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be important to thousands of applicants seeking low-down-payment home mortgages, the Federal Housing Administration has rescinded tough new credit restrictions that had been scheduled to take effect July 1.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, where the aggregate amounts were $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 Some mortgage industry experts estimate that if the now-rescinded rules had gone into effect, as many as one in three FHA loan applicants would have had difficulty being approved.
Under the withdrawn plan, borrowers with collections or disputed unpaid bills would have been required to “resolve” them before their loan could be closed, either by paying them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 The rescinded policy would have replaced more lenient rules allowing loan officers to discuss the accounts with applicants, and determine whether they represented material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 charge off unpaid accounts, then 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 the scales 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” in the mortgage industry.
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. Why? Because they are super-cautious in the post-bust marketplace and 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. According to an analysis by Ellie Mae LLC, a company that tracks conventional and FHA loan originations, the average FICO score for an FHA-approved loan to purchase a house in May was 713. Though down slightly from March, when average FICOs for purchases hit 724, according to Ellie Mae, both scores suggest a strong trend toward financing applicants who have relatively fewer issues in their credit files. 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 — such as the rescinded collections and disputes rule — is “to find a balanced yet flexible approach to promote access to affordable credit while protecting the mortgage insurance fund.” FHA plans to issue a new rule “soon,” agency sources said, that addresses collection accounts and disputes separately rather than lumping them into a single standard.
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 pay off or 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 facts and circumstances of your collections or disputed accounts. This, in turn, will almost certainly slow down your approval. There are exceptions, according to the agency, such as when the disputed account is both less than $500 and more than 24 months old.
But beware lenders’ overlay practices. They may get you turned down even if FHA’s more generous rules say you are acceptable. Kenneth Harney is executive director of the National Real Estate Development Center.