FHA Loans – Proposed Changes that Affect Home Buyers

Published by nora | Filed under Buyer / Seller Tips, Market Trends, Mortgage / Finance, Real Estate

Home buyers now need to improve their financial situation and their credit scores before pursuing their home purchase plans, as the U.S. Housing and Urban Development Department has proposed three policy changes for home loans backed by the Federal Housing Administration.

In the middle of July, the HUD released a notice soliciting public comment for a period of 30 days on the changes, which are intended to help the FHA reduce its risk and sustain its ability to help families achieve their homeownership dreams through affordable loans.

The three proposed policy changes are the following:

    1. Reduction of Seller Concessions from 6 to 3 Percent

Seller concessions are amounts of money that sellers contribute to help cut down buyers’ costs. These can be payments for home inspections or appraisals or can be portions of the total closing costs. They can also include free upgrades.

Because the FHA has determined that bigger seller concessions mean higher home prices and higher default rates, it has decided to lower the allowable percentage to three percent of the home sales price, which is closer to industry standards.

      2. Higher FICO Credit Score Requirements

Borrowers applying for FHA loans are now required to have a FICO score not lower than 580 in order to qualify for the low down payment requirement of only 3.5 percent. Those with credit scores that range from 500 to 579 will have to make a down payment of ten percent or higher. Prospective borrowers with FICO scores lower than 500 are no longer qualified for FHA loans.

The FHA has found that as of the first month this year, the default rate for borrowers with FICO scores lower than 580 is three times the rate for borrowers with scores higher than 580. By tightening credit score requirements, the FHA hopes to cut down its default rate significantly. Nonetheless, before the release of the FHA proposals, many lenders have already been approving only home loan applications from borrowers with scores of 580 or higher. Records show that only one percent of owners of FHA-backed single-family homes have FICO scores lower than 580.

     3. Tighter standards for home loan underwriting

When underwriting, mortgage lenders are now strictly required to use factors which can best predict the performance of home loans, such as loan-to-value ratio, cash reserves and loan applicant’s credit history. The financial activities of borrowers with FICO scores lower than 620 would be more thoroughly scrutinized and the overall debts of borrowers, including their home loans, should not be more than 43 percent of their monthly incomes.

As the volume of FHA loans shot up from only 3 percent of all single-family mortgages nationwide in 2006 to about 30 percent in 2009, the default rate spiked. To sustain its operations, the FHA needed to implement the changes described above.