FHA-backed home loans are about to become more expensive and harder to get.
The details will be revealed in late January. But this much already is clear: Borrowers will need higher credit scores and more cash at closing to get the lower interest rates and cheaper insurance of FHA-backed mortgages and refinanced loans.
The rules are changing because the Federal Housing Administration is in a financial hole. It's been paying out more to cover defaulted loans than it's taking in from mortgage-insurance premiums. The imbalance has drained agency reserves to 1.5% of the loans it covers -- below the 2% level required by law.
To cure the problem, President Barack Obama's administration has announced it will tighten the screws, making four changes that will hit consumers:
- Increasing the down payment required for an FHA loan.
- Raising the minimum credit score you need to qualify.
- Increasing the cost of mortgage insurance and possibly changing how premiums are collected.
- Decreasing the amount that sellers can pay toward a buyer's closing costs.
"FHA is now making changes which are intended to shore up the strength of the FHA insurance fund," says Scott Stern, the CEO of Lenders One, an alliance of 150 mortgage bankers across the country. He worries that the FHA may be becoming too restrictive.
But, he says: "It's a tightrope. If FHA doesn't tighten its guidelines enough, they risk the existence of the FHA insurance, (the loss of which) would be devastating."
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Why the FHA exists
The agency was created during the Depression to put builders and contractors back to work, keep the mortgage industry going and help keep homeownership affordable.FHA doesn't make loans; it insures them. Anytime borrowers have a down payment smaller than 20%, lenders require mortgage insurance. FHA's mortgage insurance is low-cost, and the agency will insure borrowers that private industry often won't touch. Essentially, FHA insurance lets borrowers -- especially first-time homebuyers -- get homes with low down payments. (Read "Get into a house for just 3.5% down" and "Got 2,500? Buy a house" to learn about using FHA-backed mortgages.)
When mortgages became hard to get a couple of years ago, the FHA "helped when no one else would, when everyone else buried their head in the sand," Stern says. "It's fair to say the very survival of the housing sector in 2007-08 is thanks to FHA."
As the housing bubble expanded, FHA loans took a back seat to cheap, quick, subprime loans, dropping to about 4% of market share in 2005 through 2007 for new mortgages and refinances combined. But once subprime products disappeared in the housing collapse, the FHA's market share grew, to 21% in September 2009.
Here are the changes being discussed and what they could mean to borrowers:
1. Mortgage insurance
Borrowers pay two kinds of premiums for FHA mortgage insurance: an upfront lump sum that's due when the loan closes (currently 1.75% and usually rolled into the loan amount and financed) and monthly payments (0.5% or 0.55% of the loan amount, depending on your down payment).Here's what you'd pay now in FHA mortgage insurance premiums on a $250,000 loan:
- $4,375 (1.75%) at closing.
- $1,250 to $1,375 (0.5 % or 0.55%) a year, broken into monthly installments.
An increase appears certain on at least the monthly charges, based on recent remarks to Congress by Housing and Urban Development Secretary Shaun Donovan.
There's also speculation, says Lenders One's Stern, that the FHA might require the upfront fee to be paid in cash and close off the option of rolling it into the loan.
Stern says that financing option is "one of the primary benefits of FHA."
The cost to you: Higher mortgage insurance premiums will increase your monthly payments. And if you're not allowed to finance the upfront insurance premium, you'll have to produce the entire amount in cash at closing. (Your monthly payments would drop a bit, though, if you couldn't roll the lump sum into your loan.)