In a recently published editorial in the American Banker entitled "Rewarding Debt Limits Could Revive Housing," I argue that the Department of Housing and Urban Development (HUD) could - and indeed should - play a key role in driving the housing recovery by promoting lending solutions that simultaneously encourage first time home ownership while rewarding borrower responsibility. The Homeowners Responsible Rewards Program is but one of many such options. Unfortunately, this important discussion has been largely preempted by the debate surrounding how to solve the current crisis. Is it too soon to be thinking about such things?

American Banker | Friday, January 16, 2009
By Brian T. O'Reilly
As much as we want to leave last year's housing market behind and hope for improvement in the new year, signs are not looking good.

Until creditworthy home buyers return to the market, homeowners, the housing industry, and the economy will suffer. We need bold, short-term action by the federal government not only to help solve the crisis, but also to set a new tone for how the housing finance system will function once the recession passes.

The key lies in what now seems like America's distant past, when "responsibility" was the central tenet that guided all mortgage lending. Fortunately, one opportunity to define strong, new standards of responsible lending already exists today with the Federal Housing Administration loan program.

Right now, the Department of Housing and Urban Development could implement what might be called the Homeowners Responsible Rewards Program. If this idea took hold, FHA borrowers could agree to accept voluntary limits on their ability to borrow for some period after closing on the loan, in exchange for more favorable loan pricing.

The program would function much like most commercial loans today, which often limit a company's ability to incur new or additional debt during the loan's term.

Borrowers would have the option of agreeing not to obtain new or additional consumer credit during some initial period — say, 36 months. In other words, no new credit cards, no increases to credit lines, and no new car loans. Loans they had when the mortgage was underwritten and approved would not be impacted.

Of course, some provision would need to be made to handle certain exigent circumstances, such as a family member's catastrophic illness.

In exchange for contractually agreeing to this condition, borrowers would receive a discount on their mortgage rate. The minimum discount for participating in the program could be mandated by HUD — say, 50 basis points. Of course, lenders who wanted to attract borrowers to this program could give them further incentive by increasing the discounts available to them.

Those electing not to participate would simply continue to be subject to current FHA guidelines and market rates.

For first-time homebuyers, and for borrowers with limited experience managing consumer credit, the program would shield them from the often predatory solicitations that inundated borrowers today after they close their first home loan. These borrowers (who, in many cases, are being approved for loans that represent a very high percentage of their gross income) would get the time and opportunity to learn how to manage the significant new expense of homeownership.

Many FHA lenders would jump at the opportunity to participate. Loans to borrowers whose back-end ratios are high to begin with — as is the case with most FHA loans — are at a greater risk of default within the first year after origination than others. The risk increases significantly during the first year when borrowers with already high ratios increase them by taking on new or additional debt. With this idea, the probability of default during the early months would be greatly reduced.

Lenders who originate and hold the loans would cultivate a pool of customers who embrace the challenge of responsible borrowing. Imagine if in 36 months — after meeting the program's requirements — those borrowers were given access to car loans or credit cards. Cross-selling opportunities would abound. Given that these borrowers have proven their credit quality and responsibility, new profits for lenders could be significant.

We will pull out of housing's current tailspin when we invest as much creativity in lending programs that promote long-term borrower success as was spent in the recent past devising programs with no regard for responsible homeownership.