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FHA back pedals on credit dispute underwriting rule, perhaps only temporarily

by Broderick Perkins

(7/5/2012) The Federal Housing Administration recently offered some good news for those applying for a mortgage and also face certain credit disputes.

The agency recently rescinded a rule that could have caused lenders to slow or reject FHA mortgage applications, if the borrower had a credit dispute on their credit report.

However, if you have an ongoing credit dispute and plan to get an FHA mortgage, get rid of any credit dispute as soon as possible. The rule could return as the FHA continues to seek ways to cut its growing losses.

"Miscellaneous Underwriting Issues- Rescission of Disputed Accounts and Collection Accounts Guidance (Mortgagee Letter 2012-3)" canceled the maligned rule slated to go into effect July 1.

FHA had planned to reject home loan purchase applications if the applicant had an ongoing credit dispute or collections action amounting to at least $1,000 on his or her credit report.

Mortgage applicants would have had to either pay off the outstanding balance of the disputed account or document a payment plan the lender would have submitted to the FHA before the deal closed.

The new rule would have forbidden borrowers to pay down a disputed amount to below $1,000 to skirt the rule.

Any payments arranged would have been included in the calculations of a borrowers debt-to-income ratios.

The National Association of Homebuilders (NAHB) and others lobbied heavily against the proposed rule which would have restricted the flow of mortgage money and blocked otherwise creditworthy borrowers from qualifying for an FHA-insured loan.

John Burns Real Estate Consulting reported, based on input from homebuilders, the new rule could have disqualified 60 to 84 percent of buyers already under contract at some new home communities.

The rescinded rule may not be permanent. The FHA plans to issue new guidance on the topic in the near future.

The FHA has been making it tougher to buy a home with an FHA mortgage.

Along with stiffer underwriting rules, changes are also costing borrowers more in mortgage insurance premiums so the agency can raise millions and offset losses to its insurance fund. Congress mandated that the fund keep 2 percent of its portfolio in reserve. Last year, the level slipped to only a little more than 0.2 percent.

FHA insures low-down payment home loans that cover as much as 96.5 percent of a home's value. FHA loans virtually replaced toxic subprime loans which became popular as the market peaked.

Unfortunately, subprime loan teaser starter rates, loose payment options and low- to no-down payment deals eventually become too expensive for many borrowers who defaulted on their mortgages under the weight of ballooning payments.

FHA loans have been suffering the same fate and could require a taxpayer bailout as large as $50 billion, according to a recent George Washington University's study, "The Role of the Federal Housing Administration in a Recovering U.S. Housing Market."

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