FHA Hints At Tighter Mortgage Standards

by Peter G. Miller
July 19th, 2010

A curious notice by HUD asks the public to comment on three ways that FHA loan qualification standards might be tightened. Let’s look at them individually:

First, FHA proposes to reduce the amount of closing costs a seller (or other interested party) may pay on behalf of a homebuyer financing the purchase of a home with FHA mortgage insurance.

Nope, this one doesn’t work for me. Back in January HUD announced that it would raise the up-front mortgage insurance premium and said that it also wanted to reduce the maximum size of a seller contributions from 6 percent to 3 percent.

If the idea here is to reduce seller contributions further then we ought to suggest a collective no. Here’s why: The marketplace is many areas is weak. In other areas it’s lousy. The goal at this time should be to encourage as many sales as possible to reduce local inventories of unsold homes. Lower prices is one way to encourage buyers, but so too are seller contributions, especially when you consider that we are not exactly renowned as a nation of savers.

Secondly, FHA proposes to introduce a minimum credit score for eligibility, as well as reduce the maximum LTV for borrowers with lower credit scores.

A good idea, but unnecessary. In May the typical FHA credit score was 698, that’s up from 678 a year ago. Also, HUD announced in January that “new borrowers will now be required to have a minimum FICO score of 580 to qualify for FHA’s 3.5% down payment program. New borrowers with less than a 580 FICO score will be required to put down at least 10%.”

If HUD is saying that it simply doesn’t want certain borrowers — the implicit message of the January announcement — that’s fine. What would not be fine would to ban borrowers with credit scores of say 600 or 620.

Finally, FHA proposes to tighten underwriting standards for mortgage loans that are manually underwritten.

Given the way lenders screwed around with underwriting standards in the private sector there’s little reason to believe that tighter FHA loan guidelines — holding lenders to higher standards — is not without merit.

However, a by-product of tougher underwriting standards will be more requirements for documentation and verifications. More vigorous FHA quidelines will be irritating for some borrowers, but so what. It’s vastly more important to insure the integrity of the lending system, something not done during the glory days of toxic mortgages.

Whether HUD moves forward on these standards or not, it “wins” merely by posting such an announcement. If it goes forward with it’s proposed changes then it gets the tougher standards that it wants. If nothing happens, then you can see lenders and borrowers reading between the lines and understanding that HUD means to enforce FHA loan guidelines to the limit.

For what it’s worth, the betting here is that the second and third standards will be adopted.

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