FHA Guidelines: Proposal Would Increase Downpayment, end Financing of Closing Costs

by Karen Lawson
October 2nd, 2009

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In a move intended to reduce taxpayers’ exposure to losses associated with defaulted FHA loans, legislation is being proposed that would tighten FHA loan requirements:

The minimum down payment would increase from 3.5% to 5% of the loan amount.
Closing costs would no longer be permitted to be “rolled into” the loan amount.

This would mean that potential homebuyers would need to have more cash available for coverin these costs. The principle concern behind these proposed changes is that lenient lending requirements can encourage people to take out home loans they;re not prepared to pay over the long term.

Demise of “Sub-Prime” Lending Increases FHA Market Share

As mortgage lenders have restricted sub-prime lending and ceased offering mortgage loans with exotic terms including negative amortization and interest only payments, more and more homebuyers are turning to FHA for affordable mortgage loans. Low down payment requirements and the ability to roll closing costs into the mortgage amount can help cash-poor homebuyers purchase a home. Critics argue that creditworthiness is in part determined by meeting higher down payment requirements; borrowers who have little investment in their homes may be more inclined to walk away during hard times. As FHA’s reserves decrease as the result of paying mortgage insurance claims resulting from mortgage foreclosures, Congress may be required to act if reserves fall below minimum required amounts.

During 2008, FHA insured home loans accounted for about 21 percent of the market as compared to less than 5 percent of the market during 3005 and 2006, when sub prime home loans were widely available. As mortgage credit requirements have become increasingly stringent, homebuyers are turning to FHA for home loans. Congress is concerned that if increasing numbers of FHA loans “go south,” taxpayers will be footing the bill for paying mortgage insurance claims filed by lenders.

Federal Reserve Chairman Ben Bernanke noted at a recent hearing that FHA remains the primary source of mortgage loans requiring less than a 20 percent down payment, and is assisting people who would not otherwise be able to buy homes. It appears that FHA could be caught between a rock and a hard place in terms of weighing the risk of making riskier home loans against serving those who want to buy a home, but can’t meet conventional lending requirements.

FHA is awaiting the results of an actuarial study that is expected to shed light on potentially increasing risk due to insuring more lenders against foreclosure losses. In the meantime, if you’re sitting on the fence, this could be a good time to find out if you’re eligible for an FHA home loan. Interest rates remain low and FHA guidelines have not yet changed.

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