Over the last few years, as the private mortgage market has remained in lockdown, the FHA, which is backed by the government, has increased its lending activity.  Instead of requiring borrowers to put down 20% on a home as a bank might, FHA mortgages require as little as 3.5% down.

The low barrier to entry made FHA mortgages a more popular option among borrowers.  Today, they make up about 30% of the existing mortgage marketplace, up from just 3% in 2006.

Now, some of the friendly terms attached to FHA mortgages are about to change, thanks to the rising risks and losses associated with these loans.  Ninety-day delinquencies, bankruptcies and foreclosures have been rising during the past year, according to the Department of Housing and Urban Development's quarterly report to Congress in September.

The FHA's reserve funds, which the administration uses to cover losses from these mortgages when borrowers default or go into foreclosure, are shrinking.  As of June 30, its capital reserve account had dwindled to $3.5 billion, compared to a $19.3 billion balance on Sept. 30, 2008, according to the HUD report

To reduce future risk, the FHA is raising borrower requirements and increasing the costs attached to these mortgages.  Here are four changes that potential FHA-mortgage borrowers can expect.

Higher annual insurance premiums

The FHA plans to raise the annual premium from a range of 0.50% to 0.55% to a range of 0.85% to 0.90%.  The annual premium is paid along with the monthly payment, but it is not rolled into the mortgage.  In exchange, the FHA will lower the required upfront premium from 2.25% to 1.00%. (The upfront premium can be rolled into the mortgage.) Both fees pay for the FHA insurance that makes the loan possible.

Reduce seller contributions to closing costs

Earlier this year, the FHA proposed new changes that would raise the requirements to get approved for an FHA mortgage.  Among the changes is a reduction in how much Sellers can contribute toward the closing costs.  Until now, sellers have been able to pay for up to 6% of closing costs toward the buyer's purchase of their home.  According to the new proposals, sellers would be limited to contributing up to 3%.

New credit score requirements

Historically, the FHA hasn't had an official minimum required credit score, leaving that decision mostly up to the lenders underwriting FHA mortgages.  Now, the agency is proposing a minimum required credit score of 500 to get approved for an FHA mortgage and a minimum credit score of 580 in order to qualify for the 3.5% down payment.  Borrowers with a credit score between 500 and 580 will have to make a down payment of at least 10%.  The FHA is also requesting that lenders tighten underwriting standards by looking more closely at a borrower's credit history, debt-to-income ratio and cash reserves.

FHA-approved lenders are comfortable providing these mortgages because they're backed by the government, and that means the lenders won't incur the loss if a borrower defaults on their mortgage.  Instead, the FHA pays the lender an insurance claim equal to the sum of the unpaid principal balance of the loan, foregone interest and a portion of the foreclosure expenses.  

Recent changes already in effect

In April, the FHA increased the upfront insurance premium from 1.75% to 2.25% of the mortgage balance.  And in 2008, it increased its minimum down payment from 3.0% to 3.5%.

However, FHA requirements are still comparatively liberal.  Although full documentation of employment is required before a borrower gets approved for an FHA mortgage, the biggest risk remains the low down payment, especially at a time when home values in many parts of the country are still dropping.  Those declines could leave many new borrowers underwater within a few months of their home purchase. 

If you have questions about an FHA mortgage, or if you are interested in buying a home in Fishers, Indiana, please contact the Evelo Team at 317-863-4663 or email us at team@eveloteam.com. 

btw – The Evelo Team can also help Buy or sell Real Estate in the Indianapolis, Indiana area.