The Federal Housing Administration (FHA) just announced a set of policy changes to strengthen the FHA’s capital reserves, which have declined to dangerous levels. FHA will take the following steps: increase the mortgage insurance premium (MIP); update the combination of FICO scores and down payments for new borrowers; reduce maximum seller concessions to 3%, from the currently allowed 6%; and implement measures to enhance enforcement of FHA policies on lenders.

The changes directly impacting home buyers and sellers using the FHA program include:

• The mortgage insurance premiums (MIP) will be increased to build up capital reserves.
  • The first step will be to raise the up-front MIP by 0.5% to 2.25% and request legislative authority to increase the maximum annual MIP that the FHA can charge. If this authority is granted, then the second step will be to shift some of the premium increase from the up-front MIP to the annual MIP. This shift will allow for the capital reserves to increase with less impact to the consumer, because the annual MIP is paid over the life of the loan instead of at the time of closing. The initial up-front increase will go into effect on April 5, 2010.

• Update the combination of FICO scores and down payments for new borrowers.
  • New borrowers will now be required to have a minimum FICO score of 580 to qualify for FHA’s 3.5% down payment program. New borrowers with less than a 580 FICO score will be required to put down at least 10%. This allows the FHA to better balance its risk and continue to provide access for those borrowers who have historically performed well. This change will be posted in the Federal Register in February and, after a notice and comment period, would go into effect in the early summer.

• Reduce allowable seller concessions from 6% to 3%
  • The current level exposes the FHA to excessive risk by creating incentives to inflate the appraised value of the home. Private lending standards have limited seller concessions to 3% for many years. This change will be posted in the Federal Register in February, and after a notice and comment period, would go into effect in the early summer.

The increased enforcement on FHA lenders includes, for example, publicly reporting lender performance rankings, enhanced monitoring of lender compliance with FHA guidelines and standards, and enhancing  the enforcement of indemnification provisions. This would require all approved lenders to assume liability for all of the loans that they originate and underwrite.

What does all this mean for homebuyers? Well, first off, if you don’t want to pay the higher mortgage insurance premium, buy before April 5! Check with your lender, but my understanding is you have to have a property identified before a FHA case number can be assigned, and that’s the critical action to beat the April 5 deadline. As for the FICO score minimum of 580 to get the 3.5% down payment, most FHA lenders already require scores of 600 to 620. And, allowable concessions from the seller being reduced to 3% really just reflects the realities of the Northern Virginia market – sellers are not going to accept such an offer, because they know that the appraisal will be too low to support the higher sales price they would have to get to compensate for it. And if you need a low down payment, you probably don’t have the cash to waive the appraisal.