Changes coming to FHA loans
By Michael D. Larson • Bankrate.com

The government's continuing effort to improve its loan products took another step forward recently when federal legislators approved a bill that will broaden the Federal Housing Administration mortgage program, cut costs on refinancing reverse mortgages and make more money available for home improvements.

Passed by the House of Representatives on April 6, the American Homeownership and Economic Opportunity Act now awaits Senate action. H.R. 1776 or a similar compromise bill will likely make it through the gauntlet, observers say, if supporters can beat this fall's election season malaise.

"This bill is the last piece of the housing reform puzzle in America," said Congressman Rick Lazio, R-N.Y., after representatives voted for it 417-8. "This bill works to make the dream of homeownership more accessible by removing regulatory obstacles that stand in the way of the individual's ability to purchase a home."

What the changes are
Thanks to the proposed changes, FHA loans should be even more attractive for the borrowers who typically use them. They include first-time home buyers and people with less-than-perfect credit attracted to the loans' low down payment requirements and liberal underwriting standards.

But the benefits of the act don't stop there. Seniors won't have to spend as much money to refinance certain reverse mortgages if it becomes law. Plus, current owners looking to improve their properties will be able to borrow more money under the Department of Housing and Urban Development's Title One program.

From a broader perspective, it's just the latest example of a reform process that's been under way for years. Take FHA, for example. HUD has been eager to respond to an administration focused on boosting homeownership. As part of that effort, they have modified the application process so borrowers experience faster turnaround times and less red tape.

But other interested parties have done their share as well. Legislators in 1998 hiked FHA loan limits by up to 26 percent, allowing consumers who need larger mortgages to use the government program. Meanwhile, the agencies behind the two dominant automated underwriting systems have upgraded them so they can process FHA loans electronically. That has accelerated the closing process. Finally, HUD recently announced plans to introduce its own automated underwriting engine later this year. The system will operate "transparently," meaning consumers will know exactly what it considers when deciding whether to approve or deny a loan application.

"It's consistent with the efforts to increase homeownership and also make the FHA program attractive to first-time home buyers," says Bud Carter, senior director of residential finance at the Mortgage Bankers Association of America in Washington. "That's the predominant group FHA serves, that and low- to moderate-income families."

More loan options available
So what changes are in store? For starters, consumers will have a wider choice of FHA loans than they do today. Borrowers will be able to get so-called hybrid ARMs -- adjustable rate mortgages that have initial fixed-rate periods of three, five or seven years before adjusting annually thereafter -- in addition to the 15-year fixed rate, 30-year fixed rate and 1-year adjustable rate mortgages now offered.

"That product has been quite popular in the conventional market -- 3/1 ARMs, 5/1 ARMs, 7/1 ARMs," says Al Jackson, vice president of compliance and government issues for Principal Financial Group's mortgage division. "It's a matter of keeping up with the times for FHA and HUD. This is the kind of product consumers want and HUD needs to be in the business of providing consumers with what they want."

A temporary fix that effectively lowered the FHA down payment requirement will be made permanent with the legislation, too. The government used to calculate how much a person needed to pay at closing using a complex tiered formula, which usually resulted in the borrower fronting more cash. HUD adopted a simplified procedure a few years ago, but its ability to continue using it will expire soon without H.R. 1776.

"Congress only authorized that on a pilot basis and that pilot expires at the end of September," Carter says.

Civil servants gain, too
Civil servants stand to gain from the new bill as well. Under one of its sections, teachers, police officers, firefighters and others will be permitted to get FHA mortgages for just 1 percent down instead of the typical 3 percent. They'll also be able to defer the 2.25 percent fee the government usually collects at closing to bolster the insurance fund that makes FHA lending possible.

Seniors with a HUD-backed Home Equity Conversion Mortgage won't have to pay as much to refinance it into a new government-backed reverse mortgage either. Instead of having to pay another full insurance premium when moving from one HECM to another, they'll only have to pay a nominal amount. For borrowers using a HECM to cover long-term care insurance or health-care costs, HUD won't collect the usual upfront premium at all.

People who want to replace windows, add a garage or perform other non-luxury home improvements will find they can get more money, too. Title One loans from HUD currently allow consumers with little or no equity to borrow up to $25,000 for upgrades. They get the money either directly from government-approved lenders or through contractors who partner with one. H.R. 1776 boosts the loan cap to $32,500.

"You're not looking for the borrower to have any equity in the property and that makes it available to a lot of homeowners, especially new homeowners," says Peter Bell, executive director of the Home Improvement Lenders Association in Washington.

"If you have people who have bought homes in the last year or two or three with 90 to 95 percent loan-to-value mortgages, which is increasingly the case, they have no equity accumulated so they could not get a home equity loan."

All told, the changes will make borrowing cheaper and easier for a wide variety of consumers -- if they're implemented. Proponents feel there shouldn't be much of a problem getting at least part of H.R. 1776 passed, considering the bipartisan vote of confidence the bill received from House legislators a few weeks ago. And Jackson, for one, is optimistic.

"I think the prospects are good and I'm hoping that it will move through with all due haste because it makes a lot of sense," he says. "A lot of changes have taken place in the industry over the years and FHA has to change with the times."