A proposed new Bush administration home mortgage program is designed to seek out and help households with seriously-deficient credit histories and offer them Federal Housing Administration mortgage insurance for the first time.

An estimated 62,000 credit-impaired home buyers would receive financing in the first year of the program alone, according to the White House, provided Congress agrees to authorize it this session.

The new FHA "subprime" concept was outlined last week in the President’s fiscal 2004 budget proposal. Under the plan, home buyers with credit problems that would disqualify them for standard FHA financing--or for a conventional mortgage in the private market--would be eligible for an insured loan. The interest rate would be slightly higher than regular FHA financing, but insurance premiums would be reduced after 24 months of on-time payments.

The new mortgage would "reward good behavior," according to the White House, and should generate $7.5 billion in additional insurance volume for FHA. It would also be an important tool in the administration’s efforts to increase homeownership among "underserved populations," especially immigrants, minorities and households that avoid the conventional banking system and credit sources. The program should be especially helpful to Realtors,builders, and nonprofit organizations who work to assist these groups with their housing needs.

Though the operational details of the new program were not available last week, the assumption is that the FHA subprime effort will target applicants who currently are either frozen out of the home buying market altogether, or are forced to deal with predatory, high-fee lenders in the private market.

FHA’s standard home mortgage insurance program, which dates back to the Depression years of the 1930s, was designed to finance first-time, moderate income borrowers who may have minor to moderate credit glitches on their records. Many FHA borrowers already are considered "subprime" by conventional market standards, so the new program will reach even deeper into the subprime pool.

The size of the higher rate increment to be charged under the program was not detailed in the President’s budget. But most industry observers expect the rates may vary with the perceived risk associated with each applicant. Giant mortgage investor Fannie Mae has a subprime program that "rewards timely payments" after 24 months of on-time performance. That program prices loans on a three-level risk-tiering matrix; borrowers with the greatest credit issues are priced a full one percent or more above borrowers with lesser credit problems.

The new FHA program is also expected to make heavy use of FHA’s forthcoming electronic underwriting system, known as the "total" scoring plan. That system takes an applicant’s credit history, collateral, cash resources and other factors into account to assign a numerical risk rating, and to price the loan accordingly. Both Fannie Mae and Freddie Mac have similar electronic underwriting systems. But the FHA "total" concept scores applicants based in part on FHA’s experience with prior borrowers.

One additional expected benefit of the new FHA subprime program: It has the potential of functioning as a credit-repair mechanism for people who need to demonstrate solid on-time repayments on a major debt to move themselves from the subprime category up to prime, and to qualify for lower interest charges on all forms of credit.

Published: February 10, 2003

Use of this article without permission is a violation of federal copyright laws.

Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.