The FHA loan guaranty was introduced to make homeownership affordable for those who might otherwise be unable to obtain a mortgage. For generations, that is exactly the way the program played out.
In the past several years, however, faced with market conditions unlike any this country has ever seen, some mortgage lenders have begun to use the FHA loan as more of a “workhorse” product.
The industrywide tightening of underwriting standards has not spared FHA applicants, either. Once served well by FHA, they are rapidly becoming the underserved.
FHA's acting commissioner, Carol Galante, said that one of FHA's most pressing goals is to be “an important source of financing for underserved communities, and low- and moderate-income borrowers.” (Daily Business News, Oct. 12, 2011). This is an important, even critical goal. Concurrently, the Obama administration has called upon our industry to find a way to reduce the tremendous backlog of foreclosed and bank-owned inventory.
We believe that making more credit available (using proven underwriting standards and probably more manual underwriting) to the very group of people for which the FHA loan was intended would be a solid start in that direction. We believe it will be the working-class American, seeking loan amounts under $150,000 and supported by products such as the FHA loan, who will help alleviate this excess inventory. In the process, we can assist many worthy borrowers who might not otherwise neatly fit into the “bucket” reserved for the A-paper mortgages to fulfill their dreams of homeownership.
The traditional FHA loan consumer, we believe, is someone willing to do whatever it takes to stay current on loan payments. The traditional working class of America still believes homeownership is a point of pride—and a commitment to be taken very seriously. As we see minimum credit scores for FHA borrowers go up, we also see that core group losing what has historically been its most important vehicle for achieving the American dream.
Unfortunately, when transacted in volume, the FHA loan creates a dramatic disparity between larger lenders and smaller ones. The reason is that some national lenders, able to originate large numbers of loans, are also able to be more selective in their approvals of FHA applicants. While a large national mortgage company may be able to accept only FHA applicants to a credit score of 700 or so while maintaining their numbers, smaller lenders must still target borrowers with lower average scores in a shrinking customer pool. The FHA itself has confirmed this. In June, the average FICO score of a homebuyer securing an FHA loan had gone up to 699, up from 694 in June 2010.
Today, the average FICO score on an FHA loan is up to 700 and over. In 2002, an average FHA score of 635 was commonplace for most lenders. Today, the largest lenders are unable to take the time to underwrite an FHA loan the way it was intended to be underwritten: manually. It's simply more cost effective for companies closing hundreds of millions monthly to work with credit scores closer to 700, and base those loans upon credit scores and desktop underwriting engines. The result is fewer and fewer mortgages for borrowers without the very best of credit histories.
Those firms able to tighten standards and increase minimum credit scores to mitigate risk are not doing anything unscrupulous. However, it seems clear that the FHA loan guaranty is inadvertently transforming into something it was not intended to be, and is helping its target borrower less and less frequently.
Small businesses such as correspondent lenders or local banks are no longer as willing or able to originate FHA loans as they once were. And an entire class of potential borrowers is beginning to lose out; the very program designed to help deserving families appears to be leaving them behind.
The FHA loan guaranty is a noble program, with a worthy cause and a track record to be proud of. Because of the excesses of the last decade, firms of all sizes in the mortgage industry have rightfully begun to reexamine their processes, and mortgages are undeniably harder to come by as we work out the challenges. The increased requirement for high credit scores, coupled with the heavy reliance upon desktop underwriting, however, is inadvertently eliminating many perfectly worthy borrowers—those traditionally served by FHA loans.
It is often said that a real economic recovery is impossible until the housing industry's ship is righted and the swelling inventory of bank-owned properties is absorbed, clearing the way for new construction and revived employment. This process is best facilitated by bringing more deserving, motivated borrowers to the market, not by forgetting about them.
Andrew Peters is the CEO of First Guaranty Mortgage Corp.
