Tougher Standards For Bad Borrowers Who Don't Exist

A new Housing and Urban Development rule requiring home borrowers with severely impaired credit to make larger down payments in order to qualify for taxpayer-funded loan guarantees will not apply to many people, and possibly not to a single human being.

The Federal Housing Administration (FHA) last month announced that it would raise the minimum down payment required to secure an FHA-backed mortgage from 3.5 percent to 10 percent, but only for borrowers with credit scores below 580.

"Striking the right balance between managing the FHA's risk, continuing to provide access to underserved communities, and supporting the nation's economic recovery is critically important," FHA Commissioner David Stevens said in a statement.

The announcement seemed underwhelming: Who is getting a mortgage with a FICO score of 580? A Department of Housing and Urban Development (HUD) spokesman says the government has not "run down" the numbers of how many FHA-guaranteed loans are for people with below-580 credit scores, but allows that the "vast majority" are above 580, adding, "It's safe to say most of our numbers fall above it." 

The December FHA Outlook for Single-Family Homes [pdf] says that of the 179,155 loans FHA guaranteed that month (at a total cost of $32.5 billion, for an average loan value of $181,407), the weighted average FICO score was 694, up 5 percent from an average 661 in December 2008.

That's all good news. (For why a 3.5 percent down payment is extremely dangerous to taxpayers, read Steve Chapman's column on FHA policy. Here I am explaining why low or negative equity is by far the most reliable indicator of default.) But why would anybody give a mortgage to a borrower with such a well-below-subprime credit score, and why are you and I forced to get anywhere near that stink bomb? Another HUD spokesman emails a helpful response:

Today, there is very little loan activity below 620 (let alone 580), because lenders tightened their own underwriting in 2008. The new policy change is primarily to protect us when conventional sources of credit return to the market. We are protecting the MMI Fund from "adverse selection," which is a statutory requirement for the Secretary. It means that, when private capital comes back, we don't want to pushed back into having a significant share of business with low FICO scores. Just two years ago our average score was around 625.

I'll take their word for it that few or no loans are currently being insured at taxpayer expense for borrowers with 580 credit scores. But I think my new friend at HUD is being coy with his reference to the return of "conventional sources of credit." In a conventional credit market (that is, one with no support from the government), nobody would be giving mortgages at all to people with credit ratings that bad.

This is not to put much confidence in the hocus-pocus by which Equifax, Experian and TransUnion determine credit scores. (In a world where no lender could bail out on Uncle Sam, banks would be doing a lot more due diligence than simply getting reports from those three robonic stooges.) But there is no planet on which it's a good move to lend a whole lot of money to a person with an extensive history of not paying it back, whether that person can put down 3.5 percent or 10 percent. You can't keep encouraging lower lending standards and also bragging that you're bringing them up.

Ladies and gentlemen, give it up for the Three Robonic Stooges: