Upcoming Changes to FHA-Backed Loans Could Move Buyers Off the Fence

If the extension of the home buyer tax credit doesn't motivate more buyers to make a home purchase this year, maybe the thought of it costing more to finance a home in the future is what will force buyers to make the move.

That seems to be one of the few positive things that could come out of the Federal Housing Administration (FHA) increasing its borrower fees and putting tighter restrictions on its qualifications.

On Wednesday, the FHA announced its proposal to tighten lending requirements for home buyers and charge higher fees to protect itself, the general taxpayer, as well as the overall economy from rising mortgage defaults.

The FHA, a division of the Department of Housing and Urban Development (also known as HUD), is not a lending agency itself. Instead, it is a government insurer of mortgages that offers insurance to lenders to protect against defaults for loans that meet specific criteria (requirements to be classified as an FHA-insured loan vary by state). Lenders bear less risk because the FHA will pay the lender if a homeowner defaults on his or her mortgage.

FHA charges an upfront premium to buyers for the insurance. The mortgage insurance premium (MIP), is currently set at 1.75% of the loan amount, but is set to increase to 2.25% beginning April 5, 2010. FHA also charges a monthly fee to buyers for mortgage insurance, which is usually included in the buyer's mortgage payment.

FHA-backed loans have always been a favorite-or a necessity-for some buyers, despite the upfront insurance premium and monthly fee, because buyers previously could be qualified for a mortgage with less than stellar credit and with a lower down payment. However, the FHA is also proposing to make changes to these conveniences.

The FHA will keep minimum down payments at the current 3.5% level for most borrowers, but the agency will require riskier borrowers with credit scores below 580 to make a minimum down payment of 10% in order to qualify. For comparison purposes most lenders offering conventional loans require a minimum credit score of 620.

Another valuable perk that the FHA is looking to change is the amount of money that sellers can contribute for closing costs. While buyers had previously enjoyed seller concessions of up to 6% of the purchase price of the home, the FHA is looking to reduce this amount to 3% of the sale price.

According to its website, the FHA currently has 5.2 million insured single-family mortgages and 13,000 insured multifamily projects in its portfolio. With these proposed changes, riskier borrowers and those without a lot of cash should look to get under contract-very soon.