New FHA Credit Requirements Turn the Heat Up on Borrowers -- SPONSORSHIP

Ever since the housing crisis hit, homeowners unable to secure loans from private lenders -- which have gone back to requiring the traditional 20 percent down payment -- have relied on government-insured loans offered for as little as 3.5 percent down. Now the Federal Housing Administration (FHA) is tightening its belt by making the credit requirements for such loans more stringent.

In 2009, defaults on FHA loans surpassed 9 percent, up from 6.8 percent the year before. As delinquencies on loans rise, the FHA's largess is contracting. According to the Department of Housing and Development's latest quarterly report to Congress, the FHA's reserve funds --used to make up the difference when borrowers default on their loans -- has slumped to $3.5 billion, from $19.3 billion in 2008.

To account for a potential shortfall, the government agency announced some critical changes in January that will impact homeowners with FHA mortgages and for those hoping to qualify.

Some of the most significant changes relate to borrowers' credit profiles. Here's what to expect:

FHA Establishes Credit Score Minimum

In the past, the FHA did not limit borrowers by credit score; instead, that determination was passed along to the lenders underwriting the mortgages. To qualify for the 3.5 percent down bracket, borrowers now will need a credit score of at least 580. For those with credit scores falling somewhere between 500 and 580, the down payment will more than double to 10 percent. No FHA loan will be issued without at least a 500 credit score.

Lenders Get More Cautious

These days, mortgage lenders are keen to avoid the errors of the bubble years. As a result, they are combing applicants' financial records and credit reports with a diligence verging on paranoia. The new FHA credit requirements will only make them more cautious.

It used to be simple for lenders to get their loans insured by the FHA or guaranteed by Fannie Mae. The only instance in which banks would be required to to repurchase a mortgage was in cases of fraud. "Now, if FHA feels the lender didn't follow guidelines, they can refuse to insure and the lender has to pony up the cash to replace the funds on their warehouse line," Greg Cook, a California real estate broker and mortgage banker, told the San Francisco Chronicle. "Multiple buybacks can bankrupt a small lender."

Credit Reports Receive Closer Scrutiny

The general rules about managing your credit profile prior to a purchase still apply, only now borrowers must be hyper-vigilant. Just because you've been pre-approved doesn't mean you can rest easy. In response to FHA's stricter requirements, many borrowers are demanding clients write letters for all credit inquiries that show up after they apply for a mortgage; the loan will not close unless the client can prove they have taken no new debt related to those inquiries.

In addition, lenders are rechecking borrowers' credit reports right before closing, to make sure no significant changes have occurred since the application was opened. Because of the new FHA credit-score minimums, mortgage applicants should pay off any credit balance immediately, even if it's just a bag of groceries.

All of these modifications are way for the FHA to ensure that their borrowers are more responsible homeowners. In turn, FHA's plan is designed to help the agency to reduce their risks, lower their costs, and sustain the government-subsidized loan program for the long term. With careful planning, qualified borrowers can benefit from the FHA changes, too.

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