The Nation's Housing

New FHA Mortgage Standards Could Shut Out Some Buyers

With More Buyers Burdened by Student Loans, Banks Bracing for Hit to Business

Kenneth Harney

First-time and move-up homebuyers with heavy debt loads, low credit scores and small down payments face a daunting new mortgage hurdle: The Federal Housing Administration is toughening its underwriting standards. Large numbers of applications could be turned down in the coming months as a result. 

Industry estimates vary about the impact of the agencys abrupt changes, but mortgage company executives told me last week that they are bracing for reductions in their FHA business by anywhere from 10 percent to 30 percent. 

Heres whats happening: For several years, the FHA has insured loans to buyers who previously would have been considered too risky or marginal at best. Those applicants often carried crushing monthly personal debts  for credit cards, auto loans, student loans and other obligations  totaling more than half of their monthly incomes. Many also had histories of credit problems that lowered their credit scores. Combined with skimpy down payments of 3.5 percent and minimal bank reserves, these borrowers have a high statistical probability of defaulting on their loans. 

Disturbing Loan Quality Trends 

To prevent big losses to the FHAs insurance fund, the agency recently informed lenders nationwide that from March 18 onward, it would be applying more stringent standards to applications from high-risk homebuyers. In its letter, the FHA documented its reasons for the crackdown. According to FHA Commissioner Brian Montgomery, the agency sees disturbing trends in the quality of loans lenders have been delivering: 

  • Nearly one of every four approved home purchasers had a debt-to-income (DTI) ratio exceeding 50 percent, the worst since 2000. In January, 28 percent of buyers were in that category. 
  • FICO credit scores are tanking. Theyve fallen to the lowest level since 2008  an industry-low average of 670. In the first quarter of fiscal 2019, more than 28 percent of all new purchase loans had FICOs below 640. In the same quarter, more than 13 percent of new loans had scores under 620  19 percent higher than the same period in the previous fiscal year. Average scores for purchasers at giant mortgage investors Fannie Mae and Freddie Mac average around 750. 
  • Borrowers are siphoning equity from their homes at an alarming rate. In fiscal 2018, the FHA saw a 60 percent increase in cash-out refinancing as a percentage of all refinancings. Cash-outs allow borrowers to convert equity into spendable money. 
  • Growing numbers of loans have multiple indications of serious future risk of nonpayment  combinations of low credit scores of 640 or less and DTI ratios that exceed 50 percent. 

Given these omens, FHA clamped down by amending its automated underwriting system. Lenders must now conduct time-consuming manual analysis of every new loan application flagged as high risk. 

Compared with standard automated underwriting, manual processing is far more intensive and entails higher staffing costs and liabilities for lenders. Many balk at it. Some investors refuse to buy manually underwritten loans. As a result, fewer of them make it through the process. 

Expect ‘Substantial’ Reduction 

John Porter, vice president of Mortgage Master Service Corp. in Kent, Washington, predicted that the FHAs abrupt rule change will slash the number of FHA loans approved nationwide by anywhere from 20 percent to 30 percent in the coming months.  

Other lenders believe the decline will be smaller. Paul Skeens, president of Colonial Mortgage Group in Waldorf, Maryland, said a 10 percent dropoff is more likely. But most lenders agree that substantial numbers of borrowers hoping to qualify for the FHAs liberal down-payment and credit terms face rejections they wouldnt have encountered under the old rules. 

Absolutely theyre going to turn a lot of loans down, Skeens said 

Joe Metzler, a loan officer at Mortgages Unlimited in St. Paul, Minnesota, welcomes the stricter standards. 

The FHA has become the dumping ground for crappy [loan] files with ridiculous DTI allowances and bad scores, he said. A lot of it lately has been straight-up subprime. We should not be doing them. 

According to the FHA, nearly 83 percent of its home-purchase loans in January went to first-time buyers. Just under 40 percent went to minorities.  

Those who have the weakest financial profiles  FICO scores under 640 with debt ratios above 50 percent  could be shocked when they go to buy a house this spring. They may have to turn to subprime lenders who charge much higher interest rates, or they may have to simply postpone their purchase until theyre in better financial shape. 

Ken Harneys email address is harneycolumn@gmail.com.