¢ One-third of lenders believe that an expanded product line would lead to a ‘significant’ or ”major’ increase in their FHA volume.

� Forty-six percent of lenders believe that a stronger cash-out refinance program would make FHA programs significantly more competitive, particularly in the current interest rate environment.

� Sixty-two percent of lenders identified the closing and post-closing process of FHA loans as a significant or major contributor to higher origination costs of FHA loans.

The study was commissioned by the Research Institute for Housing America, a 501(c)(3) trust fund of the MBA, and conducted by Bernadette Kogler, Ann Schnare and Tim Willis of the Hollister Group. Sixty-one lending institutions of varying size and with varying degrees of experience with FHA participated in the study.


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