More cash and better credit — that’s what it may take secure an FHA mortgage in the coming months, according to changes announced this week by the U.S. Department of Housing and Urban Development.

With the FHA’s reserves now below government-mandated levels, the agency is considering ways to minimize risk and exposure. FHA borrowers may soon face a higher minimum down payment (it’s currently 3.5 percent) or pay more in mortgage insurance premiums.

The agency is also considering raising the minimum credit score to qualify for a loan.

“The loans FHA insures must be safe and self-sustaining for the taxpayer over the long-term,” Donovan said in his prepared remarks. “With these reforms and others we will be considering, the Administration is committed to ensuring that they are today — and into the future.”

At this point, there’s no consensus on what measures will take effect, or for how long. Changes to the credit score requirement would likely be temporary and not a permanent agency shift.

That’s also a switch that the FHA can make unilaterally. But it cannot raise mortgage insurance premiums without Congressional approval.

“We’ve learned from recent history that the market is fragile, and we have to plan for the unexpected,” Donovan told legislators this week.

The FHA has enacted a host of changes since it became clear the agency would see its reserve fund dip below the level required by law — 2 percent of the value of all its mortgages. Studies put the current fund level at about .50 percent.

For example, FHA-approved lenders now have to have more than $1 million in cash reserves. The previous level was a quarter of that.

photo credit: Kevin Cortopassi

Many people want to know what the best way to “get rid” of mortgage insurance — either Private Mortgage Insurance (often referred to as PMI) or FHA Mortgage Insurance (acts just like PMI, but payments are made to HUD, not a private mortgage insurance company).

If you want to avoid PMI altogether, you must put 20% down when you purchase the property. In the recent past, many times people would get a 2nd mortgage for that 20%, but many lenders have done away with “piggyback” loans — so more people are now buying homes and paying the PMI because they were not putting 20% down.

If you only put 5% down and are now wondering “at what point am I able to get rid of PMI” the answer is that when you reach a point where you think you have 20% equity in your property, you should contact your mortgage servicer. They will be able to tell you what their requirements are for “getting rid of PMI” and will usually send you a package of instructions that involve getting an appraisal and completing some forms.

Because the process is different between lenders, you need to speak with your current mortgage servicer to be sure. There is also a chance that they will drop the PMI automatically, but I rarely see that happen.

When dropping PMI, the factors that your lender will consider are the current value of your home and if you’ve made your mortgage payments on time. Be sure not to spend the money on ordering an appraisal to determine your property value until you have spoken with your lender about the process.

If you have an FHA loan — two things must happen in order to cancel mortgage insurance — the UFMIP account must be depleted completely (this takes 60 months from when you took out your loan) and you must have paid down the principal to 78% of your original loan balance. FHA monthly mortgage insurance does not take in to account any property appreciation that may have occured.

Good news for anyone who is a first time home buyer and can qualify for the new home buyer tax credit — HUD has now issued official guidance that will allow people to “monetize” the tax credit to use for closing costs or a down payment once the 3.5% has been paid.

Many people who want to “monetize” the tax credit ask the question of “can I use the tax credit for my down payment?” and the answer to that is officially “yes” — but not until they have put the 3.5% down as required for an FHA loan.

Another popular question that people have about monetizing the tax credit is “how much does it cost?” HUD has also done a nice job addressing the topic of how much it can cost to monetize the tax credit.

According to the Official Mortgagee Letter from HUD (2009-15):

“Any costs attendant to the purchase of the tax credit are to be nominal and discounting the anticipated credit to cover the costs and expenses of the transaction must be reasonable and disclosed to the homebuyer. In FHA’s view, fees and costs that total more than 2.5% of the anticipated credit are considered excessive. (Example: $6000 to be refunded, with all fees and costs discounted, borrower should receive not less than $5850.00 for sale of tax credit.)”

HUD also indicates in the Mortgagee Letter that they will be tracking and reporting what costs were for each person who monetizes the tax credit because the lender must report all of the FHA case file documentation and tax credit monetization data via FHA Connection.

Should an organization decide not to follow the official guidance, FHA will do any or all of the following: report to the Mortgagee Review Board, a referral to the Federal Trade Commission, or referral to the appropriate State Attorney General office, as needed.

One of the biggest problems right now is that many lenders are still trying to figure out how the details of the tax credit monetization plan will work. What the mechanics of the tax credit monetization will be, etc.

To my knowledge — as of today, many lenders are not offering this as an option — they are still trying to figure out how it will work exactly in practice. As they start to roll out the programs, I will be sure to let you know!