FHA Financing Under Fire

HUD secretary outlines plans for more stringent FHA lending guidelines, igniting financing fears.

SPOTLIGHT ON FHA: HUD Secretary Shaun Donovan is looking at risk-reduction strategies for the program.

Under pressure to shore up the Federal Housing Administration's (FHA) financials, Department of Housing and Urban Development (HUD) Secretary Shaun Donovan warned of impending changes to FHA lending during a Dec. 2 hearing with the House Committee on Financial Services, many of which threaten builders' go-to source of financing for home buyers. The FHA's secondary reserves have fallen below the required level (2 percent of the total dollar value of all the mortgage loans the FHA insures), prompting Donovan and other agency leaders to find ways to both reduce its exposure to defaulting mortgage loans while rebuilding its reserve stockpile. Tucked into Donovan's laundry list of possible risk-reduction strategies are a few changes that builders fear could significantly curb their customers' already limited access to mortgage financing:

  • Raise the minimum credit score for new FHA borrowers. Donovan stated, “We are currently analyzing what this floor should be, including the relationship between FICO scores and down payments.”
  • Reduce the maximum permissible seller concession from its current 6 percent level to 3 percent. Similar to the efforts behind the elimination of seller-funded down payment assistance programs, this proposal aims to remove incentives to inflate home values.
  • Require new borrowers to put more “skin in the game.” Donovan tiptoed around the specifics; however, with a bill proposing to up the FHA down payment requirement to 5 percent of purchase price, from 3.5 percent, under consideration on Capitol Hill, it's clear this larger down payment requirement is squarely on the table.
  • Increase mortgage insurance premiums. Donovan said HUD was requesting authority from Congress to raise annual insurance premiums to help pad the reserve fund, also mentioning that an increase in up-front insurance premiums is an option.
  • Higher minimum credit score requirements mean a percentage of potential would-be home buyers are knocked out of the market. Although fewer qualifying buyers is hardly a good thing for any builder, many builders have said the fallout might be more contained than feared.

    At Oklahoma-based Ideal Homes, a 20-point credit score jump would affect approximately 10 percent of the company's buyers, said Steve Shoemaker, the company's marketing director. “It has an impact,” he said, “But the part of the market it's hitting—it's questionable whether they can buy a home anyway.”

    It was a similar story at Texas-based LGI Homes. CEO Eric Lipar said 7 percent of his company's buyers would've been unable to qualify for FHA financing if the required minimum credit score went from 620 to 640.

    But Lipar said he wasn't sweating the new minimum credit score requirements too much—lenders, more specifically their investors in the secondary mortgage markets, rather than the FHA have largely called the shots when it comes to minimum credit scores through the establishment of credit overlays.

    However, what did have Lipar worried is the idea that some of Donovan's other proposals—the increase in a down payment requirement, the reduction of seller concessions at closing, and the increase in insurance premiums—might go into effect at the wrong time, just as the federal home buyer tax credit expires April 30.

    For example, take a buyer who wants to purchase a $200,000 home. Assume that the down payment requirement was to increase to 5 percent from 3.5 percent, seller concessions were reduced to 3 percent from 4.5 percent, and the FHA's up-front insurance premium goes from 1.75 percent to 3 percent, which Donovan said was the statutory cap. Those changes would mean that the typical buyer of a $200,000 home would have to come up with roughly $8,500 more at closing.

    Others in the industry didn't see some of Donovan's points in quite so dire a light. Josh Denney, associate vice president of public policy for the Mortgage Bankers Association, said several of the proposed changes, namely the higher credit score requirement and the reduction of seller concessions at closing, are just “bringing the FHA more into the norm of lending.”

    However, he disagreed with increasing the down payment requirement. The No. 1 barrier for people to buy a home is a down payment, Denney noted.