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Market Weakness May Force FHA to Raise Risk

Deteriorating market conditions and adverse loan performance could force the Federal Housing Administration to raise its insurance premiums later this year if Congress doesn't give the agency more tools to manage its risks, according to HUD officials.

Department of Housing and Urban Development officials are blaming high default rates on seller-funded downpayment assistance for pushing the FHA insurance fund toward the point where expenses exceed revenue.

In DPA transactions, a nonprofit group arranges for the seller to provide a cash gift that covers the buyer's downpayment or closing costs. The FHA claims the seller recoups the cost by raising the sales price, leaving the borrower with negative equity. The nonprofits claim this assistance allows low-income families to become homeowners.

To protect the general FHA single-family portfolio, the Bush administration wants to create a separate account for FHA-insured mortgages with downpayment assistance and require Congress to appropriate funds to cover the losses.

This proposal to wall-off DPA loans appeared in the president's budget request for fiscal year 2009 that the White House sent to Congress last week.

FHA commissioner Brian Montgomery told reporters last week the FHA mortgages with DPA have default rates two and a half to three times greater than other FHA loans.

"The proliferation of the seller-funded gift downpayment assistance programs unfortunately is not sustainable and the budget book reflects that," Mr. Montgomery said.

Budget documents show that the FHA expects to pay $8.4 billion in claims due to defaulted loans in FY 2008, up from $5.1 billion in FY 2007. And claims in FY 2009 are estimated to hit $9.8 billion.

HUD officials also are urging Congress to pass a FHA reform bill soon that would allow the federal mortgage insurance agency to charge risk-based premiums.

If nothing is done, the FHA will be forced to use its authority to increase its standard upfront premium by 45 basis points to 1.95% and the annual premium by 2 bps to 52 bps.

Last year, the FHA commissioner testified that he would have to raise FHA's upfront premium by 16 bps to 1.66% and its annual 50 bp premium by a few points if Congress did not pass the FHA reform bill.

However, the subprime meltdown created new demand for FHA-insured mortgages and the increase in endorsements allowed the agency to avoid a premium increase.

HUD has tried several times to curtain the DPA programs. But Congress or the courts have intervened on behalf of the nonprofits. Nehemiah Corp. of America and AmeriDream are the largest DPA providers.

Meanwhile, the future of downpayment assistance is one of the sticky issues the chairmen of the House and Senate Banking Committees are trying to resolve as they negotiate a final FHA reform bill.

The Senate FHA reform bill prohibits seller-funded DPA on FHA loans and it appears the senators are standing firm on that prohibition.

The House bill creates new standards for DPA providers along with a $4 million net worth requirement. Nehemiah has endorsed the House language sponsored by Rep. Gary Miller, R-Calif.

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