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Only the First Step: FHA Reform by Congress is Not Enough
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Only the First Step: FHA Reform by Congress is Not Enough

Home foreclosure crisis requires more than reforms at the Federal Housing Administration, writes Tim Westrich, even though that’s a positive first step.

The Senate will soon take up legislation that would give low- and moderate-income homeowners who are struggling with their mortgage payments some much needed relief—with the potential of being signed into law before the year’s end. Many families are dealing with adjustable-rate mortgages, and will likely face higher monthly payments when their rates reset over the next two years. These resets have the potential to drive even more homeowners into default and eventually into foreclosure in a very short period of time.

The Federal Housing Administration Modernization Act of 2007 would give the FHA more flexibility to insure mortgages for higher-risk borrowers and step up its role in solving the mortgage meltdown. And a valuable amendment added by Sen. Jack Reed (D-RI) will provide struggling borrowers with financial counseling to help them refinance if it’s included in the final draft of the bill.

Help for homeowners couldn’t come sooner. But while the bill and especially the Reed amendment are useful first steps, we can—and should—do much more to reduce the fallout from the subprime mortgage crisis and help preserve neighborhoods, communities, and the limited wealth of low- and moderate-income families.

The amendment added by Sen. Reed is essential to making the legislation more effective. Added during committee-level deliberations, the amendment would expand the U.S. Department of Housing and Urban Development’s (HUD) post-purchase counseling program to any low- or moderate-income borrower who seeks it. Through expanded counseling, more families will be able to get the advice and assistance needed to stay in their homes. This critical provision will greatly assist homeowners as they navigate through the tricky transaction of a loan workout or refinance. The Reed bill also provides an additional $25 million for technology and program staffing for the FHA mortgage insurance programs.

Given that lenders modify only about 1 percent of delinquent loans, troubled borrowers’ access to knowledgeable and experienced advocates is critical.

President Bush and lawmakers on both sides of the aisle tout FHA reform as the remedy for families with subprime loans that are in default and nearing foreclosure. FHA-insured lending was once a powerful countercyclical market stabilizer, but as the market expanded in recent years and lenders got savvier at serving lower income borrowers, the program became increasingly irrelevant. This bill could potentially breathe new life into what once was a useful program for assisting the market in serving lower income borrowers, at precisely the time that lower income borrowers need it most.

The House of Representatives recently approved similar legislation in a resounding 348-to-72 vote. And while there are differences between the House and Senate bills, both would allow the FHA to reach a broader segment of borrowers by raising the loan limits for insurance eligibility under FHA, and by reducing the down payments home buyers must pay. The former provision makes FHA-insured loans a viable option for struggling homeowners in high-cost metropolitan areas, while the latter may help those who have lost equity in their homes due to falling property values, with the FHA underwriting standards for refinancing established at the same levels as for new borrowers.

This is a step in the right direction, but it does not go far enough to prevent a nation-wide foreclosure crisis from becoming an economy-wide slump. According to the Center for Responsible Lending, 2.2 million borrowers will lose their homes or have lost them already due to mortgages made from 1998 through 2006. FHA reform could go a long way in providing some relief, but the U.S. Department of Housing and Urban Development itself estimates that FHA reform can refinance only 240,000 homeowners in 2008. Even if it continues at a rate of 240,000 refinances per year, it will fall well short of the 2.2 million homeowners that will need foreclosure assistance in the next couple of years. While this legislation is certainly laudable—especially the increased opportunities for counseling—it ought to be one part of a package of solutions.

Most notably, even under an expanded FHA, the borrowers who need the most help may still not be deemed creditworthy for refinancing. Neither the regulatory changes made to date nor the current bills before Congress address the growing problem of borrowers—many of whom still have good credit—who cannot refinance because their homes are now worth less than their mortgage balances.

A more proactive standard is also needed to deter homeowners unable to afford risky adjustable rate mortgages from ever applying for them in the first place. Similarly, establishing a lender or brokers’ fiduciary responsibility to the borrower would help ensure borrowers would get the most favorable loan terms they qualify for, rather than a loan with the highest profit to the lender or broker.

The dramatic increase in home foreclosures poses a risk not just to individual homeowners but also to their neighbors and to the economy at large. Active efforts to help struggling homeowners are needed now. Several proposals now exist to mitigate this threat to the wider economy, both proactive strategies and remedial strategies, among them:

Other steps included in Sen. Reed’s bill, S. 1386, which would create Homeownership Protection Centers to serve as a one-stop resource for families seeking counseling and foreclosure assistance. It would also provide funding for these centers and would improve federal recordkeeping on defaults and foreclosures.

A national mortgage foreclosure assistance program based on one of several successful state programs, which would assist families undergoing foreclosure due to income emergencies. In addition to programs such as low-interest mortgage assistance to eligible borrowers, this program would provide funds for nonprofit and government agencies offering financial counseling, legal assistance, and loan negotiation processes for such families.

A program similar to the Home Owner’s Loan Corporation, introduced during a similar housing crisis in the 1930s that was authorized to issue new loans to replace the existing liens of homeowners in default. A program of this kind would directly benefit homeowners at risk of foreclosure.

But if Congress wants to get serious about helping homeowners, congressional leaders should more thoughtfully address the mortgage meltdown by considering additional opportunities such as creating Homeownership Protection Centers and a national mortgage foreclosure assistance program, either in the current bill or in future legislation that will surely be needed.

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