On July 15th, FHA released the latest policy change proposal to their loan program geared toward boosting their capital reserve by, allegedly, minimizing risk. According to FHA, default risk is compounded when low down payments are combined with low credit scores, high debt to income ratios and low or zero cash reserves. I am awed by their superior powers of deductive reasoning.
While I completely agree that rational lending guidelines are necessary, the benefit of the three proposed changes appear to me to be questionable at best. Two of the three proposals merely give lip service to the idea of risk reduction and the third could actually increase risk (IMHO) by lowering a borrower's available reserves.
The first policy change revolves around credit score. FHA says that only borrowers with a credit score above 580 would be eligible for the regular 3.5% down loan program and that anyone with a credit score between 580 and 500 would have to put 10% down. That sounds like a prudent and well thought out policy change but bear in mind that FHA only insures the loan. Someone else actually funds the loan (puts up the money) and they have something to say about things such as credit scores also. So, when you take in to account that the "large financial institutions in the mortgage industry" (the people that put up the money) introduced a minimum credit score of 580 in 2008 (for all types of financing including FHA) and then raised it to 620 in 2009 this policy change has, for the most part, a net effect of zero.
Policy change number two revolves around underwriting guidelines. FHA is proposing that in manually underwriting loans such things as the borrower's credit history, their income to debt ratio, their housing to debt ratio and their reserves should be looked at. There are a few other things thrown in to this bucket about what the ratios should be and how much the borrower should have in reserve after closing but the main gist is that the lender should strive to determine that the borrower can actually afford the loan. What a novel idea! Again, this sounds like prudent policy but again the net effect of this proposal is pretty close to zero since those "large financial institutions in the mortgage industry" have already gone well beyond this in tightening up guidelines. Ask anyone in the industry, whether it's a real estate agent or a lender, and they'll tell you that it's become almost ridiculously difficult to obtain a loan, any loan. So...
The third policy change revolves around allowable seller paid closing costs and is the one that I believe could actually raise the risk of default by lowering the amount of money the borrower has in reserve after buying a home. FHA is proposing to lower the allowable amount of seller paid closing costs from 6% to 3%. In many instances, a healthy portion of the money the buyer has to bring to closing is actually for their "escrow reserves" which is money put aside by their lender for future property tax and insurance payments. When you take that in to consideration you can see how this reduction would be particularly detrimental in a situation with a relatively low sale price and high property tax and insurance costs. We have that here in Southern New Hampshire to some degree with properties that are still sporting tax assessments born out of the boom years and greatly devalued market prices. I believe that there are other parts of the country that would be just as negatively impacted by this.
The final point is that if you look at a $200,000 sale price, which is in the starter home price range here in Southern New Hampshire, once you add together the 3.5% down payment, the actual closing costs, the prepaids and the escrow reserves, you're talking about something in the vicinity of 14 or 15 grand. I think that's a lot of money for anyone today to be able to fork over but particularly a young person just starting out. In instances where there is "room" for it, I'd rather see the seller pay the closing costs out of proceeds thereby allowing the buyer to keep the extra dollars in their bank account as reserves. If lowering the risk of default is truly the goal, FHA should look at raising the required reserve from the currently proposed one month PITI instead of reducing the allowable seller paid closing costs.
HUD is accepting public comments until August 16th. If you'd like to put your two cents in you can do so at http://www.regulations.gov. You should do it. It'll be cheaper than your closing costs will be if this passes.