There’s a housing issue bubbling away at U.S. Housing and Urban Development Department headquarters in Washington that bears watching by any real estate professional whose clients might be helped by getting an FHA-insured mortgage in 2011.
It drew some press attention late last year, but I think the big news is yet to come. The controversy concerns credit scores and how lenders use them to screen out homebuyers seeking FHA financing — now the dominant source of mortgage money for purchasers in many markets across the country.
Last year, the Federal Housing Administration set the minimum FICO (Fair Isaac Corp.) score for its lowest-down-payment mortgages (3.5 percent) at 580. Yet dozens of large banks and mortgage companies have insisted on posting their own higher minimum scores — typically anywhere from 620-640 FICO.
Often they won’t even consider loan packages if they see the applicant’s score is above FHA’s 580 acceptable mark but below their own minimum.
They argue that despite the fact that FHA insures them 100 percent against losses from nonpayments and foreclosures, they worry about the "reputational risk" and possible uninsured servicing income losses they could incur from delinquent, low-score mortgages.
Last month, the lenders’ refusal to make loans to people with FICOs between 580 and 620 or 640 triggered federal fair lending complaints against 22 companies — all filed by the National Community Reinvestment Coalition, an umbrella organization representing 600 local and state groups and government agencies.
The charge: Cutting out homebuyers with scores between 580 and 620 or 640 disproportionately hurts minority applicants — African Americans and Latinos especially — who are more likely than other borrowers to have FICO scores in that range, according to statistical analyses presented in the filing documents.
John Trasvina, assistant secretary for fair housing and equal opportunity at HUD, welcomed the filings and said that "for lenders to deny responsible home seekers this source of credit" solely on the basis of credit scores that meet FHA’s minimum criteria but not the lenders’ own self-set minimums "would raise serious fair housing concerns, and if proven, undermine our nation’s recovery efforts."
If Trasvina’s staff finds merit in the complaints, the U.S. Justice Department is expected to step in and file federal civil rights suits against the lenders, who include MetLife Bank, Nationstar Mortgage LLC, Bank of the West, Sierra Pacific Mortgage Co., Franklin American Mortgage Corp. and PHH Mortgage Corp., among others.
Flagstar Bank was subsequently added to the complaint list, according to NCRC chief executive John Taylor.
Another 21 banks currently are in negotiations about their score cut-off policies, but three of the original defendants have decided to essentially settle and reduce their FICO thresholds to 580, according to Taylor.
In a discussion with me Dec. 30, he said he could not disclose their identities or those of the 21 lenders who could still be the subject of additional complaints.
What’s so important for real estate and lending professionals in all this? Shouldn’t banks be allowed to decide what sort of borrowers pose too much credit risk for them? Absolutely.
But here’s my take: When the FHA itself tells lenders that 580 scores represent acceptable credit risks for federal mortgage insurance, and that the government will cover the costs of defaults, why reject otherwise qualified applicants out of hand — with no other review — when they come in with FICOs well above FHA’s threshold but below 620 or 640?
That’s what NCRC’s dozens of "test shoppers" say they documented while applying for mortgages at each of the 23 banks.
Even when their applications contained substantial evidence of long-term employment, good payment histories, savings and other financial assets plus credit scores in the low 600s, their loan requests were rejected simply because they didn’t quite hit the FICO number set independently by the lender.
To put the record straight, FHA Commissioner David H. Stevens — former president of the Long & Foster real estate brokerage firm and a former executive vice president of Wells Fargo Home Mortgage — weighed in with a memo to lenders before the Christmas holiday break.
While FICO scores of 580 to 620 do "indicate a higher risk of default," he said, FHA has a historical commitment to provide "fair access" to mortgage money "to underserved borrowers," especially those who’ve suffered temporary economic reverses during the recession but who otherwise are qualified to buy homes.
"Our message is clear," he said. "We are asking our industry partners to consider all the factors to determine the borrower’s ability to repay their mortgage and look beyond a simple credit score."
Stevens made no direct reference to the fair-lending complaints filed by NCRC. But if his year-end memo has the intended impact, federal litigation won’t be necessary.
All lenders need to do is to look at homebuyers’ total financial and credit pictures before writing them off, and the civil rights cases should go away.
The big news yet to come? I expect that most banks will heed Stevens’ advice and open up FHA mortgages again to a wider span of applicants. I don’t mean giving everybody with a 580-plus FICO a free pass, but taking a closer look to give people a fair shake.
That’s got to be helpful to Realtors, builders and, yes — lenders themselves — who want to grow their business in 2011.
Ken Harney writes an award-winning, nationally syndicated column, "The Nation’s Housing," and is the author of two books on real estate and mortgage finance.
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