The Bush administration's new, multi-pronged assistance plan for the mortgage market could help tens of thousands of subprime borrowers facing unaffordable payment jumps or hefty federal taxes after loan modification workouts or short sales.

The centerpiece of the plan, outlined last Friday, is a program called "FHA Secure." Under present rules, the Federal Housing Administration cannot insure refinancings of borrowers who are delinquent on their current mortgage payments. The FHA Secure program-aimed squarely at subprime and other borrowers now facing so-called "exploding" adjustable-rate payments -- would waive that requirement provided the borrowers' credit histories and verifiable income and assets meet FHA's standards. FHA-insured loans, which were eclipsed in popularity during the subprime boom, offer fixed interest rates, 30-year terms, and prohibit prepayment penalties.

They also come with a rigorous, built-in "loss-mitigation" borrower protection system whereby lenders and loan servicers are required to reach out and identify borrowers facing financial jams and attempt to modify loan terms to help them avoid foreclosure. Subprime borrowers who refinance into the FHA program, in other words, may also receive protections and mandatory loan-modification opportunities they never received under their prior loans.

The Bush administration's plan also asks Congress to pass tax relief legislation to remove the so-called "debt forgiveness" penalty that haunts some defaulting homeowners. Under current federal tax law, when a lender modifies a delinquent mortgage to forgive a portion of the principal balance owed, or a lender agrees to a "short sale" that includes a partial reduction in the principal balance owed, the borrower faces a demand from the IRS for income taxes on the debt forgiven.

Take this example. Say a financially-distressed borrower negotiates a workout arrangement with the lender that calls for a short sale to avoid foreclosure proceedings. The sale proceeds come in at $30,000 less than what's needed to pay off the full debt owed, and the lender decides to write off that amount. But under current tax rules, the IRS requires the lender to report the amount forgiven, and then pursues the home seller for income taxes -- in this case, on $30,000.

Bills to remedy this issue -- especially troublesome in the midst of a mortgage meltdown and foreclosure boom -- have been pending in the House and Senate for months with no committee or floor action. In his plan, Bush called upon Congress to move on the legislation immediately, and said he would support either or both bills "with a couple of changes" that he did not specify.

The president also announced:

• plans for HUD and other agencies to work more closely with a variety of consumer financial counseling groups to identify and assist homeowners facing unaffordable payment resets or serious delinquency.

• plans to require better disclosures to mortgage applicants so they better understand the loans they obtain. Included here were as yet unspecified changes to RESPA and Truth in Lending disclosures, plus mandatory disclosure of yield-spread premium fees by mortgage brokers.

Published: September 3, 2007

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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.