Feds tighten housing loan standards

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The Federal Housing Administration moved on Friday to toughen its standards for approving lenders that insure mortgages on the agency's behalf.

That could have three significant effects. First, it could improve the quality of government housing loans and, critically, force lenders to buy back more defaulted FHA loans. The 30-day delinquency rate on FHA mortgages in December stood at a hefty 18 percent, suggesting that tighter underwriting is essential.

Those delinquencies account for more than 1 in 6 outstanding FHA loans, according to the American Enterprise Institute, a Washington think-tank.

Second, the rules changes could help the FHA, which insures residential mortgages, shore up its Mutual Mortgage Insurance Fund. Some experts warn that the fund may eventually require a bailout. Third, FHA Commissioner Carol Galante expressed hope that the rules, which were initially proposed in October and which were finalized on Friday, will encourage lenders to loosen credit for borrowers and speed recovery in the housing market. She said in in a statement:

Taken together, the changes announced today will protect FHA's insurance fund from unnecessary and inappropriate risk, while offering clear guidance to lenders regarding the [Department of Housing and Urban Development's] underwriting expectations.

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The tougher standards apply to lenders authorized to insure mortgages for FHA without first submitting documents to the agency. That encompasses roughly 80 percent of all FHA-insured mortgages. Some of the key rule changes:

A stronger approval process. To obtain FHA approval, lenders will need to meet stricter loan performance standards. A lender Insurance mortgagee also must demonstrate a two-year "seriously delinquent" and claim rate at or below 150 percent of the aggregate rate for the states in which the lender does business. In other words, if a state's mortgage delinquency rate is 2 percent, then the delinquency rate for an FHA lender must not exceed 3 percent.

Stricter monitoring of FHA-approved lenders. FHA will continuously monitor lender performance to ensure that participating firms meet the program's stricter eligibility standards.

Compensation to FHA for insurance claims. Under the new rule, lenders are required to reimburse FHA for a claim if they "knew or should have known" of any fraud or misrepresentation in connection with a loan. Lenders would be on the hook for compensation if the loan defaults within five years of origination.

Many lenders aren't happy with the tighter FHA oversight. Some in the industry were pressing for the reimbursement window on the government mortgages to be shortened to two or three years, citing problems like unemployment and divorce as reasons that borrowers default over the five-year origination window. But FHA determined that shortening the time period for reminbursement would be risky.

Although stricter underwriting could make for safer FHA loans, the impact on the availability of credit is less clear. Indeed, the additional restrictions for lenders could limit financing for homebuyers. Given the growth in FHA lending in recent years, that may be an inevitable trade-off, as the agency seeks to ensure that fewer of these loans go bad.

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    Ilyce R. Glink is an award-winning, nationally-syndicated columnist, best-selling book author and founder of Best Money Moves, an employee benefit program that helps reduce financial stress. She also owns ThinkGlink.com, where readers can find real estate and personal finance resources.