Expectations low for new loan-help program

WASHINGTON — Dial back the pie-in-the-sky projections.

Last month, the Obama administration launched a program to help homeowners with loans insured by the Federal Housing Administration. About 850,000 FHA borrowers are behind on their payments or in foreclosure, yet the program will assist just 45,000.

The effort targets homeowners who were ineligible for the government's other loan-modification plans. But the decision not to rescue more FHA homeowners reflects the Obama administration's need to protect the financial health of the agency and to set more realistic goals for helping borrowers as its other loan-modification programs fall short.

On Sept. 18, the FHA said its financial reserves had sunk below mandatory levels for the first time in its 75-year history. While officials insist the agency won't require a taxpayer rescue, falling home prices, rising unemployment and shady lenders continue to drive up default rates.

Nationwide, about 17 percent of FHA borrowers have missed at least one payment or are in foreclosure, compared with 13 percent for all loans, according to the Mortgage Bankers Association.

The FHA said it will raise the financial requirements for lenders and request annual audits, and it is cracking down on lenders suspected of fraud. But the agency's powers to modify more loans for distressed borrowers are being weakened by the poor economy.

FHA borrowers are concentrated in states like Michigan and Ohio, where job losses, rather than lax lending practices, are the main problem. And officials are weeding out borrowers who have too much debt.

The new steps reflect the increasing dominance and vulnerability of the FHA. About 20 percent of new loans today are insured by the FHA, up from as low as 2 percent during the subprime-loan boom.

Lou Tisler, executive director or Neighborhood Housing Services of Greater Cleveland, says FHA loans accounted for one in four of the foreclosures handled by his nonprofit in the 12 months that ended in June. That's up from about one in five the year before.

When the FHA was created in 1934, the U.S. housing market was in even worse shape than today. The banking industry was devastated, and the government stepped in to get home lending going.

The idea was to guarantee that lenders would get their money back, even if the borrower defaulted. Doing so allowed Americans to take out long-term mortgages with a 20 percent down payment rather than the 50 percent that was customary.

But with defaults rising, the FHA could be forced to increase its fees or be rescued by taxpayers. "The FHA, if it explodes, could be another disaster," said Sen. Kit Bond, R-Mo.

When FHA borrowers can't pay their mortgages, the government takes the hit. In Detroit, the government is trying to get rid of almost 1,700 houses and is forced to compete with banks that have cut prices to near zero. Hundreds of modest single-story homes on small plots of land sell for $10,000 or less.

FHA borrowers, by law, are not eligible for the Obama administration's mortgage-modification plan, called Making Home Affordable. So Congress passed a bill creating a similar program for them.

Other loan-modification programs focus on reducing the interest rate, but the FHA program takes a different approach. It sets aside up to 30 percent of the outstanding loan balance, interest free. If you have a $200,000 mortgage, you'll get charged interest on only $140,000, saving more than $300 a month, based on a mortgage rate of 5 percent.

The homeowner is still on the hook for the full principal amount when the house is sold or the mortgage is refinanced.

For each loan modification, the government will pay the lender up to $1,250. If 45,000 people sign up, that works out to around $56 million in costs. But HUD estimates the program will ultimately save $370 million in losses from avoided foreclosures.

But there's a catch: Borrowers who spend more than 55 percent of their total pretax income on any recurring monthly debts including home and car loans and credit-card debt are out of luck. Officials say the risk that these debt-burdened homeowners will fall behind again is simply too high.

Around 16 million homeowners, or about a third of the 51 million Americans with a mortgage, have a debt load that high, according to Moody's Economy.com.

Borrowers who think they may qualify can call 1-888-297-8685. The FHA's hotline is available weekdays from 7 a.m. to 7 p.m. CST.