Prospects for reviving the long-slumping FHA (Federal Housing Administration) mortgage program took a big jump last week as the House of Representatives overwhelmingly approved reform legislation.

By a 415-7 floor vote, the House sent the bipartisan "Expanding American Homeownership Act of 2006" (H.R.5121) to the Senate. The legislation would:

• Eliminate current rules banning FHA downpayments below 3 percent. FHA would be authorized to offer zero down or 1-2 percent down options for credit-worthy but cash-deficient homebuyers.

• Shift FHA to "risk-based pricing" -- a loan underwriting approach widely used in the conventional marketplace. As envisioned by the bill, FHA would be able to charge high-risk borrowers significantly higher mortgage insurance premiums -- as much as 3 percent upfront compared with the current standard of 1.5 percent -- and charge low-risk borrowers lower premiums.

• Raise FHA's mortgage limits to each local market area's median home price, but not to exceed Fannie Mae's and Freddie Mac's loan limits, which are currently pegged at $417,000. In designed "low-cost" areas, the FHA maximum would rise to a new ceiling of 65 percent of the Fannie-Freddie limits, or currently about $271,000.

• Open the FHA program for the first time to effective participation by the largest group of home loan originators -- mortgage brokers, who account for more than 60 percent of the marketplace. Under current rules, small-scale brokerage firms are frozen out of the FHA segment because of rules mandating annual submission of audited financial statements -- a costly process for many firms. The new legislation would require that brokers post surety bonds to protect the FHA against fraud and financial failures.

FHA Commissioner Brian D. Montgomery said the legislation will transform his agency and make it more directly competitive with subprime lenders.

"We are now closer to a (new) landmark," he said, "a modernized, flexible FHA that can respond to the needs of today's low and moderate income home buyers who need a helping hand."

Chartered by Congress in the midst of the Great Depression in 1934, FHA traditionally functioned as the go-to resource for mortgage financing for first-time buyers short of cash. It has also been a key homebuying portal for consumers with imperfect or minimal credit histories. As recently as the mid-1990s, FHA accounted for 10 to 12 percent of all mortgage originations, but that percentage has fallen sharply as subprime lenders using private mortgage insurance cherry-picked the agency's customer base with aggressive marketing campaigns, often through brokers who were effectively excluded from FHA participation.

The legislation has potentially large significance for realty agents and brokers who specialize in serving first-time purchasers in general, or African-American, Hispanic and other minority groups. FHA's combination of low interest rates and substantial consumer protections -- no prepayment penalties, for example -- often offers clients superior terms compared with those available from subprime lenders.

FHA has also adopted a series of administrative reforms designed to attract realty agents -- especially its termination of its long-controversial rules requiring repairs of property defects before closings, at the seller's expense.

The outlook for final action in the Senate is uncertain at the moment. A companion bill is pending before the Senate housing subcommittee, but has not been reported out. After its August recess, Congress will only have about a month before its final recess for the election cycle. The situation is complicated by the go-slow approach of housing subcommittee chairman Sen. Wayne Allard (R-Colorado), who is no fan of government involvement in the mortgage market and is a political ally of the private mortgage insurance industry.

FHA commissioner Montgomery, however, pledges an "all-out effort" to convince the Senate to pass the bill before its final recess. As a former White House aide -- secretary of President Bush's cabinet -- Montgomery brings political skills and the muscle of the Administration to the task. HUD Secretary Alphonso Jackson, a personal friend and former Houston neighbor of the President's, also has pledged to work to push the bill through the Senate, underlying the White House's strong backing for FHA reform this year.

Published: July 31, 2006

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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, consmer 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.