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Consumer Issues: FHA Changes Impact Prospective Borrowers

May 27, 2010

Posted by

Julie Garton-Good

Julie Garton-Good has designed the "CCREC" (Consumer-Certified Real Estate Consultant) designation and training course, sanctioned by the National Association of Real Estate Consultants (NAREC) for ag Read more

 

In order to shore up its balance sheet and capital reserves for its federally-insured loans, the Federal Housing Administration (FHA) has rolled out financial changes, many that impact prospective borrowers.  The changes impact loans originated on or after April 1st.

In its official announcement, FHA said that “it’s trying to better position itself to manage risk while continuing to support the nation’s housing market”.  And the statistics speak volumes.   FHA loan origination is estimated to be upwards of as much as 50 percent of all mortgages, up from just 3 percent before the housing collapse.  Meanwhile, FHA foreclosures were up 21 percent from a year ago and 120 percent from just two years ago; and experts predict it could worsen.  That means that FHA’s insurance reserves are also down, 3 percent over the last twelve months to $3.6 billion, an amount that’s far below the amount required by Congress.

Changes in Borrower’s Qualifications

The general purpose of tightening FHA loan borrower’ qualifications is to lend to more well-qualified borrowers, thus lessening default and FHA’s risk.  The first change requires borrowers to have a minimum FICO credit score of 580 in order to qualify for FHA’s 3.5 percent down payment loan; otherwise the borrower must make a 10 percent down payment.  Prior to this change, many lenders were already using 620 as a minimum.  But since the absence of equity in a home has become one of the key predictors of borrower default, requiring a greater down payment in the absence of a minimum credit score is a step in the right direction, for FHA and for consumers.

It’s important to note that FHA underwriting guidelines are merely that, minimum guidelines.  And as FHA lenders start to roll out the changes, some lenders may choose to be more restrictive (termed “investor overlays”) in order to limit the number of defaults.  In other words, a borrower might be denied simply because he applied at the wrong lending institution!  If one lending institution’ denies your mortgage, there’s no harm in reapplying with another lender who underwrites using FHA’s minimum guidelines.  This is yet another good reason to always shop as diligently for the lender as you do the interest rate, points, and fees.

Changes in Borrower’s Costs

In order to shore up FHA’s failing insurance coffers, the upfront mortgage premium will rise from 1.75 percent to 2.25 percent of the loan amount.  On a $200,000 house with a $193,000 mortgage amount, this adds $965 to the borrower’s costs.  As the second premium increase in two years, it can be rolled into the loan, but it still increases the monthly payment and therefore, the ability to qualify. 

Changes in Seller’s Maximum Contributions

Since the greatest problem for a majority of buyers is accumulating the down payment and closing costs, seller contributions have been an attractive option in FHA loans.  But since experts say that higher maximum contributions often encourage sellers to mark up the price to compensate, FHA will cut seller contributions in half---from the previous 6 percent of the sales price, to just 3 percent.  For many borrowers, this means accumulating more cash down payment or purchasing a house of lesser value.

Increased Enforcement of FHA Lenders

In January of this year, the Federal Housing Administration subpoenaed fifteen FHA lenders with the highest default rates and has since pulled the licensing ability to write FHA loans from some. Moving forward, lenders who exceed the maximum number of defaulted loans as prescribed by HUD, will automatically lose their FHA license.  HUD realizes the importance of monitoring lender performance and compliance, and has implemented more tools for oversight, including publicly reporting lender performance rankings on the HUD website, www.hud.org.  Additionally, HUD is pursuing legislative authority to increase enforcement on FHA lenders including requiring all approved Direct Endorsement lenders to assume liability for the loans they originate and underwrite. 

Questions to Ask a Prospective Lender

While greater oversight of FHA lenders and their practices is great news for consumers, it’s more important than ever for the borrower to know the past track record and current status of the lender they’re dealing with. 

Here’s a brief list of questions to pose to a prospective FHA lender:

  1. How long have you been in the mortgage business and making FHA loans?
  2. Do you specialize in FHA loans?  What percent of your overall loan origination is it? (You want a specialist, not a generalist who only makes an occasional FHA loan).
  3. Do you underwrite using the traditional FHA guidelines, or do you overlay tougher underwriting requirements?
  4. Could you please provide me with the names of three or more recent satisfied clients I could contact?  (Never work with a lender who is unable or unwilling to give you references…it’s a huge “red flag” since word-of-mouth referrals are a lender’s stock in trade). 

The recent changes to FHA mortgages mean higher fees, tougher underwriting, coupled with greater lender oversight.  If an FHA mortgage is in your future, your best bet is to put yourself in the capable hands of a real estate professional.