FHA Reduces Risk To Institutions Lending To Low FICO Score Borrowers

By | August 19, 2015

The Federal Housing Administration (FHA) is tweaking its single-family Neighborhood Watch System!

In what appears to this untrained eye to be a move back towards some of the excesses that brought the financial crisis on in the first place, FHA is adjusting its Neighborhood Watch System in an attempt to spark more mortgage lending to borrowers with lower FICO scores.

Looking back at recent history, the goal of the Community Redevelopment Act of 1977 once it had morphed in the 1990’s to a focus on actual outcomes, was to reduce discriminatory credit practices against low-income neighborhoods, or redlining.

The result was to make homeownership available to most by ‘encouraging regulated financial institutions to help meet the credit needs of the local communities in which they are chartered’ (Wikipedia)

The ensuing and increasingly more lax credit environment was eventually coupled with lower interest rates (sparking a refinance boom) and loan securitization’s which helped to fuel the housing bubble.

Then came 2008 and the bubble burst in what became known as ‘the financial crisis’.

After the dust had settled, lending standards tightened to the point where a borrower needed to be pristine in order to qualify for a mortgage.

Now, fast forward to today and the FHA is going to make it easier (i.e. less risky) for banks to offer mortgages to borrowers with FICO scores below 640.

Neighborhood Watch System

The Federal Housing Administration has enhanced its single-family Neighborhood Watch System in an effort to ensure that lenders are not unfairly penalized for making loans to creditworthy borrowers with low credit scores.

The new “supplemental performance metric” is designed to compare lenders’ performance on loans with credit scores below 640.

“This is one more tool to help FHA, lenders and the public know exactly who we’re serving,” said Ed Golding, principal deputy assistant secretary for housing. “By better understanding FHA’s acceptable risk tolerance levels for a variety of credit scores, lenders will have the confidence to lend more broadly and FHA will have more data on how successful those lenders are.”

Under the Neighborhood Watch System, FHA lenders with high early default rates can be targeted for audits and administrative actions.

Over the years, lenders have complained that Neighborhood Watch discourages lending to borrowers with low credit scores. The average credit score on FHA-insured loans in the second quarter was 681.

FHA currently calculates a ratio that compares a lender’s rate of early defaults to other approved lenders in geographic areas, which FHA uses to identify lenders with high default rates. The supplemental performance metric complements that ratio by measuring default rates and claims in three separate credit areas.

The new metric is “intended to encourage lenders to originate more creditworthy loans with below 640 credit scores and should only help a lender facing a potential Credit Watch action,” said Brian Chappelle, a mortgage consultant.‘ (Source)


Article written by Michael Haltman, President of Hallmark Abstract Service in New York.

HAS is a provider of title insurance in New York State for residential and commercial real estate transactions.

Learn more by watching the Hallmark Abstract WhiteBoard Animation here.

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