One major consequence of the sub-prime mortgage implosion is the difficulty many consumers with limited or impaired credit will have in obtaining mortgages.
But if suddenly tougher lending standards result in slamming doors at banks and mortgage companies, the venerable Federal Housing Administration loan might look much more inviting.
The long-established FHA loan has always been designed to help the first-time buyer purchase a home of their own. However, it fell out of favor in recent years as its natural constituency was attracted to the exotic mortgages offered by sub-prime lenders.
As a result, many consumers ended up with loans -- and houses -- they really couldnt afford.
At the urging of some in Congress, the U.S. Department of Housing and Urban Development is looking at modernizing the FHA loan to give consumers, who in the past would have obtained sub-prime mortgages, a better alternative.
Assistant Secretary for Housing Brian Montgomery urged a Senate Appropriations Subcommittee last week to pass legislation that enhances the FHA's government-insured mortgage products and "provides lower-income families safe, secure homeownership opportunities."
"Many first-time and minority homebuyers face significant challenges when trying to purchase a home. In recent years, such difficulties have resulted in many of these individuals assuming risky, adjustable-rate, sub-prime loans. The impact on African American and Latino borrowers has been particularly profound," Montgomery said.
According to 2004 HMDA (Home Mortgage Disclosure Act) Data, 40 percent of African-Americans and 23 percent of Hispanics pay an interest rate three percent higher than the market rate. The Center for Responsible Lending reports that 51 percent of refinancing transitions in African American neighborhoods are sub-prime loans.
"There needs to be a mortgage alternative which will qualify a wide swath of borrowers and simultaneously provide them with the loan options they require. Everyone should have access to a safe, affordable mortgage product; and this should not change just because that person is a first-time homebuyer, a minority homebuyer, or a homebuyer with troubled credit history," Montgomery added.
FHA was created in 1934 to stimulate the housing market during the Depression. Over its long history it has financed more than 34 million homes. But as lending practices have evolved and modernized, critics have charged the FHA has been slow to adapt, and reforms are necessary to adapt the program to today's marketplace.
Specifically, critics would like to see changes that reflect the recent escalation of home values, allowing home-buyers to make smaller down payments and take out larger loans, as long as they can qualify. Currently there are limits on the sizes of FHA mortgages.
Rep. Barney Frank (D-MA) would like to see additional changes. He introduced legislation in 2006 to allow FHA greater leeway in financing manufactured homes, which are more affordable than conventionally build houses.
These proposed changes, however, buck a significant trend. Banking regulators are busy tightening rules on sub-prime lending, virtually doing away with nothing-down, interest only loans that were in vogue as little as a year ago. Currently, FHA rules require the homeowner to put at least three percent down, and loans are limited to roughly $363,000.
But unlike sub-prime loans, FHA mortgages are not traded on Wall Street and subject to market panic attacks.
Instead, they are backed by U.S. Government bonds. But because they are administered by a government agency, they can be slow, cumbersome and bureaucratic. As a result, FHA loans fell out of favor with many realtors, who heavily influence where their clients turn for financing.
While not falling into the same sinkhole as the sub-prime lending industry, FHA is trying to become more flexible and consumer friendly. Its proposed modernization plan would create a new, risk-based insurance premium structure that would match the premium amount with the credit profile of the borrower. It would replace the current structure, in which there is standard premium amount for all borrowers.
As a result of excesses within the sub-prime mortgage industry, it will likely be harder for consumers of modest means to purchase a home. But the FHA says, with some retooling, it could provide a safe alternative for many of these would-be homebuyers.
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