Loan Modification

Are lender FHA credit scores set too high?

By Peter G. Miller

The debate concerning FHA credit scores and the possibility of discrimination has begun to expand.

The matter got started with a report from the National Community Reinvestment Coalition which alleges that lenders have engaged in discriminatory practices. How?

“Many of the country?s largest financial institutions,” alleges the study, “are refusing to lend under the FHA loan program to consumers with credit scores between 580 and 640, despite the fact that FHA policy establishes a 100% guarantee for refinance and home purchase loans to a credit score of 580 for borrowers with a 3.5% downpayment.”

Specifically, a check of 50 lenders allegedly found that “44 did not lend at a 580 credit score. Thirty two lenders, or 65 percent, refused to lend to consumers with credit scores below 620. An additional 11 lenders, or 22 percent, refused to extend credit to consumers with credit scores below 640. One lender refused to lend to consumers with credit scores below 600. Only 5 lenders, or 10 percent, had policies in place that served the needs of consumers with credit scores between 580 and 620, in accordance with FHA policy and in compliance with fair lending laws.”

“This decision is arbitrary,? says John Taylor, president & CEO of the National Community Reinvestment Coalition, ?because the loans are 100% guaranteed, whether the borrower?s credit score is 580 or 780. That means the loans with lower credit scores don?t pose additional risk to the company, so there?s no legitimate business defense for this across-the-board practice.?

In other words, the FHA has made a decision to insure borrowers with 580 credit scores and 3.5% down. It may not be a great decision in terms of risk, it might be changed, but for now the FHA is putting its money where its FHA guidelines are: a lender who properly makes an FHA loan is fully guaranteed against loss if the mortgage is foreclosed.

Cause and Effect

But aren’t lenders thrown out of the FHA program because of “excess default levels” and, therefore, shouldn’t FHA lenders be allowed to raise credit score levels to a point they find comfortable to protect their interests?

Not quite. An FHA lender in Nevada who plays by the rules is likely to have a higher default rate than a lender in South Dakota simply because of local economic factors. The FHA knows that credit scores and default rates don’t tell the whole story.

?We know that lower credit scores, in and of themselves, indicate a higher risk of default,? says FHA Commissioner David H. Stevens. ?But, as we have discussed with industry stakeholders for months, borrowers with the same credit scores can pose very different risks. For instance, a habitual late payer is likely to pose a different risk than someone who lost his or her job but otherwise has a history of paying their bills on time. It has been well documented that homeownership produces better outcomes for health, education, and long term wealth. Denying responsible families the opportunity to own a home based solely on their credit score is in no one?s best interest and may have a disparate impact on many.?

Full post as published by FHA Mortgage Guide on December 27, 2010 (boomark / email).