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Lower credit scores for FHA loans?

by Peter G. Miller
February 7th, 2011

Late last year we described the growing issue of lender layering, the process of adding qualification requirements above FHA guidelines. As an example, rather than needing a 580 credit score to get an FHA loan with 3.5 percent down a lender might require 620 or 640.

The issue arose when the National Community Reinvestment Coalition alleged that lenders were engaging in discriminatory practices when layering FHA loans.

The logic of the NCRC complaint goes like this:

Because FHA loans are 100-percent insured there is no additional risk to the lender when using the FHA credit score requirements.

“This decision is arbitrary,” says John Taylor, president & CEO of the National Community Reinvestment Coalition, “because the loans are 100% guaranteed, whether the borrower’s credit score is 580 or 780. That means the loans with lower credit scores don’t pose additional risk to the company, so there’s no legitimate business defense for this across-the-board practice.”

The catch, said the NCRC, is that the use of layering with FHA loans is also discriminatory because as credit score requirements are raised members of minority groups are less likely to qualify for financing.

In response, HUD launched an investigation of 22 lenders in December.

One of the lenders not named in the NCRC report was Quicken Loans. However, Quicken says that while it has demanded higher credit scores than required by FHA rules, it’s now changing that practice:

“In an effort to make homeownership possible and more affordable for families across the country,” says Quicken, it has announced that it has “eased the minimum credit score necessary to qualify for an FHA loan to 580. This change allows more consumers to qualify for an FHA loan, as previous guidelines required a minimum credit score of 620.”

“There are folks who have steady incomes, and a solid payment history but were temporarily affected by the economy or a life event in some way. These challenges can lower their credit score significantly. We believe that a credit score, on its own, is not the sole arbiter of a person’s credit worthiness,” said Bob Walters, Chief Economist at Quicken Loans. “This change will open up credit to a significant group of people and allow them to again have access to purchase or refinance a home.”

Quicken points out, correctly, that more than appropriate credit scores are required to obtain an FHA mortgage or any mortgage, including down payments, certain debt-to-income ratios, etc.

The move by Quicken essentially will end FHA layering. The reason is that other lenders cannot possibly claim layering is required when Quicken — which says it’s “the nation’s largest online retail mortgage lender and among the five largest overall retail home lenders in the United States” — makes loans without such a requirement.

As to the NCRC, it ought to be congratulated for making the FHA loan process more open to everyone.

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