Once again this week, FHA loan rates fall to record levels.  Qualified borrowers can qualify for a 30-year fixed rate at 4.25%. Yet, HUD is considering even more changes to FHA guidelines for purchase mortgages and FHA refinance options. HUD has been talking about implementing a minimum credit score requirement of 500 for FHA mortgage loans.  In regards to FHA purchase loans, borrowers with credit scores below 580 would be required to make a down-payment of at least 10% rather than the 3.5%.  Many FHA lenders have already taken steps like these with minimum credit scores and higher down-payments.  In regards to FHA refinancing, many lenders have been requesting more home equity in situations when the borrower’s credit is in question.  FHA credit has always been paramount to FHA lending.

Will a Minimum Credit Score Requirement Hinder the Ability for Americans to Refinance with an FHA Mortgage?

Over the years, FHA credit has been a great alternative to subprime lending because FHA would consider borrowers with low credit scores if they had compensating factors.  These types of FHA loans were manually underwritten and in most cases would be required to have cash reserves equal to at least one monthly mortgage payment.  Rumor has it that HUD is considering reducing the ability for FHA refinance opportunities if the mortgage balance is greater than the home values.

HUD is set to roll out a few new policies that could significantly affect the way some FHA lenders originate mortgages nationally.  FHA invited public comment on several of these policy changes in an effort to bolster FHA loan reserves.   According to FHA Commissioner David Stevens, “Striking the right balance between managing the FHA’s risk, continuing to provide access to underserved communities, and supporting the nation’s economic recovery is critically important ” to FHA’s success.

Congress granted the FHA loan program an exemption that could put the federal mortgage loans at risk. The American Banker reported that the FHA loan volume could see increased market-share boost from regulatory reform, because of exemptions that are tied to FHA mortgage loans.  FHA home mortgages are insured by the government and are fully exempt from the recent landmark legislation risk-retention requirement.  The mortgage reform bill was finalized by the conference committee last week requires mortgage originators to retain at least 5% of the credit risk in loans they securitize unless the assets meet a “qualified mortgage” test. All loans backed by the FHA, the Department of Veterans Affairs or the Rural Housing Service will automatically meet that test.  Senior director of industry relations for IMARC David Kittle said, “FHA loan programs gets a pass.”  Kittle continued, “Does it give them an advantage? Well, sure. Anytime you are carved out of something that can be onerous for everybody else, then certainly you benefit.”

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.

The FHA loan defaults have been rising the last few years and the FHA reserves have dipped to dangerous levels.  The FHA refinance loans continue to play a major role in helping borrowers with adjustable rate mortgages convert to a fixed interest rate loan that provides a more affordable monthly payment.  A lot of work has been done to improve FHA home loan programs and reduce the FHA foreclosures.  The Federal Housing Administration have worked with FHA lenders and it appears they have made the necessary changes in the FHA loan programs to reduce the risky FHA mortgage loans and get back on the path for a healthier financial outlook for this government run mortgage program.  Last fall industry analysts had forecasted weak performance for FHA loans in 2010, but the portfolio performance has been much better.  The Housing and Urban Development Secretary Shaun Donovan made these comments as the Obama administration renewed their commitment to stabilize the housing market.

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 government approved ameasue to increase FHA insurance premiums for FHA home loans.  While this could appear to be a responsible move to bolster FHA lending, it will no doubt prolong the housing crisis, because borrowers will be less likely to buy home if their monthly mortgage payments rise.  To a first time home buyer, raising the mortgage insurance premiums is no different than raising the interest rates because either way, their monthly payment rises. 

The U.S. House of Representatives on Thursday approved a bill to shore up the finances of the cash-strapped Federal Housing Administration while also backing a measure to raise the loan limits for FHA-backed mortgages used to develop some apartment buildings.  In a 406-4 vote, lawmakers approved legislation to strengthen the finances that back the FHA loan programs by giving it authority to nearly triple the annual fees it charges to borrowers, known as mortgage insurance premiums. 

In related news, lawmakers did strike down a proposed amendment to require borrowers who buy a home with a FHA loan to put more money down.  Minimum down-payments will remain still 3.5%, but lawmakers pushed a new plan that would require FHA to examine down-payment requirements every year and submit a report to Congress.  New Jersey Republican Representative Scott Garrett introduced a new proposal to increase the down-payment minimums to 5%.  This provision had not been expected to pass but did force members of the committee to vote against tightening FHA guidelines.  This could pose a political problem for the members who voted against raising FHA lending standards at a time when the mortgage industry is under scrutiny to improve its credibility nationally.  The FHA is required to maintain at least 2.0% in capital reserves, but FHA reserves equal to just 0.53% of the value of the thousands of outstanding FHA home loans that they insure.

The new bill gives the FHA authority to increase annual FHA mortgage insurance premiums that are paid out by the borrower over the term of the home loan to a maximum 1.5%. That’s up from the current 0.55% maximum, though the FHA says that if the measure becomes law it would gradually raise the premium–first to 0.85% or 0.9%.  To become law, the measure still faces approval by the Senate before President Barack Obama could sign it into law. A Senate version has not yet been introduced.  If the FHA is granted authority to raise the annual premium, FHA has said it would lower a separate upfront premium from the current 2.25% to offset those costs. The upfront premium is paid all at once at the time the loan is issued.  HUD has made a concerted effort to tighten FHA home loan programs and it appears they will continue to make changes until the FHA loan default problem goes away. 

Representatives Anthony Weiner, a Democrat from high-priced New York and Republican Gary Miller from high-priced Southern California, sponsored the amendment, approved by voice vote, to increase the loan limits for buildings to be developed into rental apartments. 

FHA Commissioner David Stevens has repeatedly expressed confidence that the agency’s Capital Reserve Account would return to levels above 2% as recent changes to FHA underwriting standards would bring an additional $5.8 billion to FHA coffers.  Since over 75% of the FHA loan business comes from first-time home buyers most of the down payments are made at the 3.5% minimum.  The government has made FHA the center focus in their efforts to help the housing sectors rebound. Since the 2006 mortgage crisis, FHA has increased their mortgage market-share over 30% of for home financing but the FHA reserves have dropped to dangerously low levels.  .

FHA home loans have been an icon for first time home buying since 1934.  This government home financing initiative has been bolstering homeownership for decades with low FHA mortgage rates and fair lending criteria for all Americans.  The Wall Street Journal reported that the Federal Housing Administration is in serious talks with HUD to raise the insurance premium in an effort to raise the dwindling FHA loan reserves.  After FHA loan defaults have dropped for three straight months for FHA mortgage loans.  If that trend holds, the agency could avoid burning through the FHA reserves, which are estimated to fall sharply over the coming years. Still, the FHA’s commissioner, David Stevens, says “there’s plenty of room for caution.”  Clearly, FHA mortgage financing has not recovered enough to not be concerned about it’s future.

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?

After the subprime mortgage crash, FHA took on more lending with their FHA loan programs than any other type of home loan in the mortgage business.  FHA guidelines have always kept an open mind in that they look at the borrower rather just the borrower’s credit score.  This type of underwriting worked great when the FHA loans were performing, but as soon as FHA loan defaults rose to record levels in 2008 and 2009, something needed to be done to the FHA loan requirements to prevent the foreclosures and diminishing FHA reserves. 

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.

FHA loan reserves have become a growing concern for the government mortgage program.  The FHA reserves were finally addressed by the House Financial Services Committee.  Government representatives confronted the challenges of balancing the FHA reserves by revising FHA guidelines so that less borrowers default. FHA continues to play a major role in offering FHA home loans to first time homebuyers.  Even as FHA rates have recorded record low, the reserves have fallen to approximately .53%  of the value of FHA insured home mortgages, well below the legally mandated level of 2%.

FHA reserves are getting dangerously low agian. In an effort to bolster FHA reserves while minimizing the impact on borrowers of FHA home loans, the Committee approved allowing FHA to  raise  the annual mortgage insurance premium from its current level of .55%. This move is designed to move some of the cost of mortgage insurance from the up-front mortgage insurance premium (UFMIP)  paid at closing to the annual portion of the premium, which is pro-rated monthly and added to monthly mortgage payments.

HUD continues to review new proposals to raise the minimum FHA down payment amount from 3.5% to 5% and eliminating seller contributions to buyer closing costs were defeated by the Committee. According to the FHA Loan Pros, “These FHA mortgage proposals may have been well intentioned toward raising FHA reserves, but have endured hardships for the first time and homeowners who depend on FHA  loans” for home buying and lowering interest rates with refinance loans.  HUD has made it no secret of their plan for FHA to begin increasing the annual mortgage insurance premiums from their current rate of .55% to 1.5%.