According to an article in the National Mortgage News by Brian Collins, the Department of Housing and Urban Development (HUD), would like to see FHA lenders lower their credit score requirements. From the article:
“Federal Housing Administration loans once served a broad spectrum of borrowers until the subprime mortgage meltdown came along and pushed lenders to tighten underwriting standards and credit score requirements. Today the average score on an FHA-insured mortgage is 700.”
In order for FHA lenders to loosen their underwriting standards, changes to the FHA’s Neighborhood Watch program may be necessary. Neighborhood Watch is a HUD program that monitors lenders to make sure that they aren’t issuing a lot of loans that end up defaulting. It does this by comparing the default rate from a given lender to the average default rate for all FHA loans, regardless of credit score or other risk factors. Default rates above the norm could set off audits or monetary penalties for potential losses. This makes FHA lenders reticent to lend to people with lower credit scores or higher risk factors.
In order to encourage lenders to loosen credit score requirements, some would like to see the Neighborhood Watch program altered so that default rates are not compared to the general FHA default rate, but are adjusted to account for risk factors such as lower credit scores. The FHA is looking at changing Neighborhood Watch policies, but does not want the pendulum to swing too far in the other direction, leading to increased losses through elevated default rates.
According to a USA Today article from 2010, more than 25% of Americans had credit scores of less than 600. This type of credit score would preclude a quarter of the population from receiving a mortgage given current underwriting standards. A more recent article from the Boston Herald showed that between 2008-2009, 50 million people saw their FICO scores drop by 20 points, and 21 million of these people lost more than 50 points. Delinquent payments, unemployment, and medical bills are among the many reasons so many Americans saw their credit scores decline during the recession.
HUD and the FHA have to walk a fine line here. One could definitely make the argument that underwriting standards have become too restrictive in the wake of the credit bubble, and that too many Americans are precluded from refinancing or getting a new mortgage. However, we must remember that lax underwriting standards were among the causes of the housing bubble in the first place. We need to find some sort of middle ground between underwriting standards that are too lax and too restrictive in order to help heal the housing market.