A subprime bailout plan that works

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NEW YORK (CNNMoney.com) -- One government response to the subprime mortgage crisis is up and running and on track to help a significant number of borrowers avoid losing their homes.

The Federal Housing Authority's FHASecure program offers refinancing options to move delinquent hybrid ARM borrowers into reasonable, fixed-rate loans. It should help about 250,000 home owners through 2008, according to Department of Housing and Urban Development spokesman, Steve O'Halloran. FHA is part of HUD.

The program launched August 31 as delinquency filings were soaring. About 225,000 default and other foreclose notices were filed, nearly double the total of October 2006, according to the latest data from RealtyTrac.

Those numbers are likely to increase. Interest rates on hybrid adjustable rate mortgages (ARMs) are set to reset at a record pace of about $362 billion in 2008, according to Banc of America Securities.

The resets will push monthly mortgage payments higher for many borrowers and put 2.2 million of them in jeopardy of losing their homes through 2008, according to the Center for Responsible Lending.

FHASecure can minimize the impact of higher interest rates on borrowers whose ARM loans have already reset. Instead of a borrower's interest jumping from, say, 7 percent to 10 percent, which would mean a typical payment increase of several hundred dollars a month, an FHASecure loan might drop the interest rate back to 7 percent, and it would never go up.

In a speech Monday, HUD secretary Alphonso Jackson, reported that 33,000 borrowers have already refinanced their subprime ARMs into fixed-rate, FHASecure loans. An additional 20,000 are in the pipeline for approval this month, bringing the total to more than 53,000 in four months.

But to John Taylor, chief executive of the National Community Reinvestment Coalition, a consumer rights group, "That's just scratching the surface."

Even using HUD's own statistics, FHA will only solve the problems of about a tenth of all the borrowers facing foreclosures through the end of 2008. "We were one of the first to support the use of FHA. I'm not pooh-poohing the program, but let's not overstate its impact," Taylor said.

First off, not all subprime ARM borrowers are eligible for FHASecure loans.

FHASecure targets owners whose mortgages have gone delinquent due to the increase in payments after interest rates have reset. Since that doesn't happen for at least two years for most hybrid ARM loans, those written after December 31, 2006 will not qualify for the program.

Foreclosure rescue: No help for you

The original loan must also be a non-FHA ARM, and the borrower must show no late payments for at least six months before the reset. (Some exceptions are made for delinquent loans if there is sufficient equity in the homes.)

The existing mortgage holder must write off any indebtedness not covered by the FHA loan and take back second loans if that would mean FHA loan-to-ratio values are exceeded; and lenders must determine that borrowers have sufficient income and assets to pay off the FHA loan.

Borrowers apply for loans through private, FHA-approved lenders. The FHA doesn't actually make loans - it insures them, charging borrowers a small insurance premium. With government backing, the loans are practically guaranteed to sell in the secondary market, making them attractive for lenders.

Lenders use an FHA scorecard to underwrite the loans that outlines acceptable payment-to-income ratios (up to 31 percent) and debt-to-income ratios (43 percent). It also requires analysis of borrowers' credit histories and determines if past delinquencies were connected to resets.

The FHA also requires that lenders properly review appraisals and determine that the values are accurate. Lenders will be held equally responsible, along with appraisers, for violations if the lenders knew or should have known appraisals were inflated.

Another of Taylor's criticisms is that FHASecure cherry-picks low hanging fruit, that is, borrowers with fairly good credit histories. Many of the home owners who qualify for FHASecure could get already help through conventional refis.

There's also the problem of low cap limits. The maximum amount of the loans ranges from about $200,000 to $362,000, depending on local home prices, according to HUD spokesman, Steve O'Halloran. That leaves out many people living in high-cost areas like California.

"Hundreds of thousands more could be helped if Congress passes the FHA Modernization bill," said O'Halloran. That bill, which was enacted with overwhelming support in the House and sailed through the Senate Banking Committee, has yet to pass through the full Senate.

The bill may not come up for a vote before the end of the year as appropriations bills monopolize Senate floor time. "It's difficult to get anything up for a vote in the Senate right now, including common-sense bills like this one," said Jim Manley, a spokesman for majority leader, Harry Reid.

If it does pass, FHA Modernization would, among other things, raise FHA cap limits to $417,000, enabling many more borrowers to gain entry. O'Halloran estimates it would double the number of borrowers who would qualify for an FHA loan to 500,000.