Depending upon your point of view, Housing & Urban Development’s (HUD) recent decision on September 3, 2010, to lower new minimum credit scores and loan-to-value (LTV) ratio requirements for FHA-insured loans is either a genius financial decision to reduce a large inventory of empty homes and soon to be foreclosed homes, or it’s a monumental mistake about to bite us all in the backside by, once again, manipulating free markets to serve political agendas.
Highlights from HUD’s announcement:
In accordance with the final Federal Register Notice [FR-5404-N-02] on
minimum decision credit scores and LTV ratios for FHA-insured single
family mortgages, the new requirements are:
- Borrowers with a minimum decision credit score at or above 580 are eligible for maximum financing.
- Borrowers with a minimum decision credit score between 500 and 579 are limited to 90 percent LTV.
- Borrowers with a minimum decision credit score of less than 500 are not eligible for FHA-insured mortgage financing.
As someone who discusses the real estate bubble quite a bit, I’m feeling some ambivalence here.
Pros of Easing Lending Requirements
- Buyers with a foreclosure, jingle mail voluntary foreclosure, short sale, etc., now have a chance to buy another home. Regardless if you feel it’s a bad decision to lend to anyone below 600, the humanitarian side of me people always deserve a place to live. If they can afford the home, don’t let an imperfect metric like FICO scores get in the way of basic human needs.
- It improves liquidity. Like it or not, the housing market as it exists today is fairly illiquid. If you don’t have a near perfectly constructed home with all the trimmings, or you’re selling your home a discount to market, it would behoove you not to get your hopes up about selling your home quickly. This isn’t like the good old days of 2005, when I put my home on the market at 9am on Monday morning, and got my full asking price by noon same day.
- It cashes out some boomers. I know about a dozen baby boomer families who bought homes in the 1980s, and their home’s resale value will fund a sizable portion of their retirement. If they can’t sell, and downsize from a McMansion to a two bedroom condo on a golf course, they are, sad to say, screwed.
Cons of Easing Lending Requirements
- Only a small percentage of banks will go for it. Just because HUD issues news lending standards, it doesn’t mean all banks will go for it. Many small, neighborhood banks and credit unions will still set their minimum FICO for underwriting standards in the mid to low 600s.
- Subprime loans were a significant cause of the real estate bubble. It’s true, you can’t ween a junkie off heroin without winding down his dosage in increments or the immediate shock can cause symptoms worse than the drug itself, but economics doesn’t follow biological functions 100% of the time. Do we really have to make more risky loans during “The Great Unwind“, which implies that home prices will revert to historical trend lines regardless of all we do to keep them artificially inflated?
- Down payments requirements are still pretty lax. I hate to say it, but 10% down payment on a high risk 500+ FICO borrower still seems pretty small to me. I understand that saving 10% of a high price asset like a home is very difficult for many people, but still, I’m not so sure I’d be willing to loan 90% of a home’s value to a borrower with a bad history of repaying their debts in a deleveraging real estate sector.
For full details, checkout HUD Mortgagee Letter 10-29.