The Changing Face of FHA Mortgages

Halloween is just around the corner, but that isn’t why FHA loans are about to have a whole new face. The housing crisis has caused problems for the FHA, and the mortgage insurer must make some changes to avoid saddling taxpayers with another bailout.

Once the subprime market blew up and disappeared, the FHA became a primary service provider for low-income mortgages by insuring them. Borrowers pay the premiums, and the FHA accumulates the money in its capital fund, which is then tapped to cover losses on the insured mortgages. Unfortunately, cumulative losses from bad loans are depleting that capital fund far too quickly.

Last year, the FHA admitted that its fund had fallen to $3.6 billion as of September 30, a whopping 72 percent lower than it was in the prior year. The fund was well below the required level and was careening down a dangerous path to insolvency.

Tougher rules, higher fees

As a result, the FHA has been mulling over new rules and fee structures since late last year. It looks like the agency is gearing up to approve significant changes to its credit score requirements, monthly and upfront fees, down payment minimums, and seller contribution caps. Here’s a rundown of the most significant proposed changes. 

• Credit scores. The FHA has never used credit scores as one of its approval metrics, until now. It’s proposing to implement a minimum credit score of 500.

• Monthly fees. This charge will likely rise from 0.55 percent of the loan balance annually to 1.5 percent. On a $200,000 mortgage, this change would raise the monthly insurance premium from $92 to $250. 


• Upfront fees. The higher monthly fee will be offset by a lower upfront insurance fee. The FHA has said it will drop its current upfront fee of 2.25 percent to 1 percent. This change reduces the upfront fee on a $200,000 mortgage from $4,500 to $2,000. 


• Down payment. There has been some talk of raising the FHA mortgage down payment requirement from 3.5 percent to 5 percent across the board. However, it looks as though the agency will only raise it for borrowers with credit scores that fall between 500 and 580. These people will pay as much as 10 percent down, which equates to $20,000 on a $200,000 loan.


• Seller contributions. The FHA currently allows home sellers to contribute up to 6 percent of the selling price to an FHA buyer. Typically, the seller would cover some of the upfront closing costs, and additionally make an adjustment to the sale price. Now, the agency wants to reduce this seller contribution cap to 3 percent. FHA policymakers believe that sellers were artificially inflating home prices to award the contribution. Doing so puts the FHA at risk and ultimately costs the borrower more.

This FHA loan makeover is intended to lower the insurer’s risk, while generating higher ongoing revenues. Hopefully it will replenish the FHA’s capital fund before policymakers start pushing for a taxpayer bailout.