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FHA & Credit Score Changes

by Peter G. Miller
September 15th, 2010

In August I wrote about credit score standards and how they were changing in practice as well as by regulation. Now we have new FHA guidelines which say that after October 4th you won’t be able to get an FHA loan with a credit score below 500, regardless of how much you put down.

The new standards look like this:

___ Borrowers with a minimum decision credit score at or above 580 are eligible for maximum financing (that is, loans with 3.5 percent down).

___ Borrowers with a minimum decision credit score between 500 and 579 are limited to 90 percent LTV (10 percent down).

___ Borrowers with a minimum decision credit score of less than 500 are not eligible for FHA-insured mortgage financing.

___ Borrowers with a non-traditional credit history or insufficient credit are eligible for maximum financing if they otherwise meet FHA guidelines.

___ Borrowers using 203(h), Mortgage Insurance for Disaster Victims, are eligible for 100 percent financing and no downpayment is required, provided that the borrowers have a minimum credit score of 500 (borrowers with decision credit scores below 500 are not eligible for FHA financing).

Loan Limits

Nothing in the HUD notice should be surprising or hard to figure out. Folks with weak credit (a polite expression) should not be able to get a mortgage from the FHA. Or, to go further, from any mortgage lender.

The thought here is not to be exclusionary but to deal with the reality that a loan is something which must be repaid. In the same way that borrowers should rightfully have certain expectations with lenders, lenders — and mortgage insurance programs — should rightfully have certain expectations when dealing with borrowers.

As I tell folks, this is the “good for the goose, good for the gander” standard that I often employ.

FHA credit scores are now averaging a respectable 695, that’s up from 662 a year ago. It’s difficult to imagine too many people getting FHA loans with credit scores below 600 in today’s world.

I would actually prefer to see loans individually underwritten on the basis of loan applications, credit scores and relationships with lenders. Marginally qualified borrowers in such circumstances might catch a break.

But such a process reflects how mortgages used to be made, something archaic in the new world of automated credit scores and secondary markets where loans are instantly bought and sold. As well, the old system could easily be discriminatory — and often was.

The combination of a low credit score and a 10-percent down payment is unlikely except for those named in a will or who recently won the lottery. Effectively, HUD is seeking to re-shape the mortgage market by requiring borrowers to demonstrate more financial responsibility and credit capacity. That’s a reasonable standard, especially given the loose guidelines outside the FHA program which lead to massive foreclosures and economic distress during the past few years.

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