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HUD is seeking public comment on three proposals to help FHA control risk, and stem the losses from claims against the FHA mortgage insurance fund.

  • The first proposal is that FHA require a minimum credit score of 580 in order to eligible for maximum financing, and that no scores lower than 500 be accepted at all. Borrowers with credit scores between 500 and 579 would be required to make a 10% minimum down payment.

In my opinion this change would have very little meaning in the real world outside the bureaucracies. Lenders have already implemented very similar guidelines.

As I have expressed on these pages in the past, excessive reliance on credit scoring is a huge factor in the mortgage industry crash over the last few years. Credit scores were created to predict consumer credit outcomes and aren’t the great predictors of mortgage success that some would have you believe. I believe that credit scores and automated underwriting are too often used as crutches to speed up underwriting and avoid real analysis of the credit risks particular to individual loans. However, the industry is too far down this road to turn around now.

  • The second proposal is to reduce the allowed seller contributions from 6% to 3%.

The rationale behind this change is that appraisals are inflated to cover the difference. This might have been the case at some point in the past, but the idea is almost silly today with all the incredible scrutiny that appraisals now go through. This would only serve to either a) stop some good borrowers from buying at all because they don’t have the extra funds available, or more likely b) put more borrowers with limited reserve funds into homes, thus making the whole transaction more of a risk. Why add something else to slow down the market when the change will likely create more risk instead of less.

  • The third proposal is to “Tighten underwriting standards for manually underwritten loans. When using compensating factors in the underwriting process, lenders will be required to consider those factors which are the best predictive indicators of loan performance, such as the borrower’s credit history, loan-to-value (LTV) percentage, debt-to income ratio, and cash reserves.”

I am quoting all of that exactly because I don’t really understand what it means! I was under the impression this was already the thought process underwriters were supposed to be using.

I’m sure the trouble has been that bad underwriters regularly make the decision blindly that a particular number of compensating factors from the official list are all that is needed for approval rather than a real analysis of the credit profile. As noted above, I would prefer to drop all the credit scoring and automated underwriting and use this common sense old style rule.

Has anyone thought to just crack down on the underwriters making bad decisions rather than trying to leave it up to a bureaucrat with 20/20 hindsight to second guess which factors were more predictive for that particular loan? More than likely this particular rule is geared to leave HUD an out to avoid paying claims by citing violations of this rule. My opinion is that the uncertainty involved here will create an atmosphere in which underwriters overcompensate and more loans get turned down.

Bottom line, the simplest solution to all of this would be to crack down hard on lenders with high default rates. Judge everyone by their results and let the lenders themselves decide how they are going to underwrite. Quit trying to have bureaucrats micromanage things. There isn’t anything in the world a bureaucrat does better than someone in the real world.

Here is the website where you can make your comments until August 13, 2010.

History of FHA


Related posts:

  1. FHA Guidelines: New Risk Based Mortgage Insurance Guidelines
  2. FHA Guidelines Tightened
  3. FHA Guidelines: FHA Down Payment Assistance On The Chopping Block?
  4. FHA Guidelines: FHA Waives Anti-Flipping Rule

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Filed under: FHA guidelines

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