Beginning April 1, potential borrowers with ongoing credit disputes totaling more than $1,000 will not be able to get a mortgage insured by the Federal Housing Administration.
The rule marks a significant belt-tightening at the FHA whereas the adminstration earlier held no such requirement that disputed credit accounts needed to be paid off. Before this rule, a direct endorsement underwriter could determine if any of the borrower's outstanding debts should impact the approval of the FHA-backed mortgage.
After April 1, the borrower must either pay off the outstanding balance on these collections accounts or document a payment arrangement that the lender must then submit to the FHA before closing. The payment arrangement will be counted into the debt-to-income ratio for the new home loan.
Jeremy Radack, a real estate attorney who helps builders in Houston get buyers financed, expects between a 33% and a 50% reduction in FHA originations this year because so many borrowers in the 650 to 680 FICO score range have a past due collections account.
"Take the 750 borrower with a medical collection outstanding from five years ago when they were in college for $5,000. Is that really a bad loan? I don't think FHA looked at how much of their performing borrowers have collections accounts," Radack said. "There are so many other things they could do to mitigate risks to the fund."
The rule excludes disputed accounts from more than two years ago, along with those related to theft. But the lender must document an identity theft or police report on the fraudulent charges.
The unintentional consequences could be severe for those still originating mortgages.
"We expect this revision will certainly kick some buyers out of the marketplace, and we’re in ongoing efforts to quantify how extreme the impact will be," said Lisa Jackson, senior vice president of research at John Burns Real Estate Consulting. "We did a quick sample of some of our builder clients focused on the entry level. They cited impact to varying degrees, with one reporting the new rule would disqualify 60% to 84% of his buyers currently under contract at specific communities."
An FHA spokesman said the rule was designed as another protection for the FHA emergency fund. The fund levels slipped to 0.2% of at-risk insurance last year, well below the 2% mandated by Congress. The FHA will raise insurance premiums on April 1 as well to boost the fund by $1 billion.
"When performing loan-level reviews of FHA loans, we found that many borrowers with mortgage payment delinquencies had prior credit deficiencies including unpaid collections and unresolved disputed accounts prior to the approval of their loan," the spokesman said. "This change was made to eliminate this layer of risk to FHA-insured loans and help protect our insurance fund."
Because of the FHA insurance premium raises to 1.75%, Radack expects the more qualified borrowers to go to Fannie Mae or Freddie Mac loans, which have smaller charges for private market insurance premiums.
"FHA is not going to be in my vocabulary," Radack said.