Loan Modification

FHA guidelines: Meeting lender and borrower needs

By Karen Lawson

The Department of Justice (DOJ) has announced a settlement resolving alleged lending discrimination by a major FHA lender. In its announcement, the DOJ notes that a prominent FHA lender is agreeing to pay $2 million to settle allegations that it engaged in a pattern or practice of discrimination against African-American borrowers between 2006 and 2009. In the wake of recent discussions of the practice known as “investor overlay,” where FHA lenders increase minimum requirements for credit scores on FHA loans, this news highlights further concerns about FHA loan underwriting requirements and how (or if) its guidelines can be uniformly enforced without causing liability risk to FHA lenders.

FHA approved lenders need protection against FHA penalties, sanctions

Until recently, FHA did not require a minimum credit score for qualifying potential borrowers for FHA loans. The agency has recently implemented a minimum FICO credit score of 500, which is relatively ineffective as the average FICO credit score for FHA borrowers is approximately 620. How can lenders follow FHA guidelines, while avoiding problems with FHA when FHA loans go south? Although the considerations and arguments are many, it could be helpful for lenders if FHA accepted more responsibility by establishing and enforcing specific requirements designed to protect FHA lenders and FHA from making loans to those who are incapable of making mortgage payments over the long term.

FHA guidelines: Economic conditions call for considering more than credit scores

Raising the minimum required credit scores may be a solution for reducing underwriting risks, but even some of the most qualified consumers have seen their credit scores tank as the result of long term unemployment, foreclosure, and mortgage defaults stemming from their inability to sell homes worth less than the mortgage amounts they owe. Underwriting to a specific credit score seems unfair if borrowers can prove that one event beyond their control caused their credit scores to fall.

Meanwhile, FHA lenders do their best to interpret FHA guidelines while guarding against FHA scrutiny arising from FHA auditors finding errors and inconsistencies with lender loan underwriting or servicing processes for failed loans.

Although imposing concrete requirements for FHA lenders may provide an easy solution, would it work? FHA currently allows lenders some leeway in interpreting its underwriting criteria, and allows prospective borrowers flexible means of proving their creditworthiness. If these policies were to change, it’s likely that fewer borrowers depending on FHA loans would be approved for home loans and refinance mortgages. Should FHA decide to implement stricter and less flexible loan approval guidelines, it would remove some of the burden from FHA lenders who’ve been making their best interpretations of the agency’s ambiguous loan requirements.

Full post as published by FHA Mortgage Guide on December 13, 2010 (boomark / email).