In a policy switch that could be important to thousands of applicants seeking low-down-payment home mortgages, the Federal Housing Administration has rescinded tough new credit restrictions that had been scheduled to take effect July 1.
The policy change would have affected borrowers who have one or more collections or disputed-bill accounts on their national credit bureau files, with aggregate amounts of $1,000 or greater. Some mortgage industry experts estimate that if the now-rescinded rules had gone into effect, as many as one in three FHA applicants would have had difficulty being approved.
Under the withdrawn plan, borrowers with collections or disputed unpaid bills would have been required to “resolve” them before their loan could be closed, either by paying them off in full or by arranging a schedule of repayments. In effect, if you couldn’t resolve the outstanding credit issue, you might not be able to obtain FHA financing. The rescinded policy would have replaced more lenient rules allowing loan officers to discuss the accounts with applicants and determine whether they represented material risks that the borrower might fail to make the mortgage payments.
Disputed bills are commonplace in many consumers’ files, but may not indicate serious credit risk. Rather, they might simply be a disagreement between merchant and customer over price, quality of the product or the terms of the credit arrangement. Open collection accounts are also common but tend to be viewed more ominously by lenders, since they often indicate nonpayment over an extended period. Unpaid creditors frequently sell the files to collection agencies who pursue the customer and report nonpayments to the national credit bureaus – Equifax, Experian and TransUnion.
Critics of the policy complained that it tilted too heavily in favor of creditors and disproportionately harmed FHA’s traditional core borrowers – low- to moderate-income families, first-time buyers and minority groups. Other critics argued that the policy would not help FHA weed out serious credit risks since private lenders already are doing so by imposing their own credit score and other restrictions on applicants, known as “overlays.”
Clem Ziroli Jr., president of First Mortgage Corp. in Ontario, Calif., noted in an interview that although FHA accepts FICO credit scores as low as 580 – FICO scores run from 300 to 850 with lower numbers portending higher risks of default – many large lenders require 640 scores or higher. They are super-cautious in the post-housing-bust marketplace. They don’t want to be required by FHA to “buy back” a mortgage that had a marginal FICO score at application, then went to foreclosure.
As it is, FHA’s recent average scores are far higher than historical norms. This contrasts with the agency’s long-standing tradition of helping “low to moderate wage earners and the underserved” – often minorities – to buy homes, says Ziroli.
During much of the last decade, FHA routinely financed borrowers with credit scores in the low to mid 600s.
Deputy Assistant Secretary Charles Coulter says the FHA’s ongoing interest in re-evaluating its credit policies is “to find a balanced yet flexible approach to promote access to affordable credit while protecting the mortgage insurance fund.”
Meanwhile, if you plan to apply for an FHA loan and you think you have collections or disputes on file, here’s the good news: You won’t be forced to resolve the accounts before closing, but you are likely to have your application referred for “manual” underwriting, where a loan officer takes a hard look at the circumstances of your collections or disputed accounts. This, in turn, will almost certainly slow down your approval.
