FHA Looks to Offer New Home Loan Options; Increase its Program Popularity

The Federal Housing Administration (FHA) - the federal government’s largest home finance program - might soon offer consumers a range of options they’ve never had before: mini-downpayments, lower than 3 percent, scaled all the way down to zero.

To accomplish this goal, the FHA wants Congress to allow it to use electronic “risk-based pricing” for the first time in its 72-year history. Risk-based pricing has been used in the private mortgage marketplace since the mid-1990s, when Fannie Mae and Freddie Mac introduced their Desktop Underwriter and Loan Prospector systems.

What is risk-based pricing?

All risk-based pricing involves electronic credit checks and credit scores, ordered and obtained in seconds from the national credit bureaus. The risk-based system then prices the mortgage according to the probability of future default posed by the applicant and the size of the downpayment. Applicants with shaky credit and very low downpayments tend to get quoted higher interest rates and home loan fees than applicants with better credit.

The FHA never has adopted risk-based pricing for the premiums it charges on its mortgage insurance. Instead it has pursued a “cross-subsidization” approach whereby applicants with better credit pay slightly higher premiums than they deserv” on the basis of default risk, while borrowers with lower quality credit pay less than they deserve on a risk-adjusted basis.

Changes to the FHA approach

However, the Bush administration’s new budget proposes to do away the traditional cross-subsidization approach and replace it with risk-based pricing.

The reason? Many applicants for FHA Florida home loans with better credit profiles have abandoned the program in recent years, attracted by fast-growing competitors in the private sector that offer subprime lending. The White House estimates that 70 percent of FHA’s business has shifted elsewhere during the past three years alone.

FHA’s chief operating officer, federal housing commissioner Brian D. Montgomery, said in an interview that “we are losing our core group of customers” in part because the agency cannot offer rates and down payment levels on a risk-based sliding scale.

Combined with FHA’s substantially higher loan limits - up to $362,790 for 2006 in high cost areas - the zero-down, risk-based pricing approach could help turn around FHA’s declining mortgage insurance volume.

This, in turn, could be very good news for moderate-income and minority first-time home buyers. As housing affordability becomes more and more of an issue, any changes that make it easier to acquire a Florida home loan should be welcomed.