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Low expectations for new loan program

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September 20, 2009

Dial back the pie-in-the-sky projections.

Last month, the Obama administration launched a program to help homeowners with loans insured by the Federal Housing Administration. About 850,000 FHA borrowers are behind on their payments or in foreclosure, yet the program will assist just 45,000.

The effort targets homeowners who were ineligible for the government’s other loan modification plans. But the decision not to rescue more FHA homeowners reflects the Obama administration’s need to protect the financial health of the agency, and to set more realistic goals for helping borrowers as its other loan modification programs fall short.

On Friday, the FHA said its financial reserves had sunk below mandatory levels for the first time in its 75-year history. While officials insist the agency won’t require a taxpayer rescue, falling home prices, rising unemployment and shady lenders continue to drive up default rates.

Nationwide, about 17 percent of FHA borrowers have missed at least one payment or in foreclosure, compared with 13 percent for all loans, according to the Mortgage Bankers Association.

The FHA said it will raise the financial requirements for lenders and request annual audits, and it is cracking down on lenders suspected of fraud. But the agency’s powers to modify more loans for distressed borrowers are being weakened by the poor economy.

FHA borrowers are concentrated in states like Michigan and Ohio, where job losses, rather than lax lending practices, are the main problem. And officials are weeding out borrowers who have too much debt.

“Stretching too far, not only risks taxpayer funds and greater losses than we would otherwise have … it also is not good for those homeowners,” said Shaun Donovan, President Barack Obama’s housing secretary.

The new steps reflect the increasing dominance and vulnerability of the FHA. About 20 percent of new loans today are insured by the FHA, up from as low as 2 percent during the subprime loan boom.

Lou Tisler, executive director or Neighborhood Housing Services of Greater Cleveland, says FHA loans accounted for one in four of the foreclosures handled by his nonprofit in the 12 months that ended in June. That’s up from about one in five the year before.

Many of those homeowners have lost their jobs and drained their savings and retirement accounts. Now they’re out of options.

Lorrin Montag and his wife, Dianna, are fearful about their future. Their unemployment and disability benefits run out next year, and the couple’s one-story manufactured home in Corona, Calif. is worth around $150,000, far short of their $280,000 FHA loan.

Lorrin, 65, has been out of work for nearly a year, after a back injury forced him to retire from his job as a truck driver. Dianna, 61, was laid off from her job doing computer-aided design at a maker of manufactured homes.

Their hopes were raised when she was brought back this summer to do some temporary work. But that ends this month.

While it might make sense just to walk away from their home and rent, Montag said, “we want to be able to live here the rest of our lives.”

When the FHA was created in 1934, the U.S. housing market was in even worse shape than today. The banking industry was devastated, and the government stepped in to get home lending going.

The idea was to guarantee that lenders would get their money back, even if the borrower defaulted. Doing so allowed Americans to take out long-term mortgages with a 20 percent down payment rather than the 50 percent that was customary.

But with defaults rising, the FHA could be forced to hike its fees or be rescued by taxpayers. “The FHA, if it explodes, could be another disaster,” said Sen. Kit Bond, R-Mo.

When FHA borrowers can’t pay their mortgages, the government takes the hit. The government is currently trying to sell 40,000 foreclosed properties backed by FHA loans around the country — about 10,000 more than the typical level before the recession started.

In Detroit, the government is trying to get rid of almost 1,700 houses and is forced to compete with banks that have cut prices to near zero. Hundreds of modest single-story homes on small plots of land sell for $10,000 or less.

“If you have excess inventory, plus high unemployment, you just can’t sell anything,” said Vance Morris, the HUD official charged with taking those properties off of the government’s books.

FHA borrowers, by law, are not eligible for the Obama administration’s mortgage modification plan, called Making Home Affordable. So Congress passed a bill creating a similar program for them.

Other loan modification programs focus on reducing the interest rate, but the FHA program takes a different approach. It sets aside up to 30 percent of the outstanding loan balance, interest free. If you have a $200,000 mortgage, you’ll get charged interest on only $140,000, saving more than $300 a month, based on a mortgage rate of 5 percent.

The homeowner is still on the hook for the full principal amount when the house is sold or the mortgage is refinanced.

For each loan modification, the government will pay the lender up to $1,250. If 45,000 people sign up, that works out to around $56 million in costs. But HUD estimates the program will ultimately save $370 million in losses from avoided foreclosures.

But there’s a catch: Borrowers who spend more than 55 percent of their total pretax income on any recurring monthly debts including home and car loans and credit card debt are out of luck. Officials say the risk that these debt-burdened homeowners will fall behind again is simply too high.

Around 16 million homeowners, or about a third of the 51 million Americans with a mortgage, have a debt load that high, according to Moody’s Economy.com.

Borrowers who think they may qualify can call 1-888-297-8685. The FHA’s hot line is available weekdays from 7 a.m. to 7 p.m. CST.

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Associated Press Writer Corey Williams contributed reporting from Detroit.