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FHA-Backed Mortgages: Could Increased Flagging Hurt First-Time Homebuyers?

First-time buyers could soon have a harder time obtaining a home loan. According to a recent Wall Street Journal article, the Federal Housing Administration (FHA) will begin implementing stricter standards for loan approvals, possibly impacting about 50,000 loans annually.

“We have continued to endorse loans with more and more credit risk,” Keith Becker, the agency’s chief risk officer, told WSJ. “We felt that it was appropriate to take some steps to mitigate the risks we’re seeing.”

The FHA typically insures consumer loans with lower credit score and down payment minimums, allowing more homebuyers to qualify for homeownership. The FHA backing provides lenders with assurance against these less-than-ideal borrowing standards, reducing the level of risk they take on.

A reversal from loosened standards in 2016, the amended TOTAL Mortgage Scorecard states the FHA will now flag more loans as “high risk,” requiring a more comprehensive manual underwriting process to minimize the chances of loan default. The FHA will be looking more closely at mortgages with debt-to-income (DTI) ratios above 43 percent and credit scores under 620.

According to an FHA letter, the decision came in light of multiple factors that signaled risk:

  • In 2018, cash-out refinances increased 60 percent.
  • Borrowers had a DTI ratio of over 50 percent for nearly 25 percent of all FHA mortgages in 2018.
  • The average credit score dropped to 670 in 2018, the lowest since 2008.
  • Loans with credit scores under 640 combined with DTI ratios over 50 percent have increased.

“When updated, lenders submitting mortgages with case numbers assigned on or after March 18, 2019, to the TOTAL Mortgage Scorecard via an automated underwriting system (AUS) may receive feedback results for certain mortgages indicating that they must be manually underwritten. The lender’s final underwriting review decision for those mortgages must be documented in accordance with existing FHA requirements for manually underwritten mortgages,” states the FHA letter.

“Federal Housing Commissioner [Brian] Montgomery has publicly stated numerous times in recent months that FHA must seek the right balance between managing risk and fulfilling its mission of supporting sustainable homeownership. To be successful long-term, FHA must maintain the integrity of its insurance endorsements. This includes assessing the causes of the increase in higher-risk credit characteristics in the portfolio and making prudent and necessary changes to recalibrate and adjust its policies as warranted to manage credit risk,” the letter continues.

The FHA will continue monitoring credit and DTI trends to determine whether additional changes are needed in order to better manage risk, according to the letter.

Liz Dominguez is RISMedia’s associate content editor. Email her your real estate news ideas at [email protected].