Credit Scores Still High for FHA

Although loans guaranteed by the Federal Housing Administration can be the best way to buy a home with a low down payment, its lending guidelines are suddenly very strict.

The Neighborhood Watch guidelines mean that the average credit score for a loan guaranteed by FHA is now about 700. This is a sea change from five years ago, when FHA was guaranteeing loans to borrowers with scores below 600.

Making taxpayers obligated to sub-600 credit scores was probably a bit too lenient, but 700 is also a bit outside of the range of good policy. For better or worse, FHA lending is dramatically expanding demand for a home.

The situation reflects a hot potato dynamic: FHA wants lenders to loosen up their credit requirements, but lenders push back and argue that they will not do that until FHA drops the implied threat of the Neighborhood Watch program.

Neighborhood Watch tracks default rates by lender. When a lender has a high ratio of defaults, FHA puts them on a watch list. Once a lender goes on watch, it is only a matter of time before the FHA audits their operations. If the results are troubling to FHA, then the agency demands that it be indemnified for future losses.

The best way to argue that FHA is overstepping is to look at the actual data for seriously delinquent loans. Here are some data points for 2-year FHA in North Carolina, as of November 30th, 2011:

• Overall: 1.95 percent
• Highest rate of delinquency by loan amounts: loans for between $375,000 and $400,000 – 28 percent.
• Rate of delinquency for loans in underserved areas: 2.38 percent
• Refinance: 1.92 percent
• From Bank of America: 2.60 percent
• From Wells Fargo: 1.56 percent

This does not sound like a reason for alarm. Lenders seem to bringing good loans to FHA.

Still, the policy is unfortunate.Plenty of borrowers with moderately blemished credit are still a legitimate risk.

It even serves to make things hard for HUD itself. Today, HUD is trying to sell a glut of foreclosed homes on its books. A realtor recently told me that HUD brings four thousand homes to market in North Carolina every year. “HUD is ready to wheel and deal,” she says. One of the obstacles to getting the best price is that FHA is far less flexible than Fannie Mae. Fannie Mae offers low down payment loans to investors, whereas FHA directs all investors to conventional programs.