The Federal Housing Administration rescinded a rule that would have forced potential homebuyers to settle ongoing credit disputes of more than $1,000 before getting financing, according to an alert sent to lenders Friday.

The FHA quietly drafted the rule in March to mitigate risks to its emergency fund. The rule went into effect April 1. Borrowers had to either pay off the outstanding balance on collections accounts or document an arrangement to pay before the mortgage was approved.

Industry experts pushed back, particularly homebuilders and lenders with much of their business tied to first-time homebuyers.

Combined with the increasing insurance premiums to bolster an FHA emergency fund on the brink of a bailout, many claimed more business would be pushed to Fannie Mae and Freddie Mac, two mortgage giants the government wants to wind down.

On April 3, the FHA clarified a borrower can be exempted from the rule if the disputed collections account stems from a "life event," such as a medical bill, death, divorce or loss of employment.

Lisa Marquis Jackson, vice president of John Burns Real Estate Consulting, said roughly 25% of the builders they surveyed the week FHA announced the revised rule anticipated either a delay or losing up to 60% of their sales.

"The ripple effects of the FHA credit dispute rule would have had a notable impact on the housing market," Marquis Jackson said.

The FHA delayed the rule a week after it went into effect and said it would take comments from the industry until July.

According to the letter sent Friday, the FHA completely revoked the rule. Any loans written to fit the guidelines in the week between April 1 and April 8 will not be deemed in violation of HUD requirements.

An FHA spokesperson said they are still taking comments on the original proposal.

"We'll issue new guidance very soon," the spokesperson said.

Edward Mills, senior vice president at FBR Capital Markets, said the FHA has to strike a tough balance between helping potential homeowners who cannot get credit elsewhere and protecting the insurance fund.

"FHA killing off the rule is not a surprise when you take into account the resounding objection from the housing finance community and their concern that this would overly constrain credit," Mills said. "This action shows how it can be incredibly difficult to make choices that move towards protecting the insurance fund over keeping mortgage credit available."

jprior@housingwire.com

@JonAPrior