Draft bill would hike FHA loan down payments to 5%, slash loan limits

Republicans on the House Financial Services Committee have drafted legislation that would raise the minimum down payment for FHA mortgages to 5 percent, cut FHA loan limits in most markets, and move the Agriculture Department's rural housing program to FHA's parent agency, HUD.

Though the draft bill has not been introduced, titled or assigned a number, it is expected to be the main subject of a hearing Wednesday before the Subcommittee on Insurance, Housing and Community Opportunity, chaired by Rep. Judy Biggert, R-IL. After that, the bill is likely to be formally introduced and sped through subcommittee and committee votes and head for action by the full House.

The text of the draft bill appears to be a partial answer from House Republicans to the Obama administration's call earlier this year for a smaller federal government footprint in housing.

By lowering maximum FHA loan limits in large numbers of local areas -- well below even the limits that are already scheduled to kick in Oct. 1 -- the bill would squeeze down FHA loan volume across the country, cutting a resource for some home purchasers who can't obtain a conventional mortgage.

Here are some examples of current FHA loan ceilings, how they’re scheduled to adjust in October, and where they’d end up under the Republican plan:

• In Los Angeles County, the present high-cost area maximum is $729,750, which was set by the federal economic stimulus legislation passed by Congress following the financial crisis of 2008. That ceiling is scheduled to drop to $625,500 Oct. 1. Under the new bill, however, the maximum FHA-insured loan amount allowed in Los Angeles would be $412,500 — a $317,250 plunge from the current limit and $213,000 below the scheduled reduction this fall.
• Other counties in high-cost California would experience even sharper declines, such as Monterey, where the maximum would decline by $436,000 and Contra Costa, where the drop would be $379,750. Every county in California — from big urban communities to rural areas — would be on the losing end of the new FHA equation, and most reductions would be in the six figures.
• The lower limits would be significant in other states as well. Monroe County, Fla., would see maximum FHA loan limits go from $729,750 to $425,000. Under the scheduled Oct. 1 statutory decrease, the county — which comprises the Florida Keys — would have a $529,000 maximum. Sarasota, Fla., would see a $261,250 drop under the bill, Miami-Dade a decrease of $161,250, and Orange County (Orlando) limits would decline by $128,750.
• Large counties in the high-cost areas around Washington D.C. would see FHA limits drop by anywhere from $398,500 (Prince George’s, Md.) to $366,250 in Baltimore. Most New England and mid-Atlantic states would end up with lower loan ceilings along with major markets in the Midwest and the Rocky Mountain states.

The FHA loan limit formula would be revised to 125 percent of the median home sale price in the local county under the bill, and the current $271,050 floor for loan limits nationwide would disappear.

Though major housing, real estate and lending groups had no comments pending the Wednesday hearing, they are likely to oppose the sharp cuts in loan limits.

Mortgage industry consultant Brian Chappelle, head of Potomac Partners in Washington, D.C., is scheduled to testify at the hearing and told Inman News that the higher loan ceilings are a bad idea.

Audits of FHA loan performance, Chappelle said, repeatedly have shown that higher-balance mortgages default and trigger claims against FHA’s insurance funds at lower rates than smaller-balance loans.

“FHA is essentially an insurance company,” he said, “and you need those (higher-balance) loans to spread the risk,” just as private sector insurers do.

The Republican bill’s call for a 5 percent minimum down payment on FHA loans also is likely to draw criticism from industry groups.

The National Association of Realtors and the National Association of Home Builders have opposed such a move in the past, arguing that there is no statistical evidence that adding 1.5 percent onto the current 3.5 percent minimum would significantly affect default probabilities of new FHA loans.

However, the higher down payments, along with the bill’s prohibition of financing of closing costs, would make home purchases more difficult for substantial numbers of consumers.

Chappelle estimates that “40 percent of FHA borrowers would fall out” — unable to afford the transaction — “if they go to 5 percent down.”

The bill also proposes shifting the Agriculture Department’s rural housing program to the U.S. Department of Housing and Urban Development. A Republican staff member said “HUD has the housing responsibility and the expertise,” so the change is logical.

However, proponents of the rural housing programs may not want to risk being swallowed up in an urban-oriented agency, nor is the Agriculture Department likely to want to lose a chunk of its traditional turf.

Where’s the bill headed? Republicans say they are merely seeking to move the agenda they share with the Obama administration — the smaller footprint concept — which is, in turn, part of a larger agenda to phase out Fannie Mae and Freddie Mac.

Passage of the bill by the full House appears to be a real possibility, as Republicans are in control on that side of Capitol Hill.

But all bets are off in the Senate, where Democratic support for continuing FHA’s role in the market is far stronger, and where dramatic cuts in loan limits in places like California, New York, Massachusetts and the East Coast’s expensive markets likely won’t fly.

Ken Harney writes an award-winning, nationally syndicated column, “The Nation’s Housing,” and is the author of two books on real estate and mortgage finance.