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FHA Loans Offer New Avenues – While Closing Others

by James Bellandi

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In an effort to regain the share of loans that the FHA has lost the last couple years, the agency has put a new policy into effect that would allow for aspiring homebuyers with lower credit ratings to get an FHA loan.

The new policy revamps the FHA’s evaluation of ‘high-risk’ loans, or loans below a 580 credit score. The FHA judges lenders using a statistical evaluation system. Previously, the system would penalize banks and mortgage companies that took on too many “high-risk” loans, based on their FICO credit score, when compared to other banks in the same geographical area.

The change alters what the system looks for, and does not outright punish companies who would take on borrowers with lower credit scores. FHA loans are set into two tiers – 580 and above for maximum financing with at least 3.5 percent down, and 579 and below at 10 percent down with a 90 percent loan to value ratio – and lenders would very rarely take on the latter tier. Even with the policy change, the decision ultimately falls on the lenders, who will have to decide whether or not they want a higher risk loan. Interest.com reported that, in fall 2014, the average credit score for successful FHA applicants was 683, and the average credit score for rejected applicants was 659.

The FHA’s market share has been on a roller coaster since the downturn. The FHA’s share of loans rose from 6 percent in 2007 to 40 percent in 2010, as tight lending in the conventional market pushed more consumers to the agency. However, thanks to stricter guidelines for FHA loans due to fears of defaults, the share of people who could get FHA loans dropped drastically after that initial surge, ultimately bottoming out at 23 percent in the beginning of 2015.

Will New Restrictions Dampen High-Risk Regulation?

While the FHA has eased its high-risk process, other regulations have been tightened. For instance, if consumers experience employment gaps of six months or longer (including raising kids), they must then work for at least six months before they can apply for an FHA mortgage. Additionally, deferred student debt is now being treated as normal debt when looking at debt-to-income ratios.

That final change could hurt Millennials coming out of college, who are likely saddled with student debt. Twenty-nine percent of Millennials delay purchasing a home because of student debt, according to a recent Bankrate survey. The share of first-time homebuyers who use FHA loans has held consistently around 80 percent since 2001, according to an Urban Institute study.

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