Major FHA Changes Effective April 5th - Does This Mean You Should Buy Sooner?

Major FHA Changes Effective April 5th - Does This Mean You Should Buy Sooner?

There's been a lot of discussion on this site about the upcoming changes to Federal Housing Administration loans that will be effective later this year. To recap, the reason for the changes is to strengthen the FHA insurance fund's capital position. This fund, which is legally mandated to hold 2% of all outstanding insured loans in reserve, had recently dropped to 0.53% on the unusually large claim volume that has resulted from the housing crisis. To address this shortfall, FHA has announced a few steps, among them increasing its insurance premiums to bring in more cash, and tightening underwriting requirements to reduce claims.

These challenges are forcing FHA to make changes to its loan program which will especially affect First Time Homebuyers. Please follow with me for a discussion of these changes.

Specifically, on April 5th, 2010, FHA will implement an increase in its upfront Mortgage Insurance Premium to 2.25% from 1.75%. This represents a significant increase in the premiums that will be collected with each closing, however borrowers will initially be insulated from this, as FHA guidelines allow this premium to be financed into the loan. On a net $150,000 loan, the difference in premium would be $750, which translates into $4.26 per month at a 5% interest rate over 30 years. Most buyers won't even blink at a $4 per month difference in payments.

Legislation is in the works to shift a part of this rate increase from the upfront MIP to the monthly MIP. While the exact details remain to be seen, there are two rumored proposals I have seen:

1. Decrease upfront MIP to 2.0% while increasing monthly MIP to .8% per year
2. Decrease upfront MIP to 1.0% while increasing monthly MIP to .9% per year

Of these proposals, the 1st is much more likely to go forward, as the purpose of the change in premium is for FHA to rebuild its gutted reserve fund. Under the 2nd option, it will not collect more than under the current 1.75%/.55% system until the 4th year. Considering that FHA upfront premiums have historically been as high as 3.8%, the current rates are not as out of line as they might seem. The potential change does have a significant effect on qualification, though. For the net $150,000 loan previously discussed, at a 5.5% interest rate over 30 years, here's what the different options look like:

Today April 5th Proposal 1 Proposal 2

MIP Rates (UF/Annual) 1.75%/0.55% 2.25/0.55 2.0/.8 1.0/.9

Total loan $152,625 $153,375 $153,000 $151,500

Monthly Payment $936.54 $941.14 $970.72 $973.83

As previously mentioned, the upfront MIP change has a nearly meaningless effect on payments. A borrower who qualifies today needs only $11 per month in additional income to qualify in April. This difference becomes much more significant if one of the two proposals goes through, as a buyer will need $83 additional monthly income to buy the same house. Put it another way, and that $37/month difference costs the buyer about $7000 in maximum approval level. This does make a difference!

Beyond cost differences, credit requirements for FHA loans are changing. Historically, HUD hasn't set a minimum credit score for FHA loans, but effective April 5th a 620 minimum FICO score will be required to finance at the maximum 96.5% loan-to-value ratio. This changes a few things. First, it clearly sets a guideline where none had previously existed. Second, by setting a minimum, it is likely we may see lenders begin to require a credit score higher than that minimum. It has been challenging, if not impossible, to get an FHA mortgage for a client with a credit score below 620 for nearly a year now, as lenders imposed policies stricter than HUD minimum requirements. If banks continue to impose stricter standards, a 660 credit score may become more the norm. What this means is that borrowers on the edge could be left out in the cold when this goes through.

In addition to the 620 score for maximum financing, HUD also announced a 580 score would be required for 90% financing. I feel that the impact of this will be minimal, as borrowers with 580 scores present a greater risk than banks are willing to accept, even with FHA insurance.

Requirements for use of a seller concession to pay closing costs will change, too. Effective April 5th, maximum seller concessions will be reduced from 6% to 3% of the home's purchase price. While buyers of higher priced homes, usually $150,000 and more, will likely be able to have most of their closing costs paid by the seller, buyers of lower priced homes will see a meaningful increase in out of pocket expenses. 3 years ago, with a down payment gift program and seller concessions, a buyer could purchase with no own funds invested. With the reduction in seller concessions coming, the required investment will increase substantially.

The Verdict: Who should buy before April 5th?

If you're going to buy this year, there are three reasons why you have to move quickly to buy before April 5th:

1. Tight budget: if the MIP changes might cause you to not qualify
2. Lower credit score: if you're at 625, you might not qualify if requirements increase
3. Limited savings: if you only have just enough to purchase today, you won't in the future.

First-Time Homebuyers, in particular, are likely to be affected by these changes, as many are spending a larger part of their savings and monthly income to buy a home than experienced homeowners. In addition, all buyers wishing to avoid the increase in the Upfront Mortgage Insurance premium should accelerate their purchase.

There are instances where a purchase should be delayed, though. If your lease is expiring after July and carries substantial penalties, that could present a problem. Move-up buyers hoping to get the $6500 tax credit, but who will be short of the 5 year requirement until after April 5th may benefit from waiting. In some cases employment issues may make waiting a sensible option.

If you have questions about a specific scenario, please comment below or contact me directly on my cell phone at (800) 701-1775.

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