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·         JANUARY 19, 2010, 7:38 P.M. ET

By NICK TIMIRAOS

The Federal Housing Administration will announce more stringent lending requirements on Wednesday to cushion against rising defaults and to stave off the need for a possible taxpayer bailout.

The FHA, which has taken on a major role in the housing market during the economic downturn, doesn’t lend money to home buyers, but insures lenders against default on loans that meet FHA criteria. In exchange for that backing, borrowers who take out FHA-backed loans must pay an upfront insurance premium, which is currently set at 1.75% of the total loan amount, or $1,750 on a $100,000 loan.

The FHA is set to raise that fee to 2.25%, the second increase in the last two years, according to people familiar with the matter. If the larger upfront fee had been in place last year, the FHA would have boosted its reserves by more than $1 billion. The value of those reserves, after projected losses, has fallen to $3.5 billion. Also to boost the reserve, the FHA also will ask Congress to increase a separate insurance fee that borrowers pay annually, people said.

FHA officials declined to comment.

The FHA, which backs up to half of all new loans in certain housing markets, has come under fire for insuring loans with little or no money down as home prices plunged over the past three years, and its reserves have fallen to razor thin levels. That is forcing the agency to walk a tightrope between protecting taxpayer dollars and helping to facilitate the housing recovery.

The FHA will keep minimum down payments at the current 3.5% level for most borrowers. But the agency will require riskier borrowers with credit scores below 580 to make a minimum 10% down payment. While the FHA doesn’t have a credit score cutoff, most lenders require a minimum 620 credit score.

Some housing analysts have pushed for higher down payments on FHA-backed loans, and a bill in Congress would raise down payments to 5%, from the current 3.5%.

Instead, the FHA will reduce the amount of money that sellers can kick in for closing costs, to 3% of the sale price, down from the current level of 6%. The higher cap led to abuses where sellers “heavily marked up the purchase price,” says Lou Barnes, a mortgage banker in Boulder, Colo.

The FHA is also set to announce a series of measures to boost its ability to oversee and take action against lenders that originate loans with FHA backing.

“Mortgage lenders will find the new rules painful but necessary,” says Howard Glaser, an industry consultant. He says the rules were overdue given that “an ‘anything goes’ environment” had prevailed in recent years as former subprime brokers migrated into FHA-backed loans.

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Howard Glaser

hglaser@glasergroup.net

(202) 277-2336