Kenneth Harney

FHA Alternatives To Subprime Loans

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By Kenneth R. Harney
Saturday, May 14, 2005

Housing and Urban Development Secretary Alphonso Jackson has a request for potential first-time home buyers, especially those with limited or imperfect credit histories: When you shop for a home this spring or summer, take a hard look at the new, consumer-friendly breed of Federal Housing Administration mortgages now rolling into the marketplace.

Equally important, be wary of the higher rates, fees and penalties that often come with loans in the "subprime" market.

Jackson has a special reason for wanting first-time buyers to check out FHA loans. The FHA has lost significant ground during the past several years to competitors in the booming, private subprime sector. FHA-insured mortgages had an 11 percent share of the American home market as recently as 1995, but plunged to 4.3 percent in 2003 and 3.3 percent in 2004.

Almost all that business was siphoned off by lenders who targeted FHA's traditional core customers -- first-time buyers who have minimal down-payment cash and lower-than-average credit scores -- with offers of quick loan approvals and fewer hassles than FHA.

Subprime lenders accounted for one-fourth of the market in 2004, up dramatically from their single-digit shares in the previous decade. Their explosive growth partially has been the result of their willingness to say yes -- at a price -- to almost any applicant.

Jackson, who took over the top spot in the housing department last year, has no beef with the subprime lending industry. But he thinks the new FHA loans coming into the market are often superior to their subprime competitors on rates, fees and consumer protection features.

"We need to reach out" to African-American, Hispanic and other first-time buyers with better loan concepts, more flexible guidelines and quicker service, said Jackson in an interview. "I am absolutely emphatic about winning back our share of the market" that has slipped away to subprime lenders.

Among FHA's new wave of consumer-friendly mortgage products:

· A low-down-payment mortgage, scheduled for nationwide debut June 4, that allows prospective buyers to add $5,000 to $15,000 to the loan amount to finance renovations required to meet FHA minimum property standards. Any FHA-approved lender can provide the new fix-up loan feature. Say you're interested in buying a townhouse, but it needs a new roof or heating system. To qualify for a traditional FHA loan, you would have to persuade the seller to make the repairs necessary to bring the house up to minimum property standards before you could close the deal. Under the new program, any FHA lender can quickly sign off on extra funds to make the repairs after the closing. That should remove one of the major objections some sellers and real estate agents have to purchasers using FHA financing.

· "Hybrid" five-year adjustable-rate FHA mortgages that carry popular 2 percent annual rate-increase limits and 6 percent life-of-the-loan limits. Hybrid adjustables come with 3 percent down payments and a $312,895 maximum mortgage amount. They also allow first-time buyers to lock in a relatively low fixed rate for the initial five years of the mortgage. After that time, if the buyers decide to stay in the house and retain the loan, annual rate adjustments -- in the event that market rates rise generally -- are limited to 2 percentage points a year, with a maximum 6 percentage point ceiling during the life of the mortgage. Hybrids with three, seven and 10-year initial fixed-rate periods are also available.

· New financial incentives for FHA-approved mortgage lenders to bend over backward to help owners who fall behind on their loan payments to remain in their homes and avoid foreclosure through forbearance agreements or loan modifications. Say your spouse got sick and you missed several months of mortgage payments. An FHA loan servicer or lender would automatically begin discussions with you on alternative solutions to your payment gap, including the possibility of modifying the basic terms of the loan.

The contrast here with the subprime market is stark. Some subprime servicers have little or no financial or legal incentives to step in and work with delinquent borrowers. To the contrary, some of them have been sued by federal agencies for allegedly predatory treatment of customers in payment trouble. FHA lenders and servicers are required by law to seek win-win remedies for borrowers, and they get substantial monetary payments from FHA when they successfully avoid foreclosures.

A couple of other points to keep in mind: FHA loans carry no prepayment penalties. Subprime loans often impose heavy early-payoff fees. FHA also now uses a new electronic credit screening technology, called the TOTAL scorecard, that allows quicker funding decisions for buyers with nontraditional credit profiles.

Kenneth R. Harney's e-mail address

© 2005 The Washington Post Company

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