First-time and move-up homebuyers with heavy debt loads, low credit scores and small downpayments face a daunting new mortgage hurdle: The Federal Housing Administration (FHA) is toughening its underwriting standards.
Large numbers of applications could be rejected in the coming months as a result. Industry estimates vary about the impact of the agency’s abrupt changes, but mortgage company executives have told me that they are bracing for reductions in their FHA business by anywhere from 10 to 30 percent.
Here’s what’s happening: For several years, the FHA has insured loans to buyers who previously would have been considered too risky or marginal at best. Those applicants often carried crushing monthly personal debts totaling more than half of their monthly incomes. Many also had histories of credit problems that lowered their credit scores. Combined with skimpy downpayments of 3.5 percent and minimal bank reserves, these borrowers have a high statistical probability of defaulting on their loans.
To prevent big losses to its insurance fund, the FHA recently informed lenders nationwide that from March 18 onward, it would be applying more stringent standards to applications from high-risk homebuyers. In its letter, the FHA documented its reasons for the crackdown. According to FHA Commissioner Brian Montgomery, the agency has been seeing disturbing trends in the quality of loans lenders have been delivering to it:
Nearly one of every four approved home purchasers had a debt-to-income (DTI) ratio exceeding 50 percent, the worst since 2000. In January, 28 percent of buyers were in that category. FICO credit scores are tanking. They’ve fallen to the lowest level since 2008 – an industry-low average of 670. In the first quarter of fiscal 2019, more than 28 percent of all new purchase loans had FICOs below 640. In the same quarter, more than 13 percent of new loans had scores under 620 – 19 percent higher than the same period in the previous fiscal year.
Borrowers are siphoning equity from their homes at an alarming rate. In fiscal 2018, the FHA saw a 60 percent increase in “cash-out” refinancing as a percentage of all refinancings. Cash-outs allow borrowers to convert equity into spendable money. Growing numbers of loans have multiple indications of serious future risk of nonpayment – combinations of low credit scores of 640 or less and DTI (debt-to-income) ratios that exceed 50 percent.
Given these omens, the FHA clamped down by amending its automated underwriting system. Lenders must now conduct time-consuming “manual” analysis of every new loan application flagged as high-risk.
Many balk at it. Some investors refuse to buy manually underwritten loans. As a result, fewer of them make it through the process.
Copyright © 2019 Washington Post Writers Group, Kenneth R. Harney; Richmond Times-Dispatch, Richmond, VA. Kenneth R. Harney heads his own consulting firm in Chevy Chase, Md.