Stricter FHA coming

Tuesday, Jan. 19
Written 10:15 a.m. EST

STRICTER FHA: The FHA will get make it more expensive or more difficult for borrowers to get mortgage insurance, possibly this week, the Wall Street Journal reports.

"But raising the credit bar could have a dangerous side effect," the Journal's Nick Timiraos writes. "In many of the nation's hardest-hit housing markets, the FHA backs around half of all new home loans. If the agency pulls back too quickly, the nascent housing recovery could fizzle, endangering the economy."

The Federal Housing Administration insures mortgages underwritten by private-sector lenders. For decades, the FHA charged more for premiums than it paid out in claims. But payouts have exceeded premiums recently, causing the agency's loan-loss reserves to dwindle. Eventually, the FHA might have to ask Congress to pony up a few billion dollars so the agency can continue to pay out claims.

In an effort to avoid begging from Congress, the FHA plans to charge more or to make it harder to get its mortgage insurance. "Options include raising the minimum down payment, establishing a minimum credit score, increasing the amount that borrowers have to pay for mortgage insurance, and reducing the amount of money sellers can kick in for closing costs," Timiraos writes.

Right now, the minimum down payment is 3.5 percent, and I doubt that the FHA will raise that. The federal government wants to stabilize house prices. You can argue about the wisdom of that policy, but the government wants to stop the decline in house prices, and raising minimum down payments would conflict with that goal.

The FHA doesn't have a minimum credit score, but most lenders have established minimum credit scores for FHA borrowers. If the FHA establishes a minimum credit score, it would have minimal effect. But the FHA could establish tiers of credit scores, charging higher premiums to people with the worst credit. It's called risk-based pricing, and I think this is the FHA's most likely course.

As far as reducing the amount of money that sellers can contribute toward buyers' closing costs: Again, such a policy would conflict with the goal of halting the erosion in house prices. It probably would make more sense to limit seller contributions after house prices have begun to rise again.

All of the above options would require congressional approval. In the long run, the FHA needs to ask Congress for more autonomy. It needs to be able to change premiums easily, and to raise and lower minimum down payments as housing cycles dictate. The FHA can make a strong argument with Congress, by pointing out that the agency was powerless to stop seller-funded down payments during the boom years. It repeatedly asked Congress to allow it to ban seller-funded down payments, and it took Congress years to take that action.


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