The FHA's balancing act
by Dina ElBoghdady
The Federal Housing Administration lost relevance in the first half of the decade when home prices soared and borrowers turned to easy-to-get subprime loans with lower upfront costs. But as the mortgage market unraveled, borrowers flocked back to the FHA. The agency does not make loans. It insures qualified lenders against losses if borrowers default. Since its creation in 1934, it has collected fees from its borrowers to pay lenders for loans gone bad. In the past year and a half, FHA-insured loans made up roughly 30 percent of all new single-family home purchase mortgages — up from 3 percent in 2006 — and about 20 percent of new refinancing deals.
But as the agency's loan volume expanded, its default rate shot up. The cash reserves the FHA has set aside to pay for unexpected losses have eroded to dangerously low levels. If FHA funds are depleted, taxpayers would have to come to the rescue for the first time in the agency's history. The agency is now trying to protect itself against risk without undermining its key role in propping up the housing market. To that end, the FHA has tightened some standards while loosening others. Here are some of the changes underway.
Upfront insurance premium
What is it? A fee the Federal Housing Administration collects from borrowers that can be paid in cash at the closing table or rolled into the loan.
What's changed? The FHA raised the premium earlier this year from 1.75 percent of the loan's value to 2.25 percent.
Why? The money will replenish the funds FHA uses to compensate lenders for default-related losses.
How does this affect me? If you take out a $300,000 loan, you will now pay $6,750 in premium instead of $5,250. If you roll the premium into the financing, you will also pay interest on it during the life of the loan.
What is it? Refinancing a mortgage for a higher amount than is owed on the loan and taking the difference in cash — in effect, pulling equity out of the house.
What's changed? Borrowers can tap up to 85 percent of the home's current value. Previously, they were allowed to take up to 95 percent of value.
Why? Borrowers can tap up to 85 percent of the home's current value. Previously, they were allowed to take up to 95 percent of value.
How does this affect me? Cash-out deals have become tougher to find. Even with conventional loans, many lenders offer this type of financing only to people with top-notch credit and significant equity.
What is it? The practice of buying a home and quickly reselling it for a profit.
What's changed? On Feb. 1, the FHA suspended a policy for one year that banned FHA borrowers from buying a home if the seller had owned it for less than 90 days.
Why? The goal is to encourage investors to buy poorly maintained foreclosures, fix them up and sell them to FHA buyers as soon as they hit the market. This in turn should help clear the glut of homes for sale.
How does this affect me? This opens up a wider range of properties to FHA borrowers. But inspections must be done to determine whether the home is in working order. If the price of the home is 20 percent higher than what the investor paid, a second appraisal is required to determine whether the increase is justified.
Condominium spot approval
What is it? To purchase a condo in a building that is not FHA-approved, FHA borrowers had to receive "spot approval" for the unit. The process required the condo's management to fill out a questionnaire addressing the agency's must-meet conditions.
What's changed? The agency eliminated spot approval earlier this year. Now, any condo buyer with an FHA loan must stick to an FHA-approved building. A lender, developer/builder, homeowners association or management company can submit a package to the FHA seeking approval. The change was part of a broader initiative to tighten FHA condo policy. Some elements of that initiative have been temporarily loosened through Dec. 31 to try to stabilize the condo market.
Why? Condos are widely considered the market's shakiest segment because they are popular with speculators and financially vulnerable entry-level buyers. A lot of foreclosure-related losses have come from condos, which is why industry policies have forced lenders to look more closely at the makeup of entire complexes before extending loans.
How does it affect me? As part of the temporarily loosened guidelines, the FHA will insure the loans on up to 50 percent of the units in a condo building, though it will back 100 percent if a project meets certain criteria. At least 50 percent of the units in a project must be owner-occupied or sold to owners who plan to occupy the units. As for new construction, 30 percent of the units must be pre-sold before an FHA loan can be financed there.
What is it? Contributions that sellers kick in to help defray a buyer's costs. They can include closing costs, inspections, appraisals and free upgrades.
What's changing? The FHA proposes slashing allowable seller concessions in half, capping them at 3 percent of the home price instead of the current 6 percent.
Why? FHA analyses show a strong correlation between high seller concessions and high default rates, possibly because the concessions can lead to inflated home prices. The theory is that some sellers might make concessions only to add the cost to the price.
What does this mean to me? This buyer's perk will soon become less generous. The proposal does not ban concessions above 3 percent. But concessions exceeding 3 percent would result in a dollar-for-dollar reduction in the home's sales price and reduce the amount of the allowable loan.
What is it? Three-digit numbers that help lenders determine how likely a person is to pay back a loan in a timely manner. The FHA uses the most common scoring formula, called FICO, with scores ranging from 300 to 850. The higher the number, the better the rating.
What's changing? This year, the FHA plans to impose a minimum credit score requirement: 500. Borrowers with credit scores below 580 would have to make a down payment of at least 10 percent instead of the usual 3.5 percent minimum.
Why? Low-scoring borrowers default at a higher rate than more creditworthy ones. As of January, the percentage of FHA borrowers who were seriously delinquent was three times as high for borrowers with scores below 580 than for those with scores above 580.
What does this mean to me? Lenders are already imposing tougher credit score requirements on FHA borrowers than the agency is proposing, which could explain why only 1 percent of borrowers with FHA-insured single-family home loans have scores below 580.
What is it? Lenders must document information about the property (such as its value) and the borrower (such as income, debt, credit score) to assess whether the person is likely to repay the loan. Most lenders typically feed that information into an automated underwriting system for approval.
What's changing? High-risk borrowers whose loans were flagged by the automated system could soon be subjected to a more in-depth manual review by the lender's underwriting staff.
Why? The agency is trying to reduce its exposure to risk by limiting the discretion lenders have in approving loans.
What does it mean to me? Borrowers whose loans are manually underwritten would be required to have cash reserves equal to at least one monthly mortgage payment. Borrowers with credit scores below 620 would be more closely scrutinized. For instance, their overall debt would not be allowed to exceed 43 percent of their income.
What is it? A new program that allows borrowers current on their mortgage payments to refinance into an FHA loan if they are underwater, meaning they owe more on their mortgage than their home is worth.
What's changing? Borrowers who have no equity in their homes would be allowed to refinance into an FHA loan. The FHA would allow refinancing of the first mortgage only. If there is a second mortgage, the two loans combined cannot exceed the current value of the home by more than 15 percent once the first loan is refinanced.
Why? Many people are vulnerable to foreclosure because their home values have plummeted, making them unable to refinance or sell their properties if they lose their jobs or face a financial setback. This programs aims to help them.
What does it mean to me? Refinancing in this manner will probably hurt your credit, and qualifying won't be easy. The lender or investor who owns your existing mortgage must voluntarily reduce the amount owed on that loan by at least 10 percent. Also, you generally must have about 31 percent or more of your pretax income available for the new monthly payment for all mortgages on the property.