FHA Tightens rules

Tighter lending requirements for loans insured by the Federal Housing Administration may leave some borrowers unable to get mortgages, but economists are divided on the impact they could have on housing’s recovery.  The changes, aimed at strengthening the FHA’s reserves in the face of rising foreclosures, shouldn’t hurt too many borrowers, officials say.

The FHA is playing a greater role in the mortgage market, insuring about 30 percent of new loans, up from 3 percent in 2007. Growing defaults have cut its reserves below the level mandated by Congress, leading to fears that it might need a taxpayer bailout.

FHA-insured mortgages are attractive to borrowers, however, because down payments are only 3.5 percent. That won’t change under the new policies the FHA announced, which are to take effect in spring or early summer. Among them:

• New borrowers will have to have a minimum credit score of 580 to qualify for a 3.5 percent down payment. Those with lower scores will have to make at least a 10 percent down payment. The average credit score of FHA-insured borrowers is 693.

• Allowable seller concessions will be reduced from 6 percent to 3 percent of the sale price. The change is intended to discourage inflated appraisals.

• Buyers will have to pay an upfront mortgage insurance premium of 2.25 percent of the total loan amount, up from 1.75 percent now. A $150,000 mortgage would require a payment of $3,375, or $750 more.

“It will slow the growth in demand,” says Joel Naroff, of Naroff Economic Advisors. “Any time you put up roadblocks, fewer people will qualify. This is just the beginning of clearer and more specific requirements so we don’t get into the mess we got into again. In the short term, it will have an effect, but it won’t be a huge effect.”

Dean Baker, co-director of the Center for Economic and Policy Research, says he expects the new FHA requirements will have a significant impact on borrowers, especially first-time homebuyers. Those who are denied FHA-insured loans, he says, are usually unable to qualify elsewhere.

“It’s a big deal,” Baker says. “Some will be unable to get loans. This will have a big hit on the market.”

Baker says it’s not surprising that FHA needed to take such steps, because it’s risky for lenders to issue loans with 3.5 percent down during a time of declining home values and rising unemployment.

While the stiffer requirements may leave some borrowers out of the marketplace, some economists say the measures are necessary to protect the FHA from losses.  Lawrence Yun, chief economist at the National Association of Realtors, says very lax lending and FHA insolvency could hurt the housing market worse in the future.  He says he doesn’t believe the requirements will stall the housing market in light of current low interest rates and a federal tax credit for first-time and repeat home buyers.

Mark Zandi, of Moody’s Economy.com, agrees the changes won’t have significant impact.  “It does highlight more broadly that policy support for the market is starting to wane. The tax credit will end in April; now, the FHA rule changes,” he says. “Policymakers are slowly exiting from their unprecedented support of the housing market to see if it can function on its own.”

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