FHA to Raise FICO Requirements, Reduce Seller Concessions, Increase Downpayment

The Federal Housing Administration (FHA) is not, as some have claimed "the next subprime," according to remarks prepared for presentation to congress this morning by Housing and Urban Development Secretary Shaun Donovan.

Secretary Donovan told members of the House Committee on Financial Services that FHA, in spite of actuarial reports that its secondary reserve level has fallen below the required two percent to 0.53 percent of its total insurance-in-force, is capable of withstanding the current economic downturn.  The actuary concluded Donovan said that FHA's reserves will remain positive "under all but highly severe economic scenarios."

He said that HUD had learned from recent history, "that the market is fragile, and we have to plan for the unexpected.  That uncertainty is complicated by an organization we inherited that, to be honest, was simply not properly managing or monitoring its risk.  Credit and risk controls were antiquated.  Enforcement was weak.  And our personnel resources and IT systems were inadequate.

"Little of this may have been obvious when FHA's market share was 3 percent as recently as 2006.  But when our mortgage markets collapsed last fall, and homebuyers increasingly turned to the FHA for help, the potential consequences of these lapses in risk management became very clear."

His department, he said, is in the process of drafting new policies to address the quality of FHA's current portfolio, improve the performance of future loans, and restore the capital reserve above its mandated levels.

The agency is looking at several measures to improve the quality of its portfolio going forward.  It plans to reduce the maximum permissible seller concession from 6 percent to 3 percent because the current level exposes the FHA to excessive risk by creating incentives to inflate appraised values.  The change, he said, will bring FHA into line with industry norms and even further reductions may be considered.

The minimum borrower FICO score will be raised although the final number has not yet been determined. (rumor is the min score will be 640 up from 620)  The agency is studying whether new FICO minimums should be accompanied by changes in other underwriting criteria for lower down payment loans.

The up-front cash that a borrower will be required to bring to the table for an FHA-backed loan will also be increased to make sure that borrowers have "skin in the game."  The exact way this will be accomplished is still under study.

These proposed changes, Donovan said, only require administrative decisions on the part of HUD, however, Congress will be asked to pass legislation to increase premiums.  The current up-front premium of 1.75 percent is below the statutory cap of 3 percent but the annual premium is at the maximum.  Raising premiums, he said, is the most effective means of raising capital for the reserve fund with the least impact per borrower.

Donovan said that more than 71 percent of the future losses the FHA is anticipating will come from loans already on its books, so, as MortgageNewsDaily reported on Monday, the agency is taking steps to enforce lender accountability.  Donovan said that, in addition to holding lenders responsible for their origination quality and compliance and increasing reviews of that compliance, lenders will be required to indemnify the FHA for losses resulting from their failures to meet FHA requirements and will be sanctioned nationally for any improper activities rather than through the FHA's current policy of sanctioning individual branches.

The secretary reported that the anticipated changes are merely the latest in a series of improvements FHA has made to shore up its lending activities.

• In 2008, Congress put an end to the practices that led to the most troubled loans in FHA's portfolio - so-called "Seller-Financed Downpayment Assistance" loans. Without these loans, Donovan said, the actuary reported that secondary reserves would have remained above the two percent threshold. "This year, we've taken several additional steps. We've steeply increased enforcement efforts, having suspended seven lenders, including Taylor, Bean and Whitaker and withdrawn FHA-approval for 270 others, including Lend America just this week."

• Credit and risk controls have been tightened. Requirements for the Streamlined Refinance program have been toughened with several improvements to the appraisal process and proposing a rule to increase net worth requirements for all FHA lenders. The latter has just entered the notice and comment period.

• The agency has hired a permanent Chief Risk Officer to provide a comprehensive and thorough risk assessment and ensure that the assumptions going into the agency's modeling reflect the most current economic conditions.

• FHA is working to increase staffing and technical capacity and upgrade our technology systems and delivered FHA's first comprehensive technology transformation plan to Congress in September.

The Secretary detailed the active role that FHA is taking in the current housing market, insuring almost 30 percent of purchases and 20 percent of refinances in the housing market, and financing the majority of minority home purchases.  But, he said, "as important as the FHA is at this moment, I want to emphasize that the elevated role it is playing is temporary - a bridge to economic recovery helping to ensure that mortgage finance remains available until private capital returns."