Subprime Swoon Sparks an FHA Revival

Not all lenders are rushing to offer FHA loans. Last summer, Washington Mutual(WM Quote) exited the business of offering loans backed by government agencies in order to pursue "higher margin products."

In July, it sold its entire $140 billion government mortgage portfolio and servicing operations, which included a portion of its conforming fixed-rate servicing portfolio, to Wells Fargo.

While the Seattle lender says it has no plans to re-enter the FHA business, perhaps it sold the business too soon. WaMu's earnings were crushed in the first quarter by weak performance from its subprime loans.

Changes in FHA lending standards might not be far off. Several bills proposing to update standards have gained traction in Congress over the past year. Proponents are even more insistent that loan standards be updated, since the industry saw a surge in subprime loan defaults in the past few months.

Among the issues that proponents say are in most need of reform are the elimination of a mandatory 3% minimum down payment for an FHA-backed loan, an increase in FHA loan caps to conform with the generally rising prices in the housing market, and the creation of a new insurance-premium structure that would match the credit profile of the borrower instead of a standard premium amount.

"The bottom line is that as lending practices have evolved and modernized, the FHA has not had the ability to fully adapt to the new marketplace and become a viable alternative to subprime loans without congressional approval," says Stephen O'Halloran, a spokesman for HUD.

Passing new legislation to improve the profitability of FHA loans will be crucial to getting more lenders on board with them.

"There are cost savings to be had from the kind of efficiency that FHA will get from a reform from Congress," Pfotenhauer says.