FHA guidelines: Meeting lender and borrower needs

by Karen Lawson
December 13th, 2010

The Department of Justice (DOJ) has announced a settlement resolving alleged lending discrimination by a major FHA lender. In its announcement, the DOJ notes that a prominent FHA lender is agreeing to pay $2 million to settle allegations that it engaged in a pattern or practice of discrimination against African-American borrowers between 2006 and 2009. In the wake of recent discussions of the practice known as “investor overlay,” where FHA lenders increase minimum requirements for credit scores on FHA loans, this news highlights further concerns about FHA loan underwriting requirements and how (or if) its guidelines can be uniformly enforced without causing liability risk to FHA lenders.

FHA approved lenders need protection against FHA penalties, sanctions

Until recently, FHA did not require a minimum credit score for qualifying potential borrowers for FHA loans. The agency has recently implemented a minimum FICO credit score of 500, which is relatively ineffective as the average FICO credit score for FHA borrowers is approximately 620. How can lenders follow FHA guidelines, while avoiding problems with FHA when FHA loans go south? Although the considerations and arguments are many, it could be helpful for lenders if FHA accepted more responsibility by establishing and enforcing specific requirements designed to protect FHA lenders and FHA from making loans to those who are incapable of making mortgage payments over the long term.

FHA guidelines: Economic conditions call for considering more than credit scores

Raising the minimum required credit scores may be a solution for reducing underwriting risks, but even some of the most qualified consumers have seen their credit scores tank as the result of long term unemployment, foreclosure, and mortgage defaults stemming from their inability to sell homes worth less than the mortgage amounts they owe. Underwriting to a specific credit score seems unfair if borrowers can prove that one event beyond their control caused their credit scores to fall.

Meanwhile, FHA lenders do their best to interpret FHA guidelines while guarding against FHA scrutiny arising from FHA auditors finding errors and inconsistencies with lender loan underwriting or servicing processes for failed loans.

Although imposing concrete requirements for FHA lenders may provide an easy solution, would it work? FHA currently allows lenders some leeway in interpreting its underwriting criteria, and allows prospective borrowers flexible means of proving their creditworthiness. If these policies were to change, it’s likely that fewer borrowers depending on FHA loans would be approved for home loans and refinance mortgages. Should FHA decide to implement stricter and less flexible loan approval guidelines, it would remove some of the burden from FHA lenders who’ve been making their best interpretations of the agency’s ambiguous loan requirements.

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One Response to “FHA guidelines: Meeting lender and borrower needs”

  1. Nathan Reynolds Says:

    Wow! Now I’m No Prophet, but…I wrote a response to a previous article with this very topic back in July 2nd of 2009 and kinda felt as though my insight had been dismissed, so I wrote this response below. I guess I’m not Chicken Little after all!

    One Response to “Will The FHA Spigot Be Closed Off?”
    Nathan Reynolds Says:
    July 6th, 2009 at 10:18 am
    Thank you for posting my comments on your recent article. I felt it was very important to get the word out on this current trend. I do want to comment further on your response as I respectfully disagree with your conclusion!

    I am a mortgage broker and because I applied and was approved by HUD to offer FHA loans I am considered an FHA approved “LENDER”. This title causes confusion to many when you reference FHA “LENDERS”. Many of the “Lenders” you referenced are in fact 3rd party loan originators that failed to meet the standards established by HUD to maintain their License and were therefore fined or had their ability to offer FHA insured mortgages terminated. HUD has an excellent system of checks and balances in place to avoid the very same outcome of the unregulated mortgage industry.

    The “Banks” (I prefer not to name names, but your readers know) that wholesale the loans are the ones that are raising the eligibility standards. Although “Banks” have the ability to manually underwrite FHA mortgage loans applications very few are opting to do so due to the risk of having underwritten an uninsurable FHA loan. The majority of all FHA loan applications are underwritten in strict accordance to FannieMae Desk top Originator automated findings. This software renders a decision based on the homeowners credit worthiness, income, assets, and home value. This automated underwriting decision is Black and White, there is no room for variance. All the Bank/Lender has to do is verify all of the required documentation per the automated approval.

    This being the fact, I ask you where is the additional risk that justifies the tighter standards that Banks are imposing on homeowners? These are not Sub prime borrowers that need stated loans; these are income qualifying full documentation borrowers with equity and reserves that qualify for a mortgage in accordance with FHA underwriting guidelines that desperately need relief from their high interest rate adjustable rate mortgages now!

    So why have the Banks chosen to disqualify eligible homeowners based on a Fico Score? And if a homeowner does meet the Banks minimum required Fico Score, why do they impose additional risk based pricing for the very same homeowner effectively pushing the interest rate higher? Millions of eligible homeowners are not being afforded the opportunity to succeed in a low fixed rate FHA mortgage.

    FHA isn’t a 1st class ticket on an airline for the rich; it was intended as a vehicle for the working class!

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