Legal Commentary

FHA Slightly Tightens Loan Requirements

By Jim Lindgren

Instead of letting housing prices find the natural market-clearing price, many in the government have been supporting the efforts of those trying to reinflate the housing bubble.

The Federal Housing Authority (FHA) has been backing up to half of the mortgage market in some locales ? allowing ridiculously low down payments of 3.5%, plus allowing the seller to provide closing costs up to 6% of the purchase price.

Now the FHA is slightly tightening loan requirements:

The Federal Housing Administration will announce more-stringent lending requirements and higher borrower fees on Wednesday to cushion against rising defaults and stave off the need for a taxpayer bailout of the agency.

The FHA, which has taken on a major role in the housing market during the economic downturn, doesn?t lend money to home buyers, but insures lenders against default on loans that meet FHA criteria. In exchange for that backing, borrowers who take out FHA-backed loans must pay an upfront insurance premium, currently set at 1.75% of the total loan amount. The premium can be rolled into the loan.

The FHA is set to raise that fee to 2.25%, the second increase in the past two years, according to people familiar with the matter. The value of the FHA?s reserves to cover losses has fallen to $3.6 billion, about 0.5% of the $685 billion in loans outstanding, down from 3% a year earlier. Congress requires the agency to maintain a 2% capital-reserve ratio. If the larger upfront fee had been in place last year, the FHA would have boosted its reserves by more than $1 billion.

Also to boost the reserve, the FHA will ask Congress to increase a separate insurance fee that borrowers pay annually, people said. If the agency were to run short of cash to cover projected losses, it likely would have to ask Congress for money for the first time ever. . . .

The FHA will keep minimum down payments at the current 3.5% level for most borrowers. But the agency will require riskier borrowers with credit scores below 580 to make a minimum 10% down payment. While the FHA doesn?t have a credit-score cutoff, most lenders require a minimum 620 score. . . .

[Instead of raising the down payment from 3.5% to 5% as some have proposed,] the FHA will reduce the amount of money that sellers can kick in for closing costs to 3% of the sale price, down from the current level of 6%. The higher cap led to abuses where sellers ?heavily marked up the purchase price,? says Lou Barnes, a mortgage banker in Boulder, Colo.

So the FHA is supporting lending at 3.5% down with the seller also providing up to 3% for closing costs. What could possibly go wrong?

Full post as published by The Volokh Conspiracy on January 20, 2010 (boomark / email).