Published on Inman Select Real Estate News
December 23, 2015
Our government created the FHA Mortgage Insurance Program right after the Great Depression, to encourage banks to lend to people who have less-than-perfect credit. More recently, the FHA Mortgage Insurance program was used during the Great Recession to cushion the loss of subprime lending. FHA was never meant to insure loans for people with a bad credit history and it was also never meant to insure loans for homes worth half a million dollars, yet FHA loan limits remain quite high. FHA’s Mortgage Insurance Fund losses from insuring loans made during the height of the real estate bubble means FHA must rebuild the insurance fund. Keeping the FHA loan limit high is one way to rebuild the fund.
Note that FHA delinquencies have always been historically higher than other conforming loans sold to Fannie Mae and Freddie Mac, but that’s because FHA has a different goal: Lend to people with less-than-perfect credit, who only have a minimal down payment which increases risk.
Expanding homeownership is a goal of HUD:
FHA’s work alone will not solve all the industry’s challenges, which is why I appreciate this focus today on out-of-the-box thinking,” he said. “I know that new credit scoring models are being developed so that non-traditional factors can be considered when determining creditworthiness.” –Julian Castro, Secretary of HUD
Expanding homeownership is also a goal of the National Association of Realtors:
“If lenders and the government-sponsored enterprises were to adopt alternative credit scoring methods, such as FICO 9 and VantageScore 3.0, they could expand access to mortgage credit without dramatically increasing risk in the housing market,” said NAR President Chris Polychron.
FHA already accepts alternative credit scoring methods and credit analysis. On page 171 of FHA’s Single Family Policy Handbook 4000.1, lenders are instructed to manually underwrite the loan if a traditional credit report is not available. On page 238, lenders are given the following guidance:
“If a traditional credit report is not available, the Mortgagee must develop the Borrower’s credit history using the requirements for Non-Traditional and Insufficient Credit, which include analyzing information that might not be available on a traditional credit report that could demonstrate the applicant’s ability to repay his or her debts in a reasonable timely manner.”
Since manual underwriting is already available for consumers without a traditional credit score, why do we need to encourage FHA to do something they already are able to do? Because FHA is not a lender; FHA is an insurance program. Lenders can and do create guidelines that are tougher than what’s required by FHA. Mortgage lenders originate loans that 1) meet FHA’s guidelines, and; 2) are a good credit decision for it’s shareholders. Along with these goals is a mandate to follow state and federal laws, like Fair Lending.
The Dodd Frank Act created three categories of loans: Qualified Mortgages, Higher Priced Mortgage Loans, and HOEPA Loans. Loans that conform to guidelines set forth by Fannie Mae, Freddie Mac, FHA, VA, and USDA are automatically considered Qualified Mortgages until 2021 (unless this deadline is extended.) Higher Priced Mortgage Loans is a new euphemism for subprime. These loans are for people whose credit profile does not quite fit within the government agency guidelines, yet these borrowers still have the ability to repay. One of the goals of The Dodd Frank Act is to encourage Wall Street to once again invest in our product: mortgage-backed securities.
Creating mortgage loans that do not fit the parameters of the government-sponsored agencies is Wall Street’s job. Is The Dodd Frank Act working? Yes.
All throughout 2014 and 2015 we have seen more wholesale lenders create products for people whose credit, income, and collateral profiles do not fit agency guidelines. Interest rates are higher because the risk is higher. Borrowers with non-traditional credit, that cannot be manually underwritten to FHA’s guidelines do not belong in the FHA mortgage insurance pool. The free market will originate these loans…at a higher rate.
Some banks and lenders have come into conflict with Fair Lending mandates by following only two of their goals: Following agency guidelines and making good quality loans. When lenders fail to lend to everyone in their market area, they are at risk of violating Fair Lending laws. We already have a program for people without a traditional credit score: FHA. Encouraging lenders to expand manual credit underwriting for folks with a non-traditional credit profile can help meet the goals of HUD, NAR, Fair Lending, mortgage lenders, and consumers. Let’s let Wall Street pick up the rest of the risk.