Bush FHA Plan Needs a Second Look

The Bush Administration this week launched a new initiative to help cash-strapped mortgage borrowers, many of them with high-interest-rate subprime loans, avoid foreclosure.

But the primary remedy the president is proposing - a bigger role in the mortgage market for the Federal Housing Administration - is dubious and it's one that should send chills up the spines of anyone who is concerned about the way the government manages our tax dollars.

Now let's be clear about something: the FHA's single-family mortgage insurance program, which guarantees payment to lenders if the borrower defaults, is a huge boon for first-time homebuyers. My family used it to purchase our first home, and I know many other families who have done so. In fact, from a consumer perspective, there are few government programs that provide more direct benefit.

But from a performance perspective, there are huge problems. Because it typically deals with borrowers who have limited financial resources, and who have put less than 3 percent down on their homes, in most cases, the FHA has experienced high rates of delinquency and default in recent years.

That's the case here in Illinois: the Mortgage Bankers Association, an industry trade group, reported that 3.6 percent of outstanding FHA mortgages made in the state were 90 days or more past due at the end of June. That figure may not seem bad by itself. But consider that the 90-day past-due rate on fixed-rate subprime mortgages in Illinois was just 3.1 percent at the end of June.

The data should give pause to policymakers who see the government-insured mortgage market as a potential bailout for the subprime market. Yes, FHA borrowers pay premiums each month for their mortgage insurance and a proposal pending in Congress would allow the agency to charge higher premium rates to borrowers with spotty repayment records. But is it really wise to infuse more high-risk borrowers into a program where public funds are potentially on the line?

So what's the solution? The mortgage industry has touted financial education as the key to avoiding foreclosure. The MBA, for instance, argues that borrowers need to learn to ask the right questions and arm themselves against fraud. It's also supported new legislation that would eliminate some of the worst abuses from the market. Consumer groups have pressed Congress to go much further by outlawing short-term adjustable rate mortgages and requiring mortgage loan originators to carefully document the borrower's payment ability.

Education is clearly important. In just about any business venture, you are better off if you are dealing from a position of strength. In financial matters, that equates to information. But financial education falls apart in the mortgage market for one important reason: mortgage brokers and other loan originators often have no stake in the overall performance of the loan. Brokers, in particular, earn payments from lenders based on the rate that they get a borrower to accept. If the borrower struggles with her payments in three or six months, the broker will simply offer to make her another loan. And so the cycle continues - as long as there is equity in the home.

It's a house of cards, and it's collapsing.

If there's a lesson to be taken from the current mortgage market mess, it's that borrowers are generally better off when they borrow locally. Don't assume that you are going to be turned down. Banks - even small ones - are much more flexible in their mortgage offerings than they were 20 years ago.

And because they will likely own your loan for the duration, they have an incentive to make sure that you get one you are going to be able to repay.