Why Sequestration Will Hit Housing on Several Fronts

Massive government budget cuts set to go into effect March 1 would be, "deeply destructive" to all aspects of the housing market, US Secretary of Housing and Urban Development Shaun Donovan told a Senate panel last week. From programs for the homeless to reconstruction after Superstorm Sandy, the sequester would, "harm numerous families, individuals, and communities across the nation that rely on HUD programs."

One of those programs that has been instrumental in the housing recovery is the government's insurer of home mortgages, the Federal Housing Administration (FHA). Should the FHA lose staff, which it likely would, it would lose much of its capacity to process new home loans and mortgage refinances as well as sell foreclosed properties that it owns. Twenty-three percent of all mortgage originations in 2012 were FHA-backed, according to a report released Wednesday by Ellie Mae.

The FHA, however, is just the beginning. Sequestration would affect all loans in process, just as housing enters the crucial spring market.

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"Borrowers need to be employed to close on their home loan, so if they have lost their jobs during the loan process, they will not be able to close on their loan," said Craig Strent, CEO of Maryland-based Apex Home Loans. "As a quality control measure, lenders call a day or two before closing to verify an individual is still employed. If a loan is denied during the process due to the borrower losing their job, they are likely to lose their loan lock as well, so even if the sequester is reversed quickly, this has the potential to upset a lot of homeowners — particularly given that rates have risen in recent weeks."

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The average rate on the 30-year fixed hit 3.78 percent this week, the highest since August of 2012, according to the Mortgage Bankers Association. Low rates have been one of the primary drivers of the housing recovery.

Sequestration could also hit the nation's home builders, especially those with a large footprint around Washington, DC and Northern Virginia, like Toll Brothers, which reported a first quarter profit Wednesday, and NVR.

"Industry tailwinds look to be gaining steam, but we believe Toll has one very large impediment to cross: The sequester," said housing analyst Stephen East at ISI Group. "With a large portion of its sales in the Mid-Atlantic area, the next few months order streams will be extremely important as the sequester knife is falling hard on well-paying defense industry jobs."

Sequestration could even slow the improvement in the nation's foreclosure rate. It would result in 75,000 fewer households receiving foreclosure prevention, pre-purchase, rental or other counseling through HUD grants, according to the government agency.

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"This counseling is crucial for middle class and other families who have been harmed by the housing crisis from which we are still recovering, and are trying to prevent foreclosure, refinance their mortgages, avoid housing scams, and find quality, affordable housing," said Secretary Donovan. "Studies show that housing counseling plays a crucial role in those two efforts. Distressed households who receive counseling are more likely to avoid foreclosure, while families who receive counseling before they purchase a home are less likely to become delinquent on their mortgages."

—By CNBC's Diana Olick; Follow her on Twitter @Diana_Olick or on Facebook at facebook.com/DianaOlickCNBC

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