Experts agree that one of the main causes of the financial crisis of the past few years was the ease with which borrowers, especially under- or unqualified ones, could receive a home loan. With mortgage companies granting loans to virtually anyone who wanted one, the seeds were sewn for the current crisis.
One of the main reasons so many loans were originated which are now unaffordable was the prominence of "no doc" or so-called "liar loans". These loans are also referred to as stated income loans because a borrower would state their salary without any formal proof of income. This created a temptation for borrowers to overstate their income in order to receive a larger loan. Once these loans adjusted, however, many homeowners found themselves drowning in interest rates far higher than the original loan.
Since the Dodd- Frank bill passed the Senate earlier this month and was signed into law by the President last week, stated income loans are virtually non-existent in the housing market. By providing documentation, there is reassurance that a loan will be affordable to the borrower. This is consistent with one of the bill's goals - increased oversight by lenders to ensure homeowners can in fact afford the loans given to them.
Recently, the Department of Housing and Urban Development announced that prospective borrowers would be required to have credit scores over 500 to qualify for FHA home loans. However, since the second quarter of 2010 did not see any FHA-insured loans granted to borrowers with a sub-500 credit score the impact of this change should not be dramatic. Furthermore, only 1% of loans given by FHA lenders were granted to homeowners with scores below 580, with 620 being the average bottom score.
So why the regulation change? According to experts, the Department of Housing and Urban Development is looking to align standards with practices already in place. In order to ensure there are no loans slipping through the cracks, as was often the case before the housing market crash, federal standards are being raised so there is consistency, uniformity and stability within the housing market. By increasing standards, FHA loan portfolio risk hopes to be reduced and the reserves backing up the department hope to be boosted.
By protecting the FHA's capital reserves, the government can better manage risk while at the same time continuing to use resources to help aide the nation's economic recovery. The FHA is dedicated to granting loans to underserved communities, and by reserving its funds for those who qualify and can repay, the FHA is ensuring they will be able to continue helping these communities for years to come.
Like most mortgage types, FHA loans have seen an increase in the number of defaults, and this preventive measure is one of a series of changes aimed to decrease the number of unaffordable, risky mortgages. In the month of May, almost 9% of all FHA loans were seriously delinquent, up from 8% a year earlier. This significantly strained FHA reserves, pulling them below the government minimum of 2%. More defaults could further deplete the reserves, which are funded by insurance payments, and further jeopardize taxpayers' money if the program is to be sustained.
Congress has also recently raised the maximum amount people can borrow so that buyers in high housing cost areas can also qualify for FHA loans, which now comprise about 25% of the entire home loan market. The maximum is different depending on the county and state in which a borrower resides because housing markets constantly fluctuate by region. Almost all of the nation's mortgages are now granted through the FHA, Fannie Mae or Freddie Mac, which have famously come under fire in the past few years for needing significant government bailouts in order to continue operations.
The FHA has also announced several other initiatives aimed to reduce the amount of defaults and further protect assets. These include an increased minimum down payment of 10% for borrowers with credit scores below 580 and reducing allowable seller concessions to no more than 3%, with the idea that buyers with more of a financial commitment to their homes will be less likely to walk away in a default. Currently, these ideas are just proposals, but the FHA hopes the new credit score minimum will help further regulate and protect the housing market.
