As first reported here in January (Realty Times, Jan. 12, 2006), the Department of Housing and Urban Development is asking Congress to increase and simplify loan amount limits placed on Federal Housing Administration-insured mortgages.

Under HUD's far-reaching proposal to modernize the FHA and turn it back into the viable option it once was for home buyers, the ceiling in high-cost areas would rise from 87 to 100 percent of the so-called conforming loan limit.

In addition, the FHA "floor," which is the maximum loan amount in lower-cost areas, would be upped from 48 to 65 percent of the conforming limit. And in areas that fall between the two extremes, FHA's loan limit would rise to 100 percent of the local median home price.

The conforming loan limit is key because it is the Congressionally-placed ceiling on loans that can be purchased and securitized by Fannie Mae and Freddie Mac, the two secondary market institutions which keep the money flowing to housing by buying mortgages from local lenders and re-selling them to investors from around the world.

Because Fannie and Freddie now "touch" about one out of every two home loans in one way or another, their rules and limits set the tone for the entire market.

The FHA used to do that. In fact, when it was created during the Depression to stimulate the housing sector, ownership wasn't a reality for most people. Indeed, prior to the National Housing Act of 1934, which established the FHA insurance program to broaden home ownership, protect lending institutions and stimulate the building industry, 30-year mortgages did not exist.

Back then, as difficult as it may be to imagine, mortgage amounts did not exceed 50 percent of the home's value and did not extend past the fifth year. At the end of a five-year period, mortgages had to be repaid or renegotiated.

The FHA has helped more than 33 million families become home owners over the years. But recently, it has lost much of its relevance. And now, says HUD, it needs to be given a shot in the arm.

The proposal to raise the loan limits is part of a number of changes HUD wants to make and were described earlier by my colleague Ken Harney (Realty Times, Feb. 20, 2006). And it was called "crucial" by FHA Commissioner Brian Montgomery is his recent testimony before a House subcommittee.

"In many areas of the country, the existing FHA limits are lower than the cost of new construction, eliminating FHA financing as an option for buyers of new homes in those markets," Montgomery told the panel. "FHA has simply been priced out of the market in other areas, such as California, where FHA insured only about 5,000 home mortgages in all of 2005.

In California, according to A.J. Pickel III, a past president of the National Association of Mortgage Brokers, whose members originate nearly two out of every five FHA-insured loans, the median price house is at or above the current FHA maximum in 29 of the state's 58 counties. Together, the 29 jurisdictions represent 85 percent of California's population.

But the problem isn't just in California, said Pickel, who is president of Lender One Financial Corp. in Lenexa, Kan. It exists everywhere houses are priced way above the area median.

In Maryland, my home state, the median is above the FHA max in five of 24 counties, while seven others are within $2,000 of it. And buyers in several counties in Pennsylvania, Connecticut, New York and New Jersey are in the same boat.

FHA Commissioner Montgomery said higher loan limits are particularly important to people who want to purchase newly constructed houses. In many parts of the country, he pointed out in his testimony, the current FHA limits are lower than the cost of new construction, which means new home buyers are all but precluded from using FHA financing.

Gerald Howard, executive vice president of the National Association of Home Builders, says that because the "artificially low" tend to limit choice, buyers who can qualify for only FHA financing are often restricted to the lowest echelon of available houses.

"We do not believe that Congress created the FHA in 1934 with the intent of constraining borrowers to homes priced at the lower end of the market," he says.

The Mortgage Bankers Association, whose members fund 90 percent of all FHA-backed loans, also supports higher loan limits. The proposal, says MBA Chairwoman Regina Lowrie, strikes a "good balance" between allowing the agency to serve a greater number of borrowers without exceeding its mission or taking on excessive risk.