FHA is Changing - What You Need to Know
Late last year, the Federal Housing Administration reported their reserves had dropped below 2%. News that reserves had dipped below the Congress-set minimum spawned a call to bolster the weakening FHA.
Currently a vast majority of new home buyers purchase their first home with FHA loans. Any changes to the FHA will undoubtedly affect this huge group of potential new buyers. While no modifications have been announced yet, the National Association of Realtors claims this week we will see major changes to the program. This announcement comes after months of delay. And, while Congress and the powers that be have the best intentions, the proposed alteration has caused concern within the real estate community and prospective home buyers.
It is said the goal of any FHA modifications would be to improve loan quality, increase mortgage insurance premiums, change requirements for lender eligibility, and overhaul the FHA’s approach to risk management.
Here is a break down of current and proposed new FHA guidelines from the buyer's perspective…
Current FHA Borrower Guidelines:
- 3.5% minimum down payment
- Money may be gifted at any amount
- Borrower can ask for up to 6% closing cost credits from the seller
- Minimum credit score of borrower: 620
- Up-front premiums are currently 1.75%
- Up-front insurance premiums (MIP) can be financed
Possible New FHA Guidelines:
- 3.5% minimum down payment - remain the same or slightly higher
- Money may still be gifted
- Reduction of closing cost credits (seller concessions) to as little as 3%
- Higher credit score requirement
- Raise up-front premiums to 2.25%
- Borrowers may not be able to finance up-front insurance premiums any more
- Implementation of loan-to-value maximum based on credit score
Let's discuss a few of these changes…
Down Payment
First of all, the down payment requirement of 3.5% has been one of the most attractive features of FHA loans. Combined with closing cost credits of up to 6% of the loan value, a buyer could essentially buy with almost no money out of pocket. This seems great from the buyer's perspective however starting off upside down on a mortgage is a scary concept to those who look at the bigger picture, especially given that thousands of similar loan scenarios are written every day.
Closing Cost Credits
As it stands, a borrower can ask for up to 6% closing cost credits from the seller. If the closing costs do not equal 6% of the purchase price, a borrower is not entitled to the remainder. That is, there is no "keep the change" provision. Currently, at least in the Chicago market, it is rare that closing costs would go anywhere near the 6% mark. As such a reduction to 3% would only affect a portion of those seeking FHA loans. This is due to two reasons: 1.) Not every negotiation results in closing costs being granted to the seller; and 2.) When they are, not all negotiations result in the full 6%. Those who would have benefited from the 6% will be the most significantly impacted, and in some cases, may not be able to move forward with their purchase.
Higher Credit Score Requirements
Right now there are some potential home buyers that have a lot of money to put down but, for one reason or another, have acquired blemishes on their credit report. So they do not qualify for a conventional mortgage despite their large down payment. Currently, these types of people have one way to go – FHA. If the minimum credit score is raised, it is conceivable that a buyer looking to put down say 30-50% may not be able to qualify for a mortgage because of that $200 medical collection they've had since college, or the divorce they had two years ago, etc. While it is true that credit improvement efforts may be enacted, many of those efforts may not come to fruition in time for the buyer to take advantage of the low prices and interest rates that are motivating them to buy now.
Loan-To-Value Ratios Based on Credit Score
While the motivation behind this change is understandable, it may have similar effects as the previous example by eliminating home buyers that had an unfortunate event lower their credit score but not diminish their ability to pay a mortgage. Unfortunately, there are any number of credit-damaging scenarios that have nothing to do with someone’s capacity to pay their bills. And this modification could prevent those people from obtaining the one type of loan that could get them in a home.
Increase MIP and Elimination of the Ability to Finance MIP
The MIP is basically the FHA's version of mortgage insurance. As it currently stands, the borrower may finance this expense and therefore does not have to come up with this money out of pocket. The proposed change would not only increase this expense by half a percent, it would take away the borrower's ability to finance the expense. It goes without saying this would eliminate potential new home buyers with insufficient capital to close.
Over all, these changes mean one thing for the borrower and potential new homeowner: MUCH higher out-of-pocket expenses. On the other hand, it also means a much more secure future for the FHA program, and therefore a more stable and accountable system for those who still qualify. It is hard to deny the importance of a more stable housing sector. That said, buyers, sellers, Chicago real estate agents, and mortgage brokers should prepare themselves for the above modifications and other yet-to-be-announced changes that will ultimately alter the playing field.
The changes may only be temporary to pull the FHA out of its sagging financial situation. But they're not making any promises one way or the other. And whether or not FHA adjustments will be enough to slow down an already struggling housing market also remains to be seen.
Posted at 04:30PM Jan 20, 2010 by Bob Billimack in General Comments[0]
