In a complaint filed with the U.S. Department of Housing & Urban Development (HUD) on Dec. 7, 2010, the National Community Reinvestment Coalition (NCRC) alleged that the lending practices of 22 banks deny Federal Housing Administration (FHA)-insured loans to African-Americans and Latinos by requiring minimum credit scores as high as 640. The NCRC is an association of more than 600 community-based organizations that promote access to basic banking services.
It is interesting to note that on Oct. 4, 2010, only two months before this complaint was filed, the FHA instituted minimum credit scores (MCS) into its policy with Mortgagee Letter 10-29 (see below). Many mortgage loan originators (MLOs) think that the scores required by banks are representative of what the FHA requires, and are unaware that FHA has established minimum credit scores.
Below is a list of the current FHA minimum scores established by Mortgagee Letter 10-29 for all standard FHA programs*:
1. Borrowers with an MCS at or above 580 ARE eligible for maximum financing.
2. Borrowers with an MCS between 500 and 579 ARE limited to a 90 percent loan-to-value (LTV).
3. Borrowers with an MCS less than 500 are NOT eligible for FHA-insured mortgage financing.
4. Borrowers with a non-traditional credit history or insufficient credit are eligible for maximum financing, BUT must meet the underwriting guidance in HUD 4155.1 4.C.3.
*Requirements DO NOT apply to: Title I, Home Equity Conversion Mortgages; HOPE for Homeowners; Section 247; Section 248; Section 223(e), Section 238.
According to the NCRC, their fair lending testers “evaluated the practices of national lenders, financial services corporations, and other regional and local FHA-approved lenders.” In the complaints filed, NCRC states that lenders were chosen according to their market share and volume of FHA loans.
I’m a former FHA underwriter trained by HUD, and it has always been my position (and it was also the position of HUD until recently) that a borrower’s loan should be underwritten according to creditworthiness, regardless of the credit score. According to Fair Isaac Corporation (FICO), approximately 6.3 million people fall within the range of 620 to 640. It’s my guess that those who fall between 580 and 620 number about another five million. In this estimated 11 million that fall between 580 and 640, a significant percentage of those wishing to buy a home are also creditworthy individuals who would pay their mortgage on time every month.
It has been my experience that a substantial percentage of individuals with lower scores are in that range due to extenuating circumstances and events that have little bearing on their ability to make their payment. The classic example would be a borrower with medical collections. These collections can occur due to billing errors, or from expensive procedures not covered by insurance but that can be, or are being, taken care of with payment arrangements (i.e. the debtor is making regular payments on time until the bill is paid off). This type of borrower is very creditworthy and, from a traditional underwriting standpoint, a very good risk, but their scores will typically be low. This type of borrower may use very little credit and is likely to be living within their means, and as such will buy a home with an affordable payment and rations below the 31/43 limits. Sadly, as of now, this creditworthy person is denied homeownership because they lack the MCS necessary to get approved.
On the other hand, look at the classic American over-spender who doesn’t “act their wage,” and in spite of being a dual-income household, manage to over-extend on their credit cards. They may have ratios of 34/46, but they get approved because of an automated underwriting system (AUS) decision. According to traditional underwriting practices, this loan would be denied because their credit profile is a foreclosure waiting to happen! All it takes is for one of them to lose their job, and they’re no longer making their mortgage payments.
Something is very wrong with this picture. I am a very big proponent of HUD forcing banks to accept the FHA scores for three main reasons:
1. All Americans deserve a chance to have their loan application reviewed from the overall perspective of creditworthiness, and not have to fear being automatically rejected because they don’t have the minimum credit score.
2. It will benefit the housing market. David H. Stevens, FHA Commissioner, was quoted as saying that 15 percent of people between the scores of 620 and 640 are potential FHA borrowers.
3. It will help the mortgage loan originator by increasing their pool of potential buyers.
I suspect that there is a very good chance we will see banks be required to accept the FHA scores because this practice does raise fair housing issues. I also suspect that if HUD wants this implemented, it will happen, since the banks received bailout money—i.e., politically they will be pressed to make the change. From the quote below, made by HUD Assistant Secretary for Fair Housing and Equal Opportunity John Trasviña in a Dec. 8, 2010 HUD press release, the HUD sentiment is clear:
“FHA is an important vehicle for Americans who want to purchase or refinance a home. We thank NCRC for bringing these complaints to HUD. For lenders to deny responsible home seekers this source of credit, without regard for their capacity to repay the loans, would raise serious fair housing concerns and, if proven, undermine our nation’s recovery efforts; HUD will take appropriate action against any lender found to be engaging in discriminatory practices.”
If lenders were required to meet the FHA MCS requirements, it would force lenders to improve the quality of their underwriting and assure that their underwriters have an expert knowledge of FHA guidelines, in both the technical aspects of the guidelines as well as the spirit of the guidelines. Let’s hope that this change is made, and that we can give more Americans a chance at owing their own homes.
Jeff Mifsud is founder of Michigan-based Mortgage Seminars LLC, a former FHA underwriter with 15-plus years of experience originating FHA loans, an FHA expert for LoanToolbox.com and creator of The FHA Originator, a monthly FHA newsletter. Jeff may be reached by phone at (248) 403-8181 or visit www.MortgageSeminars.com.