The Federal Housing Administration plans to make it tougher for borrowers to refinance a loan and take out cash as the agency tries to “limit its exposure to undue risk,” according to a letter that went out to FHA lenders this week. The decision comes at a time when defaults are rising in HUD’s flagship, FHA home loan insurance program, especially among borrowers who failed to make more than a single payment. The Washington Post reported recently that the quick loan defaults almost tripled in 2008 alone and more than quadrupled among FHA home refinancing.
FHA refinance loans now make up two-fifths of all the agency’s instant defaults, according to the Post analysis, and some lenders have singled out cash out refinance loans as especially risky. With conventional loans, many lenders now offer cash out mortgage only to borrowers with high credit scores and significant equity in their homes. The fear is that borrowers might otherwise take the cash and walk away from the mortgage.
Until now, the FHA has approved cash out refinancing for homeowners who have at least 5% equity in their properties and at least a one-year track record of on-time payments. Starting with mortgage applications that FHA lenders receive April first, this type of mortgage refinancing will be restricted to borrowers with at least 15% equity in their homes.
The change will be temporary “while FHA further analyzes the housing and mortgage industry as well as its own portfolio to determine whether permanent measures should be taken,” said the letter, signed by departing FHA Commissioner Brian D. Montgomery. The FHA does not lend money directly. It provides mortgage insurance for borrowers working with HUD-approved FHA mortgage lenders and uses the premiums to cover its losses. The quick defaults suggest that some borrowers are taking out loans they do not stand a chance of repaying, raising questions about whether the abusive lending practices that helped topple the subprime mortgage industry are making their way into government-backed FHA lending.
The agency has come under increased scrutiny in the past years because its share of the mortgage market has shot up from about 2% three years ago to nearly a third of the mortgages made after the subprime market vanished and its loans became the only option for many borrowers who lack a hefty down payment or stellar credit.
But even before the FHA loan policy change, many lenders had moved beyond what the agency requires and instituted tougher qualifying standards for borrowers, especially those looking for cash-out refinance deals. Bank of America, which adopted tighter standards in the summer, yesterday applauded the agency’s decision. “Safeguarding the FHA through this economic cycle is paramount to maintaining the liquidity FHA offers for home buyers today,” said Allen Jones, a government lending executive at Bank of America.
