FHA has implemented several changes in regards to FHA requirements for mortgage companies to be approved to offer FHA loan programs.  This government finance giant has tightened FHA loan guidelines and made significant initiatives in an effort to reduce the risk of FHA loan defaults and home foreclosures across the nation.

According to HUD Commissioner David Stevens, they have made a concerted effort to enhance the public perception for responsible lending while also boosting FHA loan reserves that act as insurance for non-performing mortgage loans.  It is clear that the HUD Commissioner believes that the entity can carry out their plan to protect the FHA loan reserves that the likelihood of FHA to continue to offer affordable home financing programs is good.  FHA has been helping first time home buyers become homeowners with affordable low rate FHA loans since 1934.  It is no secret that HUD has been concerned that the FHA loan programs was in jeopardy of becoming extinct because of poor loan performance and loan companies pushing their subprime mortgage candidates to the FHA loan products.  A few years ago, FHA loan delinquencies started to increase, but so have defaults for nearly all types of home loan products.  Conventional, jumbo, home equity and even VA loan defaults have all risen over the last few years.  FHA loan policies continued to play an important role in helping our economy rebound as they remain the biggest advocate for affordable home financing and fair lending.

Most home mortgages securitized through Fannie Mae and Freddie Mac will also be eligible for securitization without risk retention. Seeing that Fannie and Freddie are holding over 95% of the mortgage notes in America, this hardly seems like reform.  Glen Corso, managing director of the Community Mortgage Banking Project said “I believe chances are very good that in the future almost every mortgage that Fannie and Freddie either buy or securitize will be qualified mortgages under the risk-retention provision.”   Without an exemption, mortgage companies will have more obstacles when they sell home loans to Fannie or Freddie. Clearly this gives FHA lenders an advantage but doesn’t this make FHA home loans more of a risk?  FHA mortgage rates are at record lows and the FHA defaults have been decreasing, so why Congress would give the Federal Housing Administration a pass on risk is beyond me.  If the FHA loans fail, the American taxpayers are on the hook, thus jeopardizing the FHA loan program.

Notable Changes to FHA Loan Programs

• FHA Streamline Refinance – FHA changed the streamline guidelines to not allow borrowers to refinance lender closing costs.  If borrowers want the FHA streamline, they will have to pay for closing costs out of their pocket.
• FHA Home Loan – FHA increased the down-payment requirements from 3% to 3.5%.
• FHA Cash Out Refinance –FHA reduced the LTV from 95% to 85%, so borrowers who want to receive cash in their refinance must have at least 15% home equity left after the refinance loan.
• FHA 203K – Home Improvement Financing has been expanded for home rehabilitation and energy efficient initiatives.

Delinquencies on FHA-backed loans did increase to 12.4% in May from 11.7% in April, but were lower than the13.6% from the previous year.  Donovan said, “Overall FHA loan performance is somewhat better than was predicted when the actuarial review was completed” in the fall of 2009.” However, the Home Affordable Modification Program (HAMP), offers incentives to FHA lenders to modify loans for distressed homeowners, has been widely criticized because the results have been so poor. The recent HAMP statistics released Monday show that slightly more than 10% of eligible borrowers received a loan modification that became permanent.

The energy efficient home mortgage loan is available to borrowers who don’t necessarily need to refinance, but just need help financing some repairs in the home.  HUD insures the FHA loan for loss on any improvements the homeowner makes. This unique FHA mortgage can be as small as $7,500, or as large as $25,000. While this home improvement financing option is helpful to many Americans, it is not for everyone.  These FHA loan programs pose a higher risk to the FHA lender, so in most cases they will require a higher credit score than other FHA home loan products.

Are FHA Loan Programs at Risk?

As the economy continues to weaken, FHA will likely see more FHA defaults that could drain the FHA reserves even more.  I would expect FHA loan requirements to continue the trend of tightening.  This will limit the number of eligible borrowers to qualify for a FHA refinance that would lower their monthly mortgage payment and prevent home foreclosures for thousands of distressed homeowners.

Most industry insiders are forecasting additional losses because it has a much bigger exposure to housing today than it did when the housing market tanked three years ago.  Even if the HUD continues to amend FHA loan guidelines to stem the FHA defaults, it is likely that the annual audit will uncover the fact that that the Federal Housing Administration continues to operate on low reserves.  Let’s face it, if this great loan program was managed by the private sector the FHA loan program would be shut down.  One bright spot is that the FHA’s finances are performing better than anticipated.  In the last six months, FHA reserves have covered $6 billion that came from the loan defaults, but they had forecasted to pay $8.7 billion for loan defaults. Should we cheer because the FHA loan program is preforming better than anticipated or be critical of a federal loan program that is failing in a failing economy?

Let’s take a look at the FHA loan programs at risk.

FHA 203B – This FHA loan program enables borrowers to get cash out up to 85%.  FHA reduced it 10% from 95% cash out refinancing last year.  It will be interesting to see if the 10% reduction helped reduce FHA loan defaults for borrowers who took cash out when they refinanced their home. 

FHA Streamline – This legendary refinance loan is only for existing FHA borrowers seeking a rate and term refinance.  HUD tightened the FHA guidelines by not allowing borrowers to finance the lender closing costs.  FHA streamlines do not allow cash out and this new rule has significantly reduced the number of FHA streamline refinances in 2010.  My guess is that the streamline program will survive if FHA survives. 

FHA Home Loans – FHA goes hand in hand with first time home buying loans so it’s hard to imagine FHA would eliminate their flagship mortgage product, but if FHA loan defaults continue anything is possible.  In 2009 FHA loan reserves dipped to dangerously low levels, so funding the FHA program must continue to pass through Congress.  Last year FHA increased the down-payment requirements from 3% to 3.5%.  I would anticipate that this will go to 5% sooner rather than later.

To HUD’s credit, FHA loan requirements for FHA lenders have increased dramatically.  These changes were made to further solidify lending and weed out the shady or uncommitted lenders.  As mentioned earlier HUD also mandated significant changes to FHA guidelines.  Down-payment, home equity and cash out requirements were all tightened in 2009 and 2010.   It is my contention that the FHA loan product will survive, but I believe we the tightening of guidelines is far from over.

HUD decided to raise the FHA requirements and make some other changes with FHA guidelines in an effort to prevent the bad mortgages that first the first time since 1934 put the government loan program in jeopardy.  The first change HUD made was to increase the down-payment requirements for home buying.  The new FHA loan requirement for a down-payment was raised to 3.5%.  HUD also limited FHA refinancing to 96.5% rather than 97%.  Then the government agency decided it was not fair to roll lending fees into the FHA streamline loans.  Next change came from FHA lenders who were starting to require higher credit scores.  One good thing HUD did in 2010 was to keep the FHA loan limits unchanged. 

We understand HUD’s moves to minimize the FHA loan defaults, but going away from the FHA credit guidelines and allowing FHA lenders to dictate higher credit scores may significantly reduce its appeal to home buyers and consumers looking to refinance into a more affordable fixed rate.  Credit scores can be very misleading and someone needs to give these borrowers another shot.

The second mortgage relief  initiative will allow some homeowners who are not behind on their home loans but have seen their home values drop, to refinance into FHA loans worth no more than 97.75% of their home’s price. This new FHA loan program is set to start in the fall.  If the borrower has a second lien, the total mortgage debt could not exceed 115% of the property’s value. Homeowners, however, must meet FHA requirements and have a credit score of at least 500. Their new monthly payments would be no more than 31% of their monthly income.

1.  FHA loan defaults have risen dramatically over the last 48 months.

2.  FHA mortgage reserves have dropped to dangerously low levels.

3.  FHA guidelines have tightened significantly and most FHA lenders require a 640 credit score to refinance.

4.  The FHA requirements for FHA streamline programs thus fewer borrowers qualify.

5.  The change in the appraisal policy for FHA refinance loans has slowed the process and increased the closing costs for borrowers.

These 5 obstacles FHA has faced this year has brought forth new challenges for government refinance programs, but HUD maintains they are focused on improving FHA home loans for consumers, while increasing the accountability and FHA requirements for mortgage companies that offer FHA mortgage products. 

FHA mortgage rates remain low with the 30 year fixed available at 5% and the 5/1 ARM available at 4.125%.  The Federal Reserve left interest rates unchanged so FHA rates should continue their trend of affordability. For borrowers with less than perfect credit, FHA introduced a home loan that allows credit scores as low as 580, but requires a higher insurance premium with more equity or down-payment required.  FHA refinance applications dropped last month, but that doesn’t mean Americans won’t reconsider FHA if they loosen the FHA guidelines a bit while keeping the rates at record levels.

Although the FHA default rate has been climbing for months and eating into the agency’s cash, the latest figures show that the FHA’s woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA home loans made in 2007 and 2008. Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made. Most insiders would agree FHA guidelines must tighten.

If the trend continues and the FHA’s cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses — a first for the agency, which has always used the fees it charges borrowers to pay for its losses.  As these FHA mortgage loans from 2007 and 2008 go bad and clear off of the FHA’s books, agency officials said, losses are expected to taper off, aided by the housing market’s anticipated recovery and an influx of more creditworthy borrowers, who have flocked to the FHA’s home-buying program in the past year.  Agency officials said they have cracked down on poorly performing lenders and announced higher qualifying fees for borrowers. On Monday, the agency projected that the fees should generate $5.8 billion in fiscal 2011, up from $2 billion this year. That would fatten the FHA’s cash cushion, used to cover unexpected losses.

For now, just about every major measure of the agency’s financial health is worsening. The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47% more FHA home loans in October and November than in the corresponding period a year earlier, according to an FHA report.   The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26% in the last quarter from a year earlier.  FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency’s troubles with the 2007 and 2008 loans in October, when he told a House panel that “rogue players on the margin” immediately migrated to the world of FHA mortgage lending after the subprime mortgage market collapsed. Their aggressive mortgage lending tactics attracted borrowers with unusually poor credit profiles to the FHA. “That clearly impacted the books of business in 2007 and 2008, and that performance data is showing up very clearly in today’s balance sheet,” Stevens said at the time. Plunging home prices have exacerbated matters by leaving some FHA borrowers unable to sell or refinance their homes because they owe more than their homes are worth. Yet with unemployment running high, many borrowers can’t afford to keep up their payments.

Adding to the trouble was a now-defunct FHA mortgage program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble. The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said. For all these reasons, the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 — the worst rate in at least three decades. The claim rate should be nearly the same on the vastly larger volume of loans made in 2008.