Home buying gets tougher as lenders restrict FHA loans

Home ownership may be falling out of reach for more Americans as lenders toughen their standards for Federal Housing Administration-insured loans beyond what the agency itself requires.

Mortgage lenders including Wells Fargo & Co., a major Minnesota employer, and Bank of America Corp., the two largest, have raised the minimum credit score on FHA-insured loans that they will buy to 640 from 620. About 6.3 million people fall within that range, according to Minneapolis-based FICO, which created the formula for the ratings.

The higher hurdles for FHA loans, used in about a fifth of U.S. home purchases, add to challenges for a housing market already struggling with record-low sales and surging foreclosures. While lax lending fueled the bust that led the U.S. into recession, the new requirements will stifle the real estate recovery needed to revive the economy, said Ron Phipps, president of the National Association of Realtors.

"We've gone from silly to stupid," Phipps, principal partner of Phipps Realty Inc., said in a telephone interview from his home in Warwick, Rhode Island. "People who should be getting credit can't get it. To have a healthy real estate market, you need activity. You need transactions."

The FHA, which previously didn't have minimums for FICO scores, began in October to require grades of at least 500, and more than 580 for loans with down payments of as little as 3.5 percent. Borrowers with scores between those levels must put 10 percent down. Several lenders moved minimums to about 620 at the start of 2009, the companies said then.

FICO scores range from 300 to 850. The grades are based on data such as whether borrowers have missed debt payments, balances on their credit cards relative to borrowing limits, and the length of their credit history, meaning consumers who've never fallen delinquent can have lower scores, according to the company's website.

The 6.3 million people with grades between 620 and 640 equate to about 3.7 percent of U.S. consumers with credit information available, according to FICO.

Requiring a 640 credit score excludes as much as about 15 percent of FHA borrowers, David Stevens, the agency's commissioner, said in an interview yesterday. Minorities and borrowers in communities hardest hit by the recession are most likely to lose based on FICO scores, he said.

"We are restricting opportunity and access for those who can least afford it," Stevens said. "We need to find a better way to provide access to these families who are being cut out simply because lenders are putting arbitrary overlays on top of our requirements."

FHA insurance protects lenders or debt investors when borrowers default. One of every five U.S. home purchases relied on the loans in the fiscal year through July, the agency said in a report yesterday. They accounted for a third of purchases by first-time homebuyers in the year ended Sept. 30.

The FHA, the Department of Veteran Affairs and Fannie Mae and Freddie Mac, the companies taken over by the government in 2008, have been providing about 95 percent of new mortgage financing after falling home prices sparked retreats by banks and by investors in mortgage bonds without U.S.-backed guarantees, according to Inside Mortgage Finance newsletter. The S&P Case-Shiller Index of property values in 20 cities fell as much as 33 percent from its 2006 peak.

Mortgage companies are tightening FHA standards partly because of the higher costs they face in servicing delinquent loans, said Luke Hayden, president of the mortgage unit of Mount Laurel, New Jersey-based PHH Corp. By keeping defaults low, they can also boost the prices they fetch for bonds filled with the loans and thus offer lower rates, he said.

When FHA-backed loans go into default, the lender bears a greater share of the expenses than when the mortgage is backed by Fannie Mae and Freddie Mac, Hayden said. Lenders whose delinquency rates stray too far from averages can also face being cut off by the FHA or other sanctions from the agency, said David Lykken, president of Mortgage Banking Solutions, an Austin, Texas-based consulting firm.

With Fannie Mae and Freddie Mac mortgages, lenders are forced to buy back bad mortgages that were improperly underwritten, which has also prompted them to adopt tougher guidelines for those loans.

More banks tightened standards on prime residential mortgages in three months ending Oct. 31 than loosened them, a switch from the prior period, a Federal Reserve survey found.

Wells Fargo, the largest mortgage originator, has stopped buying FHA loans with FICOs below 640 from other lenders, said Vickee J. Adams, a spokeswoman for the San Francisco-based bank.

The minimum score for mortgages it makes through its own loan officers remains 600 with "no plans for an increase," she said. These types of loans accounted for 57 percent of its first-half originations, according to Inside Mortgage Finance.

Bank of America, the second-biggest lender, also stopped buying new FHA loans with FICOs below 640 last month, said Terry H. Francisco, a spokesman. About half of its originations in the first half of this year came through purchases from such so- called correspondents.

The bank, based in Charlotte, North Carolina, also requires scores at least that high on FHA mortgages for refinancing when making loans directly to borrowers. It still allows scores as low as 620 for home-purchase mortgages in its retail business because it thinks they perform relatively better and "we want to stay competitive" with those loans, Francisco said.

While Bank of America and Wells Fargo are keeping their retail credit standards in place, the changes to their loan buying affects other lenders' requirements. Quicken Loans Inc., the ninth-largest lender, has ended most of its FHA lending to borrowers with scores below 640 because of the new rules.

"When the big companies change their standards and rules, it has a huge effect on the market," said Bob Walters, chief economist at the Detroit-based company.

JPMorgan Chase & Co., the third-largest lender, had already been generally requiring credit scores of at least 640 on FHA loans before the tightening by competitors, said Tom Kelly, a spokesman for the New York-based company.

About 9.8 percent of U.S. home mortgages were delinquent at the end of the second quarter, with an additional 4.6 percent in the foreclosure process, according to the Mortgage Bankers Association. The Washington-based group releases figures through Sept. 30 Thursday.

FHA lending to the riskiest borrowers has declined in the past two years. Only 3.8 percent of FHA loans had scores below 620 or no score in the quarter ended Sept. 30, down from a peak of 50.4 percent in the period through Dec. 31, 2008, according to a Nov. 4 agency report to Congress. A score below 620 was typically considered subprime before the credit crisis, meaning the borrower had a bad or limited credit history.

"Mortgage credit availability has tightened even more than we expected," Morgan Stanley analysts Oliver Chang, Vishwanath Tirupattur and James Egan said today in a report.

At the same time, the recession and unemployment has spurred a decline in borrower credit scores, they said. There has been about a 23-point drop in FICO scores among current borrowers who took loans without government backing in 2006 and 2007, they said.

The U.S. home-ownership rate remained at a 10-year low of 66.9 percent in the quarter ended Sept. 30, in part because of rising foreclosures, the U.S. Census Bureau reported Nov. 2. The rate reached a record high of 69.2 percent in the second and fourth quarters of 2004.

Sales of existing homes were at an annual pace of 4.53 million in September, compared with the average rate of 5.82 million for the past decade, according to the Chicago-based National Association of Realtors. The pace in July was 3.84 million, the lowest in data going back to 1999.

Restricting access to credit threatens to slow a rebound even as reduced home prices and interest rates near record lows boost affordability, said Stevens, the FHA commissioner.

"This has a broad potential impact to the economic recovery in total," he said. "We're not asking for lenders to be reckless. In fact, we believe we have prudent policies for the market. But we do believe that lenders need to put more work into making certain that they provide accessibility for families who can qualify for a mortgage."