Why Credit Scores Are Now Important To FHA Borrowers

by Peter G. Miller
September 14th, 2009

Why are private lenders insisting on FICO credit scores when the FHA program does not require them? That’s essentially the question raised by Nathan Reynolds who writes:

“I have been a mortgage broker for 10 years and have survived the mortgage crisis by successfully adapting to current lending practices and becoming an FHA Approved Lender (still a broker “Lender” is the title given to those authorized to provide FHA loans). I would like to once again state that in March of 2008 Banks unilaterally began implementing FICO score of 580. This Fico requirement has since risen to 620 by the top three Banks and as high as 660 from most 2nd Tier lenders who sell to these Banks. I spoke with a representative from FHA at a Foreclosure Prevention Seminar that I spoke at and flat out asked the FHA representative what gives? The representative informed me it wasn’t FHA it was the Banks and she wouldn’t be surprised if we don’t see 680 minimum Fico scores by years end. FHA has strict underwriting guidelines requiring full documentation and debt ratios that support the affordability of the loan. Defaults have nothing to do with a Fico score, painfully proven through the whole “Sub-Prime” saga. The borrowers ability to afford the loan they are applying for determines the risk of default. FHA could in fact be the very vehicle to solve the housing crisis if FICO scores were eliminated from qualification. FHA in its purist form as you wrote does not require a FICO score. I ask you why are banks implementing a score when it is not required? Please don’t tell me because of the default risk, it has already been established that it is the borrowers DTI that determines the risk not their inability to pay a bank credit card at 29.9%.”

Let’s agree that if a question is raised that no answer should be off limits. Given that, alas, default risk is an issue, but perhaps not in the way that most borrowers would see the question.

One form of default occurs when a borrower does not repay a debt. In that event homes are foreclosed.

However, there’s another form of default risk, and that’t the risk to the originating lender.

Originating lenders can be held responsible for repayment of a mortgage, generally in two cases: First if the borrower quickly defaults, say within 120 days. Second, if the loan origination was a by-product of fraud.

Now look at what the FHA has done during the past year: In May, for example, HUD announced that 120 FHA mortgage lenders were being sanctioned for “violating FHA requirements. Violations range from failure to conduct sufficient quality control, to failure to continue to meet FHA recertification requirements, to falsifying loan documents.”

HUD said “102 lenders had their FHA approval withdrawn, five lenders agreed to make indemnification payments to FHA totaling more than $500,000, and 24 lenders were accessed fines or administrative costs totaling more than $1.2 million.”

In other words, the reason private-sector lenders are tightening their credit score standards is not because of borrowers, it’s because they want to assure that loan officers and others in the lending process are following the rules. One way to do that is to set up additional standards as a compliance check.

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3 Responses to “Why Credit Scores Are Now Important To FHA Borrowers”

  1. Jeff Says:

    The real reason seem obvious to me. The banks as an industry has figured out that this is a golden oportunity to put their biggest competition (Mortgage Brokers) out of business because they control the gates to all FHA loans. FHA is the only option left for most borrowers. This means the banks will end up with double or more profit and customers when this is all through. Saying they are doing credit overlays to reduce default is the perfect cover to monopolize the mortgage industry. FHA needs to step in and correct this before the banks totally destroy any chance of recovery in housing. I would like to see a push for congresional investigation on this subject. More evidence to this is that the wholesale side of a bank will require mortgage brokers clients to have a higher score than the retail side of the same bank. Do they really expect us to believe investors on wall street will not buy FHA guaranteed loans if the scores are lower than 620. What do you think the government gaurantee is for.

  2. Nathan Reynolds Says:

    I was hoping for clarification as to why Banks are raising their Fico score requirements, but now I am even more confused by your answer.

    You replied,” In other words, the reason private-sector lenders are tightening their credit score standards is not because of borrowers, it’s because they want to assure that loan officers and others in the lending process are following the rules. One way to do that is to set up additional standards as a compliance check.”

    In your reply you stated that it is not because of the borrower. Are you drawing the conclusion that a loan officer or others in the lending process are less likely to follow the rules on a borrower with a Fico score below 620 then they would on a borrower with a Fico above 620? No disrespect intended, but your statement does not hold water.

    No answer is off limits, I agree so lets revisit my post and try and come up with an answer that truly addresses my question. You edited out my factual statement that the homeowners Fico had suffered because they were struggling to pay their 29.9% credit card after an automatic default due to the change in the due date. I assumed you had edited this portion because I likened the Bank to a “Loan Shark” and stated even a loan shark would blush at this rate of interest. I did not slander or for that matter even names the bank that I am referencing. I do not understand why you chose to edit this portion of my post referencing the banks well known practices but you are all to willing to place blame on mortgage and lending professionals with accusations of fraud and misconduct.

    Did fraud and misconduct occur? ABSOLUTELY! And those individuals should be prosecuted to the full extent of the law, but lets not forget those on Wall Street that created the programs and further offered incentives for the production of these loans!

    I am simply a mortgage broker stating facts. You are the journalist, and as a journalist I assumed your posts would not be bias in favor of Lenders. Thousands of readers subscribe and read your posts daily (myself included), if you truly want to provide a service to your readers report the truth, there is no reason for the Banks and Lenders to implement a Fico score requirement on a Government backed program that does not require one. FHA is not a program for the privileged it is intended to help those who do not otherwise qualify for conventional lending. Raise the awareness of this practice through you public outlet and there is hope that this unfair practice could be halted thus allowing thousands to save their homes!

    This is your post, you already edited my last comment so I am anxious to see if you post this commentary, I truly challenge you to do the right thing call the Banks on what they are doing! I do not mean to be critical of your posts, this is your page you can do with it what you like. I served in the United States Marines for 5 years because I love and believe in this country! I believe that all prospective should be given the opportunity to be heard. I truly want to see those who can benefit from FHA be given an opportunity to succeed! God has blessed us with knowledge, knowledge that we need to share with those whom can benifit from it!

  3. Peter G. Miller Says:

    Nat –

    Respectfully, I have explained why banks are layering applications. That does not mean I agree or don’t agree, it’s simply what I see happening.

    As to whether some lenders and loan officers have submitted quirky FHA loan applications, HUD obviously feels the answer is yes and that’s why they have dumped many lenders.


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