FHA to Toughen Mortgage Rules in Lenders Crackdown

Amid rising foreclosures and falling home prices, the Federal Housing Administration is proposing new rules to crack down on lenders and asking Congress for the authority to raise certain borrower requirements, all in an effort to reduce risk to its $685 billion mortgage portfolio.

According to a recently released actuarial study, FHA's secondary reserves have fallen below the required two percent level, to 0.53 percent of total insurance-in-force. 

While FHA Commissioner David Stevens said in an interview on CNBC following that release that the FHA would not need additional federal funding to meet its loan losses, he added that FHA will be looking for new ways to reduce risk.

Those steps will include raising minimum borrower FICO scores, possibly requiring larger downpayments, and reducing the maximum permissible seller concession from six percent currently to three percent. 

It could also include raising annual insurance premiums, which would require Congressional authority. This is according to the testimony HUD Secretary Shaun Donovan is scheduled to present to the House Financial Services Committee on Wednesday afternoon, obtained by CNBC.

In addition to changes for borrowers, Secretary Donovan is proposing increased lender accountability.  

"We will hold lenders accountable for their origination quality and compliance with FHA policies," Donovan will tell lawmakers.  

To that end, HUD will develop a so-called "Lender Scorecard," to summarize the performance of lenders who do business with the FHA.  This is similar to steps taken by Treasury officials, who release a monthly status report on banks participating in the administration's Home Affordable Modification Program.

Secretary Donovan will tell the House panel that he intends to expand enforcement for new loans, including "requiring lenders to indemnify the FHA fund for their own failures to meet FHA requirements, and holding lenders accountable nationally for any improper activities." 

HUD is currently limited to sanctioning only individual branches.  Those requirements would also require Congress to act.

Administration officials have spoken repeatedly of cracking down on lenders, but this is the first time Secretary Donovan has asked Congress for the authority to raise annual premiums, which are currently at the maximum three percent. 

FHA was originally created as a doorway to home ownership for low income borrowers with less than stellar credit.  Last year, 51 percent of African American homebuyers and 45 percent of Hispanic homebuyers purchase homes using FHA financing.  Raising the current premiums and FICO scores may elicit criticism that FHA is straying from its original mission.

FHA, however, has taken on more risk in the past five years than ever before.  It has gone from a bit player, insuring barely three percent of U.S. mortgages in 2006, to almost 30 percent of purchase loans today and 20 percent of refinances.  The vast majority of FHA's purchase borrowers are first time home buyers.

Still, like the rest of the mortgage market, FHA is seeing skyrocketing delinquencies.  The delinquency rate for FHA loans now stands at just over 15 percent, according the Mortgage Bankers Association. 

Foreclosures at FHA are rising as well; this despite the fact that FHA only insures 30-year fixed rate loans with full documentation.  The faulty mortgage products that fueled the subprime boom and subsequent bust were never a part of FHA's portfolio.

Secretary Donovan will tell the House panel that while FHA's role today is crucial to the housing market's recovery, "the elevated role it is playing is temporary."

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(Correction: An earlier version of this story misstated some aspects of the new FHA rules. The higher minimum FICO scores could—rather than would—require larger downpayments. Also, the new rules could include raising the annual insurance premiums but not the up-front premiums.)