Here’s some unexpected good news for anybody working to get buyers into houses, especially first-timers who don’t have much down payment cash on hand: The door to an FHA-insured mortgage just opened a little wider.
With no fanfare or public announcements, two of the largest FHA-approved lenders have backed off their controversial "overlay" requirements on FICO scores (lender overlays are qualification requirements that can be more stringent than FHA’s own requirements).
Both Wells Fargo and Quicken Loans confirmed to me last week that they will now lend to applicants with 580 FICOs and 3.5 percent down payments.
Their revised standards conform in most respects to FHA’s own minimums, and open the agency’s financing to large numbers of buyers whose credit scores have sagged during the recession. Wells Fargo is the largest originator of FHA-insured mortgages; Quicken ranks third, according to industry data.
Along with most other major lenders, both companies previously had insisted on minimum FICOs of 620 for otherwise qualified borrowers seeking 3.5 percent down payment loans. If your score came in even slightly lower, they wouldn’t even look at your application.
An estimated one third of Americans now have FICO scores below 620, according to one consumer group’s estimate.
The lending industry’s rationale for imposing a higher bar than FHA’s own: They need an extra cushion of protection against potential defaults by borrowers with subpar credit scores. Many of those defaults, they said, could prompt indemnification demands by the Federal Housing Administration — essentially punitive repayments for insured loans that go belly up.
Michael D. Berman, chairman of the Mortgage Bankers Association, said last week that lenders have adopted FICO score minimums and other overlays that add to the costs of getting a loan because they "are just afraid. We are not going to play out on the edge if we’re going to get stuck" with buybacks or indemnification demands."
Similarly, FHA lenders want to avoid the costs of servicing nonperforming defaulted mortgages.
FHA commissioner David Stevens says he understands the lenders’ concerns, but that many applicants with 580 scores have solid incomes and generally good credit histories. Their current scores are depressed, he argues, because "they went through the recession and suffered some damage, such as short-term loss of income," which caused them to be late on some payments.
If lenders look hard at the causes of their problems and underwrite carefully, such borrowers "do not present excessive risks of default," he says, which is why FHA set the FICO score bar for 3.5 percent down payment loans at 580.
The mortgage industry’s overlay policies have prompted criticism from Realtors, builders and consumer groups. The National Community Reinvestment Coalition filed complaints against 23 lenders — Wells and Quicken were not among the targets — charging that setting tougher credit standards than required by FHA discriminates against minorities and violates federal fair lending and equal opportunity statutes.
Wells’ newly revised policy actually dips the FICO score cutoff line well below 580 — all the way down to deep subprime 500 — but also sets strict underwriting hoops and snares to weed out unqualified applicants.
For example, borrowers with scores between 500-579 will need a 10 percent down payment from their personal resources. They will not be able to use gift money from relatives, friends or a charitable down payment assistance program to meet the 10 percent upfront equity test.
Home buyers with scores of 580-599 will need 5 percent down payments, and will be prohibited from supplementing their own cash with gifts. Borrowers with FICOs above 600 will qualify for 3.5 percent down payment FHA deals, but will be allowed to use gift money.
Contributions from home sellers to defray buyers’ closing or loan origination costs will be limited to 3 percent. Debt-to-income ratios will be tight: 31 percent for monthly housing-related expenses, and 43 percent for total household debt service.
The expanded program will only be available through Wells’ retail lending channel, not through third-party brokers or correspondent lenders.
Tom Goyda, a Wells vice president and spokesman, told me that "these requirements are designed to ensure that we lend to customers who we believe will be able to manage their finances, given the anticipated ongoing challenges in the economy."
Bob Walters, Quicken’s vice president for capital markets and chief economist, said his firm will now accept FICO scores down to 580, but no lower. Quicken also insists on key underwriting restrictions on debt-to-income ratios and limits on gift funds.
Walters would not disclose the specifics, but said they are "very close" to Wells’ 31 percent and 43 percent requirements, and that all borrowers with low FICOs must be able to demonstrate that their down payments are from their own funds.
In a phone interview last week, FHA’s Stevens told me that the Wells approach "is well thought out and could serve as a model" for other large lenders to consider in the coming weeks.
He would not identify other major companies that may abandon their 620-640 FICO minimums, but said he hopes that many more will take a hard look and follow suit.
"The idea is not to have habitual late-payers" get FHA-insured mortgages to purchase houses, Stevens said, but rather to provide homeownership opportunities to genuinely qualified buyers who simply have temporarily depressed credit scores.
"Anybody who is lending" during the current environment of falling home prices and high unemployment "has to be extremely careful about making policy changes that add to their risks, but we also need not to exclude qualified families from access to homeownership," Stevens said.
If the mortgage industry adopts the Wells and Quicken guidelines in some form, tens of thousands of consumers — along with the real estate professionals assisting them — could be beneficiaries in the weeks immediately ahead.
But keep this in mind: You may need to reach out to loan officers to inquire about any policy changes. So far, nobody’s been on the rooftops shouting about the good news.