FHA loans get dramatically costlier

As of March 3 2010

Home buyers with credit scores below 580 now need 10% down, not 3.5%, and all buyers will pay more insurance up front.

The Federal Housing Administration changed the rules for home borrowers Wednesday morning.  Along with tightening requirements for buyers, the FHA is cracking down on unscrupulous lenders who Commissioner David Stevens implies are responsible for the agency's growing defaults and shrinking reserves.  The agency -- which is growing to become the lender of choice for buyers without sterling credit or 20% down -- has written too many risky loans and now is retrenching.

The FHA is a government insurance company that backs mortgages and refinance loans for lenders that follow its guidelines.  Last year the FHA insured 1.9 million loans, about 30% of the overall market, up from 1.1 million in 2008. More from MSN Money Mortgage terms now in plain English Raise your credit score to 740 Calculate your credit scores in seconds 10 tips on mortgages for 2010 Some mortgage rates are under 5% .

In late December, the FHA was insuring 5.8 million single-family homes -- a total of $750 billion in loans. This is more than half a million of which were "seriously delinquent and heading toward foreclosure."  The FHA's changes were made after an actuarial study took apart the agency's loan books to see where the most money is being lost.

FHA Ups Mortgage Deposits
The biggest change: Starting in spring -- no date was given -- borrowers will have to pay more up front to get a loan, at least for a while.  The FHA is raising its up front mortgage insurance premium from 1.75% to 2.25% of the loan amount. (Home buyers pay for FHA insurance in two ways: through a one-time up front premium and through monthly insurance payments.)  Today, on a $250,000 loan, you'd pay $4,375, or 1.75%, at closing. With the increase, your up front payment would go to $5,625 -- an increase of $1,250.

At the same time, the FHA will ask Congress to raise the lid on the amount it can charge for annual premiums.  Right now, the premiums can't be more than 0.55%, or $1,375 a year, broken into monthly installments, for a $250,000 loan.  The right loan for you Ultimately, the idea is to raise the cost of yearly payments and drop the up front costs back down.  But for the moment, the up front amount is going to grow.

Two other big changes, starting sometime in early summer, are coming as well: •Home buyers will need minimum 580 FICO scores to get loans with only 3.5% down. Borrowers with lower scores will need minimum down payments of 10%. Stevens, the FHA commissioner, said at a news conference Wednesday morning that the FHA's numbers show most defaults are by borrowers with credit scores of 580 or below.
•Seller "concessions" will be reduced from 6% to 3%. Sellers who really want a sale to go through aren't allowed to help buyers with their down payments.  But they can, in effect, reduce a home's price by kicking in money to cover closing costs and upgrades to the home.  The practice lets sellers keep their prices higher while allowing buyers to finance expenses like closing costs and home improvements.  The current level exposes the FHA to excess risk by creating incentives to inflate appraised value. 

While "the vast majority of lenders" participate within FHA guidelines, the focus is on identifying and eliminating lenders whose laxness has driven the agency's losses:  
•A spokesman for the industry said they are planning more-intense monitoring of lenders, including publicly reporting lender performance rankings on the FHA Web site.
•FHA wants congressional approval to clamp down even further, holding lenders liable if they underwrite loans violating FHA policies and standards.  This would require all approved mortgagees to assume liability for all of the loans that they originate and underwrite.
•The Department of Housing and Urban Development, the FHA's parent agency, will also ask Congress for authority to drop lenders from FHA programs when they violate FHA standards at regional offices.  Right now, lenders can break FHA rules in one region and then, when they're shut out locally, move operations to another region.  The changes are necessary, because loan defaults have created losses and shrunk the FHA's reserves below required levels.  The problem would right itself by 2013 without intervention, but the proposed changes should bring the reserves back into line in the next fiscal year.