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Published: Sunday, 7/1/2012

FHA voids new policy tightening restrictions on credit scores


WASHINGTON -- The Federal Housing Administration has rescinded tough new credit restrictions that had been scheduled to take effect today.

The restrictions would have affected borrowers whose national credit bureau files show one or more collections or disputed-bill accounts with aggregate amounts $1,000 or greater. Some mortgage industry experts estimate that if the rules had gone into effect, as many as one in three FHA loan applicants would have had difficulty being approved.

Disputed bills are commonplace in many consumers' files but may not indicate serious credit risk. They could be a disagreement between merchant and customer over price, quality of the product, or the terms of the credit arrangement.

Open-collection accounts are also common but tend to be viewed more ominously by lenders because they often indicate nonpayment over an extended period. Unpaid creditors frequently charge off unpaid accounts, then sell the files to collection agencies who pursue the customer and report nonpayments to the national credit bureaus -- Equifax, Experian, and TransUnion.

Critics of the policy complained that it tilted the scales too heavily in favor of creditors and disproportionately harmed FHA's traditional core borrowers -- low to moderate-income families, first-time buyers, and minority groups.

Other critics argued that the policy would not help FHA weed out serious credit risks because private lenders are doing so by imposing their own credit score and other restrictions on applicants.

Clem Ziroli, Jr., president of an Ontario, Calif., mortgage brokerage, noted in an interview that although FHA accepts FICO credit scores as low as 580 -- FICO scores run from 300 to 850 with lower numbers portending higher risks of default -- many large lenders require scores of 640 or higher. They are being super-cautious in the post-bust marketplace and don't want to be required by FHA to "buy back" a mortgage that had a marginal FICO score at application and then went to foreclosure.

FHA's recent average scores are far higher than historical norms. According to an analysis by Ellie Mae LLC, a company that tracks conventional and FHA loan originations, the average FICO score for an FHA-approved loan to purchase a house in May was 713.

Although down slightly from March, when average scores for purchases hit 724, according to Ellie Mae, both scores suggest a strong trend toward financing applicants who have relatively fewer issues in their credit files.

During much of the last decade, FHA routinely financed borrowers with credit scores in the low to mid 600s.

Agency sources said FHA plans to issue a new rule "soon" that addresses collection accounts and disputes separately rather than lumping them into a single standard.

Meanwhile, those who think they have collections or disputes on file and who plan to apply for an FHA loan are likely to have their applications referred for "manual" underwriting, where a loan officer takes a hard look at the facts and circumstances of the collections or disputed accounts. This almost certainly will slow the approval process.

There are exceptions, according to the agency, such as when the disputed account is both less than $500 and more than 24 months old.

But lenders still may reject the applicants even if FHA says they are acceptable.

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