FHA Loans To Get Costlier

It’s about to get more expensive to take out—and a bit harder to qualify for—a loan insured by the Federal Housing Administration.

Faced with rising losses and falling reserves, the FHA is preparing a series of tweaks to its underwriting guidelines and increase in fees in order to stave off a taxpayer bailout of the traditionally self-funded agency, Shaun Donovan, the secretary of Housing and Urban Development, told Congress in testimony Wednesday afternoon.

Among the changes under consideration:

• Raising the annual insurance premiums that borrowers must pay. This is the easiest place to start, but it would raise borrowing costs for home buyers. The FHA charges an upfront insurance premium of 1.75% of the total cost of the mortgage which most borrowers can roll into their loan, and then they pay additional annual premiums of either 0.5% or 0.55%, depending on their down payment.
• Setting a credit score floor for borrowers. The agency hasn’t decided what that minimum might be, but it says it is looking at requiring borrowers with minimum down payments to have higher credit scores. While the FHA doesn’t currently have a cutoff, most of the nation’s top lenders have instituted a minimum 620 credit score for FHA borrowers.
• Requiring buyers to bring more money to the closing table. The FHA says that it will limit the amount of money that sellers can provide for closing costs on home sales to 3% of the home price, from the current level of 6%. Agency officials say they are also considering potential increases in down payments, but such a move could face heavy opposition from the real-estate industry. The head of the National Association of Realtors says such an effort as would “disenfranchise” FHA borrowers.
• Making FHA-approved lenders more accountable for loans that they submit to the agency. The FHA doesn’t make loans, but it instead insures lenders against losses on loans that conform to its standards. In recent months, the agency has moved more swiftly to expel lenders that it says are putting the agency at risk. For example, on Monday, the agency terminated its approval for Ideal Mortgage Bankers, Ltd. and affiliate Lend America to make FHA-backed loans. Lend America on Tuesday said it would cease operations but that it plans to appeal that decision.

The moves may be too little too late if the economy worsens next year. While the FHA’s independent auditors last month said that the agency wouldn’t run out of money, it did project that the value of its reserves would fall to just 0.5% of the total loan portfolio that it insures. Moreover, around three-quarters of all future losses are expected to come from loans that the agency has already made.

FHA officials say the agency won’t probably won’t need to ask for Treasury money for the 2011 budget, which is being drafted right now. But they say it’s too early to tell what will happen in the years after that.

The FHA largely sat out the subprime boom because its standards were considered too strict. But the New Deal-era agency has seen its market share mushroom to around one-quarter of the U.S. mortgage market, up from 2% three years ago, first as the subprime mortgage market imploded and later as private lenders ratcheted up their standards.

The FHA accounts for more than half of all new home loans in some of the nation’s hardest hit markets. “We should not play this large a role,” David Stevens, the FHA’s commissioner, said in an interview. “It’s certainly not sustainable for the long term.”