FHA Ready to Reduce Seller Concessions. HUD Invites Industry Comment Before Implementation

By: Jann Swanson •

HUD is preparing to implement a few new policies that will no doubt affect your pipeline/loan application process.

Last week, HUD and the FHA invited public comment on three of those policy changes, which are part of FHA's strategy to "strengthen their capital reserves".

The proposed changes which are either tweaks to other recent revisions or have been telegraphed by FHA and HUD in earlier Congressional testimony, notices to lenders, or press releases will:

  1. Update the combination of credit and down payment requirements for new borrowers
  2. Reduce allowable seller concessions from six to three percent.
  3. Tighten underwriting standards for manually underwritten loans

FHA has been scrambling to strengthen its financial situation since an audit late in 2009 showed that the capital ratio of its Mutual Mortgage Insurance Fund (MMIF) had fallen below its statutorily mandated threshold.  In recent months the Administration has raised premiums on its FHA insurance, prohibited seller-financed down payment assistance, stepped up enforcement of its regulations, tightened appraisal rules, banned several lenders from writing FHA guaranteed loans and brought suit against others. READ MORE

In announcing the current revisions FHA said it is concerned with the issue of layering risk.  The chance of default is compounded in loans where there are low credit scores, high loan to value ratios, high debt-to-income ratios, and low or zero cash reserves associated with a loan.

Under the proposed requirements for credit and down payments, new borrowers will be required to have a minimum FICO score of 580 to qualify for the popular 3.5 percent down payment program.  Borrowers with lower scores will have to put up at least 10 percent down to qualify for FHA guaranteed financing and those with scores below 500 will not be eligible for FHA guarantees of any type.

FHA said that few borrowers will be affected by the change as lenders themselves have primarily used higher qualifying scores.  In 2009, approximately 93 percent of FHA loans had loan values above 90 percent, and less than 2 percent of those borrowers had credit scores below the proposed credit score threshold of 580.  Those borrowers in the higher LTV/lower FICO category, however, have proven to be unacceptable risks.  Borrowers with LTVs over 90 percent and scores under 580 have a delinquency rate of  30 percent while those in with LTVs up to 90 percent and with scores under 500 have a rate of 35 percent.  Loans given to borrowers above the proposed credit score floors have a rate of 7.63 percent.  Among the comments sought by FHA regarding the above changes is suggestions for acceptable score ranges for lenders using scoring models other than FICO

FHA is considering providing a temporary exception to the credit/down payment changes in the case of a borrower who is refinancing to reduce indebtedness under earlier changes announced by FHA.

FHA has required that seller concessions to borrowers in excess of six percent be treated as an inducement to purchase and that the FHA mortgage amount be reduced accordingly.  The new rule would reduce that allowed concession to 3 percent, with the permitted mortgage amount reduced dollar for dollar where concessions are given above that level.  FHA said that this will bring the rule in line with the guidelines of most conventional lenders.  FHA said it has found that borrowers who had been allowed to take concessions above 3 percent had a significantly higher risk of losing their homes.  For example, loans written in 2008 with no concessions had a claim rate against the FHA guarantee of 1 percent; seller concessions up to 3 percent had a rate of 1.2 percent while those loans with concessions above 3 percent had a claim rate of 1.7 percent.

The third proposed change outlines compensating factors which can be used by lenders to qualify loans that, largely because of a limited or nontraditional credit history on the part of the borrower, may need to be manually underwritten.  Under the change, lenders will be required to consider those factors which are the best predictive indicators of loan performance.

Acceptable compensating factors include:

  • A documented significant decrease or minimal change in housing expense coupled with a documented 12 month housing payment record with no more than one 30-day late payment.
  • Documented significant additional income that is not considered effective income.
  • Documented cash reserves of at least 3 monthly mortgage payments including principal, interest, taxes, and insurance.
  • Special "stretch" debt ratio provisions for Energy Efficient Mortgages.

The comment period ends on August 16, 2010. Here’s how you can provide feedback:

  1. Visit http://www.regulations.gov
  2. Scroll down about 1/3rd of the page and you will see a link for “What’s Hot –Most Visited Regulations”
  3. Click on that link and you will see a list of pending regulation. Select the notice:  “Federal Housing Administration Risk Management Initiatives:  Reduction of Seller Concessions…”
  4. That will take you to a page where the document outlining these changes is available for review.  Towards the top right-hand of the page, you will see a link in light-blue ink that reads “Submit Comment”…click on that link and fill-in your information, and type-in your comment.
  5. Hit “submit” and let your voice be heard.