The Decline of Adjustable-Rate Mortgages in 2010

The popularity of adjustable-rate mortgage (ARM) loans has declined sharply since the housing boom. This is partly because home buyers today are more aware of the risks associated with ARM loans.

Money HouseAt the height of the housing boom, adjustable-rate mortgages were about one-third of the mortgage market. They also accounted for roughly 80 percent of subprime loans. By 2008, ARM loans only accounted for about 15 percent of mortgage activity.

Today, as we move into 2011, adjustable-rate mortgages are only 5 – 6 percent of the market. That’s a huge decline, and it’s evidence of the growing stigma of the ARM loan.

How Does an Adjustable-Rate Mortgage Work?

Most adjustable-rate mortgages in use today are actually “hybrid” loans. This means they start with a fixed interest rate for a certain period of time, usually one to five years. After this initial period, the interest rate on the loan will begin to adjust or “reset” at some predetermined interval.

For example, the 5/1 ARM loan carries a fixed interest rate for the first five years, after which the rate will adjust every year. That’s what the “5/1” numbers signify. Adjustable-rate mortgages usually have caps that limit how much the rate can increase from one adjustment to the next, and also over the life of the loan.

Learn more about ARM loans.

A Brief History of ARM Loans

In 1982, during the Reagan administration, the U.S. Congress passed the Alternative Mortgage Transactions Parity Act (AMTPA). This legislation allowed non-federally chartered mortgage lenders to offer adjustable-rate mortgages. Before the passage of this act, banks were mostly limited to making conventional fixed-rate mortgages.

This legislation also paved the way for balloon loans, option ARM loans, negative amortization loans, and other so-called “exotic” mortgages. In more recent years, this act has been criticized for allowing lenders to obscure the total cost of a loan (and here the term “fuzzy math” comes to mind).

Adjustable-rate mortgages gained popularity through the latter half of the 1980s. In the mid 90s, when the housing boom was heating up, ARM loans exploded in popularity. At the height of the boom, one in three mortgage loans came with an adjustable rate. Through 2011, however, these loans will probably only account for about 5 percent of total mortgage applications.

Unpredictable in the Long Term

The risk associated with adjustable-rate mortgages comes during the first adjustment period, and every adjustment thereafter. Even if the rate is fixed for the first five years, it’s going to start changing eventually. In most cases, the rate will adjust upward to follow some kind of index. If the initial interest rate is heavily discounted, then the rate may rise significantly down the road. Save now … pay later. This kind of unpredictability makes the ARM loan a bad choice for a long-term stay.

When to Consider Using an Adjustable Mortgage

There is only one scenario when I recommend using an adjustable-rate mortgage. That’s when you know for sure that you’ll only be in the home for a few years. If you plan to sell the house and move after a few years, you could avoid the uncertainty of the first adjustment period. So, if you can get a lower initial rate with an ARM loan than a fixed mortgage, it might be in your interest to use one.

The key is to understand how these loans work, and what risks they carry. What happens if you’re unable to sell the home for some reason? Can you afford the new payments after the loan adjusts? You need to answer these questions before making a decision.

Top Ten Signs You’re Ready to Buy a House in 2011

Thinking about buying a home in 2011? If so, you’ll find this top-ten list helpful. When you’ve completed most of the steps on this list, you’re probably ready to buy.

Buying in 2011

Home-buying activity is expected to pick up a bit in 2011, when compared to 2010. High inventory, low mortgage rates, and a slowly improving job market will bring more buyers off the bench. Will you be one of them? If so, there are certain things you need to know and do, before entering the market.

Here are ten signs that you are ready to buy a home in 2011:

1. You’ve made the decision to buy on your own terms.

You’ve probably heard this line before: Home ownership is the American dream. This notion was created by mortgage lenders and home builders. After all, these people stand to gain if you buy into the “dream.” While home ownership certainly has some advantages, it’s not a one-size-fits-all scenario. Buying a home makes sense for some folks, but not for others.

So if you’re planning to buy a home in 2011, you need to make sure it’s for your reasons — and not because someone else is selling you the dream. How will becoming a homeowner change your lifestyle? Will it make things better or worse? Do you have the financial stability that’s needed to buy a house? Or do you expect some job transition in the near future? Is home ownership even a priority for you? Answering these questions will help you gauge your emotional and financial readiness to buy.

2. You’ve been watching home prices in your area.

What’s the real estate market doing in your neck of the woods? This is something you need to know, before you pour your resources into a home purchase. Are you buying a home in a city that had a big bubble / bust over the last few years? If so, there’s a chance home prices will fall even further throughout 2011.

Or maybe you live in one of those fortunate few cities that experienced stable home prices, even during the housing bust. In that scenario, there’s a better chance your investment will hold (or gain) value in the coming years.

The point is you have to know what’s going on in your local market, before buying a home in 2011. You obviously can’t predict the future. But with an eye on the past and present, you can at least make an informed decision about your home purchase. This is what professional investors do, and it’s what you should so as well.

3. Home prices are stabilizing in your area.

This is an extension of item #2 above. The worst-case scenario is to buy a home in a declining market, where home values are still dropping. The best-case scenario is to buy at the “bottom” of the market, so you can ride the upward climb. In between the two is where price stabilization occurs. Almost every city in America suffered from housing depreciation after the 2008 collapse. Some of those cities have stabilized already, and a few are even seeing appreciation. But home prices in many more cities are expected to decline in 2011.

If you’re in it for the long-haul, this might not be a big deal. Home values will head north again, sooner or later. But if you only plan to be in the home for a few years, you should avoid buying in a market that’s still declining. The savvy home buyer will wait until prices are stabilizing, before venturing into the market.

4. You’re putting money aside.

The days of reckless lending are behind us. For now, at least. That means the days of “zero-down mortgages” are also history. The VA and USDA loans are the only options for 100% financing these days. But those programs are limited to certain types of borrowers. Everyone else will need to make a down payment of some kind. When you buy a house in 2011, lenders will require you to have some skin in the game. For an FHA loan, you could put as little as 3.5 percent down (if your credit score is above 580). Most conventional mortgages will require at least 5 percent down.

The down payment is just one of the costs you’ll incur when buying a home. You’ll also have to cover your closing costs, and these can add up to $2,000 – $5,000, depending on where you live. Your lender will probably require you to have some cash reserves in the bank as well, above and beyond your closing costs.

Many first-time home buyers are caught off guard by the amount of money they have to spend. Don’t be one of them. Spend some time researching the full cost of buying a house in your area, and start saving your money early.

Related article: How much money should I save to buy a house?

5. You have a FICO credit score north of 600.

When it comes to mortgage approval, credit scores are more important today than in the past. This will be a key factor when taking out a loan to buy a house in 2011. In the current mortgage market, this single item can make or break your chances of getting a mortgage loan.

Maybe you’ve heard that the FHA allows you to have a credit score as low as 500, when using the FHA loan program. That may be true, but it’s sort of a moot point. You still have to be approved by an FHA-approved lender, and they won’t approve you with a score that low. In fact, two of the biggest lenders recently increased their credit requirements for FHA loans — from 620 to 640.

Having good credit will help you get approved for a loan. But the benefits don’t end there. A person with an excellent credit score will also qualify for a lower interest rate, which can add up to huge savings over the life of the loan.

6. You’ve established a home-buying budget.

Believe it or not, you can get approved for a mortgage loan that’s too big for you. It’s not as common today as it was during the housing boom. But it still happens. So before you start talking to mortgage lenders, you need to establish a monthly housing budget. This budget should factor in all of the other debts you have. The two biggest reasons for foreclosure are loss of income and poor budgeting. You can’t always control the first item, but you can certainly control the second. So do the math in advance.

7. You’ve researched your mortgage options.

Which is better for your situation, a fixed or adjustable-rate mortgage? This is one of the first things you’ll need to decide, when taking out a loan to buy a house. A lot of it depends on your long-range plans. Fixed-rate mortgages are better for longer stays, while an ARM loan can be used to reduce interest costs during a shorter stay.

Many of the mortgage horror stories you may have heard come from people who used ARM loans improperly. They stayed in their homes beyond the first adjustment phase, and they subsequently saw their mortgage payments swell. What can we learn from these people? That it’s critical to understand the different types of home loans, and how they work.

And what about these FHA loans you’ve heard so much about? Are they a good option when buying a home in 2011? Again, this will depend on your particular scenario. In many cases, the FHA loan can be an excellent path to home ownership. But they have their disadvantages as well (and you can learn about them here).

I recommend that you spend at least a week researching these topics, before you contact any lenders. Yes. It’s that important.

8. You’ve been pre-approved for a mortgage.

Mortgage pre-approval is when you sit down with a lender to see what options you have. The lender will review your financial situation and tell you how much they’re willing to lend you. Getting pre-approved for a home loan is useful for several reasons. It will help you identify any financing obstacles, such as income or credit problems. It will also make sellers more inclined to take you seriously.

It’s harder to qualify for mortgage financing these days. Most homeowners know this. As a result, they probably won’t entertain offers from a buyer who lacks a pre-approval letter. When we sold our house in the summer of 2010, my wife and I got an offer from some buyers who hadn’t been pre-approved by a lender yet. We basically ignored it, and accepted a qualified buyer’s offer two days later. Their agent should have told them not to waste our time, or their own.

9. Your debt doesn’t eat up too much of your income.

When buying a home in 2011, you can rest assured the lender will put your finances under the microscope. Your debt-to-income ratio (or DTI) is one of the first things they will examine. This is a comparison between the amount of money you earn each month, and the amount you spend on your various debts.

The maximum allowable DTI ratio will vary from lender to lender. It also depends on the type of loan you’re using. There are actually two types of debt ratios. One includes your housing costs as well as your other debts. This is known as the back-end ratio. The other one, the front-end ratio, only includes your housing debt. Here’s what you really need to know. If your combined debts (including your mortgage payments) account for more than 36 percent of your gross monthly income, you might have trouble qualifying for a loan.

10. You’re considering bank-owned homes, as well as the “regular” homes for sale.

When shopping for a home, you shouldn’t ignore the bank-owned foreclosures that might be available. These homes can often be purchased for less than their true market value. And many of them are in decent shape, having been lived in right up until the foreclosure took place. In some places (like California and Florida), bank-owned properties make up more than 20 percent of the housing inventory.

Bank Owned

Many buyers are afraid of bank-owned homes. Perhaps they’ve heard a horror story about the buyer who went back and forth with the bank for six months, before walking away from the deal. But in reality, buying a bank-owned home is generally the safest bet (out of all the foreclosure stages). And given the fact there are many of these homes available, you shouldn’t rule them out. Most real estate agents are familiar with the process. How could they not be? So keep them in mind, when you’re shopping for a house in 2011.

The basic process of buying a home is the same in 2011 as it was in 2000. But many of the lending rules and requirements have gotten tighter. So the modern home buyer must be knowledgeable and realistic. I hope this article has given you some firm footing to start your journey.

The 5 States With the Most Underwater Homeowners

CoreLogic, a company that provides financial and property analytics, released its “negative equity report” for the third quarter of 2010. Among other things, the data shows that the five states hardest hit by the foreclosure crisis hold some other dubious distinctions as well. They also have the most underwater homeowners.

Definition: An underwater homeowner is somebody who owes more on their mortgage loan than the home is currently worth. Thus they are underwater in the mortgage. This is also referred to as being upside down in the loan.

The envelope please. Cue the drum roll. And the five states with the highest percentage of underwater homeowners are:

  1. Nevada – In many ways, the Silver State could be considered Ground Zero for the foreclosure crisis. And it still shows. Today, 67 percent of all mortgage holders are underwater in their loans. Home prices in Las Vegas fell 4.2 percent in the third quarter alone.
  2. Arizona – Another of the so-called “sand states,” Arizona was equally devastated by the housing crisis. As of December 2010, 49 percent of the state’s mortgage-holding homeowners were underwater in their loans. An Arizona State University study recently showed that Phoenix is experiencing a double-dip in home prices.
  3. Florida – Things don’t look sunny for homeowners in the Sunshine State. Florida is close behind Arizona, with 46 percent of mortgage holders underwater at the end of 2010. Home prices in Florida are expected to decline by as much as 9 percent in 2011.
  4. Michigan – Approximately 38 percent of Michigan mortgage holders are underwater in their homes. Michigan is also a national “leader” in terms of unemployment. Last month, the state had one of the highest unemployment rates in the country (12.8 percent), second only to Arizona.
  5. California – The Golden State used to rank higher on this list. But the number of underwater homeowners there has dropped to 32 percent. The California Association of Realtors expects a 2-percent rise in the median home price in 2011. Of course, this is an organization that relies on homes sales, so we can take this forecast with a grain of salt.

At the national level, many analysts and economists are predicting further price declines for most of the U.S., well into 2011. In contrast, there are certain places where prices are expected to rise next year. But on the whole, the 2011 housing scene could look very similar to 2010.

What is a Good Credit Score in 2011?

What is considered a good credit score these days? This is one of the most common questions we receive from our readers. And as we replace our 2010 calendars with new ones for 2011, this question will surely see a spike in frequency again.

So, in anticipation of all those emails, I thought I’d share my own definition of a good credit score in 2011:

Looking Back: A Credit Score History

Are credit scores really that important for home buyers? Yes. In fact, they are more important today than at any point in the last decade. If you bought a home in 2003, for example, your credit score would not have weighed as heavily toward the lender’s final decision. If you had good income and a decent down payment, you would’ve been approved for a loan — even if your credit score was lackluster.

Things have changed. In 2011, your credit score has the power to make or break the mortgage approval, all by itself. Lenders (and investors in the secondary mortgage market) are putting more emphasis on credit scores as a risk-management tool. So you can bet it’s one of the first things they’ll review when you submit your mortgage application. We’ve reverted back to an era of sensible lending, for the time being anyway.

So What’s a Good Score in 2011?

2011 Credit ScoresLet’s talk goals before we talk numbers. As a home buyer, you have two mortgage-related goals. You want to get approved for the loan, obviously. But you also want to get a decent interest rate, meaning a rate that’s close to the current national average.

So by that definition, a good credit score in 2011 is one that helps you qualify for a mortgage loan with a relatively low rate — your two primary goals as a borrower.

So let’s talk numbers. What does it take to qualify for a loan in 2011, from a credit standpoint. Consider the following. Traditionally, FHA loans have been the best option for people with weak credit. These are government-insured loans, so the credit-score requirements are generally lower than those for a conventional / non-government-insured loan.

In 2011, the minimum allowable credit score for an FHA loan is 500. If you want to qualify for the 3.5% down payment program, you’ll need a score above 580 (related story).

But here’s the rub. Both of these numbers (500 and 580) are basically moot, because the lenders who make these loans will require even higher credit scores.  Bloomberg news recently reported that Bank of America and Wells Fargo, the two biggest mortgage lenders in the U.S., have raised their minimum credit-score requirements from 620 to 640 for some FHA loans. Other FHA-approved lenders will likely require a score of at least 620 for approval.

So, for the most part, the FHA’s minimum requirements don’t really matter. You still have to go through a lender, and they have higher minimum requirements.

What about conventional mortgage loans, those that aren’t backed by the government? Historically, it has been easier to obtain an FHA loan than a conventional mortgage. So if most lenders are requiring a credit score of 620 or higher for FHA, you can bet they’re doing the same thing for conventional — at a minimum.

Other Qualifying Factors

Credit scores are important. But they’re not everything. Your income and debt levels are equally important. If you don’t have enough income for the size of loan you want, you won’t get approved. Also, if your current debt obligations are eating up too much of your monthly income, you’ll hit a snag. But those are subject matter for another story.

Here’s what it all boils down to:

If you want to qualify for a home loan in 2011, you’ll need to have stable income, manageable debts, and a good credit score. But the definition of “good credit” has been reset to pre-housing-boom levels. A good credit score in 2011 can best be defined as a FICO score of 620 or higher. This doesn’t mean you couldn’t get approved for a loan with a score below that level. It’s possible. This is just the nearest we can come to a hard definition for a soft target.

Morgan Stanley Sees Home Prices Declining in 2011

What will U.S. home prices do in 2011? It’s a common question, as we wrap up yet another painful year for housing. Property values have fallen considerably since the crisis began in 2008. And a recent prediction suggests they may have further to fall.

It’s good news for home buyers, and bad news for homeowners. Financial services firm Morgan Stanley expects home prices to decline by as much as 11 percent through 2011 and into 2012. Many had hoped the market would hit ‘bottom’ next year. But that may not be in the cards after all, if Morgan Stanley’s predictions are accurate.

To what do their financial analysts attribute this gloomy forecast? Supply and demand, of course. They feel that rising inventory and weak demand will push the current housing-market slump all the way into 2012. This jives with the consensus reached in our housing predict-o-meter, which shows that 2011 could be a lot like 2010.

Translation: Home prices will likely continue to decline in many parts of the U.S. next year, and possibly into 2012.

The Morgan Stanley analysts, led by Oliver Chang, said that tightened lending standards will continue to hamper home sales next year. “We see the trough occurring in 2012 instead of our previous call of 2011,” Chang told Bloomberg news, during a phone interview recently.

Indeed, it is harder to qualify for a home loan today than it was before the housing collapse. During the boom, nearly anyone with a steady paycheck could qualify for a mortgage. But things have changed dramatically since then. Today, risk-averse mortgage lenders require higher credit scores, more documentation proof of income, and lower debt levels. This shrinks the pool of qualified home buyers, weakening the demand side of the housing equation.

Also restricting demand is the fear of falling prices. For decades, we operated under the assumption that home values would always go up. This was viewed as an unshakeable truth. Now we know better. Just look at California, Florida and Arizona, the states hit hardest by the housing crash. Real estate values plummeted in those markets, and are falling still. This puts hear in the hearts of would-be home buyers. It’s a legitimate concern. Who wants to spend hundreds of thousands of dollars on an asset, only to see it depreciate from day one?

We have problems on the supply side as well. Millions of foreclosure properties flooded the market after the crash. There is not nearly enough demand to absorb them all. It’s the kind of situation that is measured in years, not months. What’s worse, these distressed properties are often sold for less than market value. This puts downward pressure on property values across the board, even for non-distressed homes.

Of course, none of this comes as news to the folks at Morgan Stanley. They are intimately familiar with the many woes of housing. It’s what led to their bleak predictions for next year.

Some markets will take longer to recover than others. We are seeing this even now, as the level of depreciation lessens in some markets and worsens in others. Speaking broadly, however, I would not expect to see a national rebound in home prices until mid 2012, at the earliest.

Morgan Stanley is a financial services firm that was founded in 1935. They offer a variety of investment banking, securities and wealth management services. They are headquartered in New York and serve clients worldwide.

Freddie Mac Offers a Glimpse of the Mortgage Market in 2011

Editor’s note: This article contains outdated information pertaining to mortgage rates. For the most recent information available, be sure to visit our forecast page.

Ask 20 different economists to predict mortgage trends in 2011, and you’ll get 20 different predictions. (And don’t forget to take your No-Doz pills first.) But there are a handful of economists who are in a position to give fairly accurate predictions. One of them works for Freddie Mac, the newly-government-owned purchaser of home mortgage loans. Here’s a 2011 mortgage outlook from Frank Nothaft, the chief economist at Freddie Mac.

Frank NothaftParaphrasing: Mortgage rates will remain relatively low during 2011. Some rate increases can be expected between now and then. The average rate for a 30-year fixed mortgage will probably stay below 5 percent throughout the year, while the 5/1 hybrid ARM will probably stay below 4 percent.

Translation: 2011 will probably be a lot like 2010, as far as mortgage rates go. Mr. Nothaft’s forecast for 2011 closely matches the consensus we have posted on our housing market predict-o-meter.

What We Might See in 2011

What else will change in 2011? Disclosing the fact that we have no crystal ball in our office, here’s our view:

The job market will slowly improve through 2011, though the national unemployment rate will likely remain over 9 percent. This will increase the demand for housing in many cities across America. But a full recovery of the housing market probably won’t take place until 2012. Home prices will continue to decline in many areas, at least for the first half of the year.

Housing inventory will be the primary cause for these declines — foreclosure inventory in particular. More people will be buying homes, when compared to 2010. Refinance loans will drop considerably. Oh, and we haven’t heard the last of the robo-signing drama.

What It Means to Home Buyers

Are you planning to buy a home in 2011? Here’s how all of this may affect you. If you have steady income and a good credit score, 2011 might be a great time to buy a home. You’ll have plenty of buying power, in terms of home prices and mortgage rates. Sellers who have been on the market for a while should welcome an offer from a qualified buyer, even if it’s below their asking price. This puts the negotiation process in your favor, so long as you make a reasonable offer based on recent sales.

Just keep an eye on your local housing market. Start keeping tabs on what home prices are doing in your area, and what they are expected to do over the next few years. You don’t want to purchase a home in a steadily declining market. If you do that, you’ll likely end up with negative equity inside of a year. But if your real estate market is bouncing along the bottom, so to speak, you might want to jump in while the rates are still low. The key is to make an informed decision, based on plenty of localized research.

Disclaimer: The mortgage rate forecasts in this article should not be taken as gospel. They are an educated guess, based on current conditions in the economy.

Home Value Killers of 2011: Inventory and Unemployment

2011The current consensus seems to be that home values in most parts of the U.S. will decline, as we head into 2011. This should come as little surprise, when you consider the current level of housing inventory and unemployment.

But we may find ourselves surprised by the full scope of the price erosion. Once hailed as the “year of recovery” for the housing market, 2011 could be very similar to 2010.

Housing Inventory = Downward Pressure on Home Values

According to the S&P/Case-Shiller home-price index, home values nationwide fell 0.7 percent from August to September of this year. There was also a quarterly decline in values from the second to third quarters of 2010. That’s not to say there weren’t pockets of positivity, as in Washington D.C. where prices actually rose during the same period. But nationally speaking, the current trend is downward.

The foreclosure freeze will prolong the high inventory of homes, and probably add to it as well. If the listing of new homes continues to outpace the purchase of those homes, the inventory will rise in the coming months. Absent a major spike in home-buying activity, this will drive prices down in most areas. Supply and Demand 101.

Unemployment: Other Half of the Double-Whammy

The latest unemployment figures (as of December 2010) were unchanged over the previous month, still hovering at 9.6 percent. Some states, such as California, have more than 12 percent unemployment. This will continue to be a drag on the housing market in 2011.

Thankfully, though, we are starting to see some positive trends in the employment world. The unemployment rate in Virginia has fallen steadily over the last few months, and now sits at 6.8 percent. There are other cities and states with similar scenarios. So we will certainly see some job growth in 2011. But it will be a trickle.

What This Means for Homeowners

If you’re not planning to sell or refinance your home in the near future, this doesn’t affect you very much. Sure, your home values might drop a bit more over the next year or so. But they’ll trend upward again — eventually.

If you do plan to sell your house in 2011, you need to be realistic about how you price it. If you bought your home more than three years ago, there’s a good chance your home value has dropped since then. If you live in California, Arizona, Florida, Nevada or Detroit … well, I don’t need to tell you, do I?

The point is, you need to find out what your home is worth in the current market, and price it accordingly. It doesn’t matter what you paid for the home. It doesn’t matter how much you owe on your mortgage. Buyers and their agents will use recent sales data to evaluate your asking price. If you’ve overpriced the home out of desperation or wishful thinking, they’ll know. And they won’t give you the time of day.

What It Means for Home Buyers

If you can qualify for a mortgage loan, 2011 looks like another great year to buy a home. While home values might continue to drop in some areas, they probably don’t have far to fall. Karl Case, retired economics professor and co-creator of the S&P/Case-Shiller Index, recently said: “If I were betting even odds, I’d bet that we don’t have much further decline, but that we bounce along the bottom.”

So even if home values drop a bit after you buy, they’ll start upward again … and probably sooner rather than later. Additionally, mortgage rates will likely stay below 5 percent for most of 2011. So you have a combination of low home prices, a low cost of borrowing, and plenty of inventory. It’s a pretty good scenario for qualified home buyers.

FHA Loans Took 40 Percent of Market Share in 2010

On Tuesday, the Department of Housing and Urban Development (HUD) released its annual report on FHA issues to Congress. Among other things, the report stated that FHA loans accounted for nearly 40 percent of all purchase mortgages, for the period of November 2009 – November 2010.

The Ups and Downs of FHA Market Share

In 2005, the FHA’s market share of purchase loans was closer to 5 percent (when measured by households served). So they are clearly insuring more loans today than just a few years ago. But if we go back even further, we can find a similar pattern. In 1993, FHA’s slice of the purchase-loan mortgage market was around 15 percent.

So what’s really going on here?

For the most part, the FHA’s market share has followed the alternating trends of relaxed and restricted lending. Whenever financial side-doors open up for people with bad credit and no money down, FHA’s market share goes down. When those doors close again, FHA loans become more popular.

This is what we saw in the late 1990s and early 2000s. Remember, this was the period when all of those “exotic” mortgage loans came into use — most of which are now extinct. The stated-income loan, the subprime mortgage, etc. “So long FHA. We don’t need you anymore. There’s a new game in town.”

But now that most of those high-risk (and low intelligence) mortgage products are gone, it’s a love affair with FHA loans once again.

By this time next year, FHA loans could easily account for more than 50 percent of all purchase mortgages. Our consumer research is already pointing toward this kind of usage spike. Time will tell.

FHA Loans 2.0 – They Aren’t “Easy” Anymore

Of course, even the FHA has limits to what it will do, in terms of lending. Over the last few years, the government agency suffered huge financial losses resulting from defaults and foreclosures. The so-called “seller-financed down payment assistance” mortgages cost the FHA more than $6 billion dollars in claims.

So the organization’s leaders took a step back to review their mortgage-insurance criteria. As a result of this review, there have been a number of changes to the FHA loan program. Borrowers today will need larger down payments (3.5 – 10 percent) and higher credit scores.

The FHA is also taking steps to restore its capital reserves. During the housing-market crash, those reserves fell below the 2-percent mark that is required by congress. They are restoring capital largely by requiring higher mortgage-insurance premiums over the term of the loan.

Related stories:

FHA logoAbout the FHA: The Federal Housing Administration (FHA) is part of the federal government, under the Department of Housing and Urban Development (HUD). This agency insures mortgage loans made by FHA-approved lenders in the primary mortgage market. They insure loans against default, which increases the lender’s willingness to lend. Since its inception in 1934, the FHA has been the largest insurer or mortgage loans. Learn more

FHA Lenders Increase Credit Score Requirements for FHA Loans

There have been more credit-related changes to FHA loans in the last year than the previous ten years combined. And here comes another: Bank of America and Wells Fargo recently raised their FICO credit-score requirements for some FHA loans from 620 to 640. Going forward, borrowers with credit scores below 640 may not qualify for FHA loans.

This story was originally reported by Jody Shenn and John Gittelsohn on

We have previously written about the new credit-score guidelines set forth by the Department of Housing Urban Development (HUD) in 2010. That was when HUD established the minimum credit score for FHA loans at 500, with 580 being the cutoff for the 3.5% down-payment program. But those numbers are largely meaningless, because most FHA-approved lenders will not approve a borrower with a credit score below 620. At least, that used to be the rule of thumb.

Recent developments show that lenders are raising the bar once again. Bank of America and Wells Fargo are the two largest mortgage lenders in the United States. Combined, these lenders account for the majority of home loans being made today. They both recently increased their credit score minimums for FHA loans from 620 to 640.

FHA logoAbout the FHA: The Federal Housing Administration (FHA) does not actually make loans to consumers. Rather, they insure the loans made by primary lenders such as BOA and Wells Fargo. Thus, FHA home loans are also referred to as government-insured loans.

The lenders who make these loans are referred to as FHA-approved lenders.

The FHA has established some basic guidelines for mortgage underwriting. But the lenders impose their own (often more stringent) guidelines on top of the FHA’s minimum requirements. This latest credit-score development is an example of how mortgage lenders can be more strict than the FHA when making FHA home loans.

These changes will affect a rising number of home buyers. Ever since the housing market collapsed in 2008, the FHA’s market share has increased considerably. Today, about one-fifth of all mortgage loans are made through the FHA loan program. A 2010 home-buyer survey conducted by the Home Buying Institute suggests that FHA usage may increase even more in the future.

Benchmark Rate to Average 4.4 Percent, Says MBA

Editor’s note: This is an outdated article. For the most recent mortgage forecasts available, please see this page.

On Tuesday, the Mortgage Bankers Association (MBA) released its forecast for 2011 home-loan rates and other housing trends. They feel the benchmark 30-year fixed mortgage rate will average 4.4 percent for the remainder of 2010. For 2011, the MBA predicts that the benchmark rate will slowly but steadily increase to around 5.1 percent.

Various factors are driving our rate forecast,” said Jay Brinkmann, MBA’s Chief Economist and SVP for Research and Economics. “Absent some blockbuster post-election announcement from the [Federal Reserve] on November 3rd, we do not expect to see a further decline in rates.”

The MBA also expects to see a modest rise in home sales in 2011, along with a corresponding rise in home purchase loans.

If their rate predictions come true, it means that mortgage financing will be more affordable this year than next. But how much more affordable? Let’s look at some pricing scenarios to see how the percentages play out when applied to an actual loan amount.

Mortgage Pricing Scenarios

At the time of publication, the average rate for a 30-year fixed mortgage was 4.23 percent (up from 4.19 percent two weeks ago). The MBA is forecasting that rates will rise to 5.1 percent by the end of 2011. At first glance, these numbers don’t mean much. Sure, 4.4 percent is lower than 5.1 percent. But how does that translate into actual dollars? Here’s an example of how much money a home buyer could save by getting the lower of these two rates.

  • A 30-year fixed-rate mortgage in the amount of $250,000 at 4.4 percent interest will have a monthly payment of $1,251 (excluding insurance and taxes). Total interest paid over the full term of the loan = $200,684.
  • A 30-year mortgage for the same amount with a rate of 5.1 percent will have a monthly payment of $1,357 (excluding insurance and taxes). Total interest paid over the full term of the loan = $238,654.

In the second scenario, I would pay an additional $106 a month toward my mortgage payment. The higher interest rate would account for this increase. But look at the total amount of interest paid over the life of the loan. That’s where the true difference becomes apparent. In the second scenario, I would pay an additional $38,000 worth of interest. I could put my kid through college for that amount of money.

What does all of this mean? It means that if the MBA’s predictions are accurate, mortgage loans are going to be more expensive in 2011. It means that you could save money by buying (or refinancing) a home sooner, rather than later.

We are tracking these and other housing market predictions for your convenience.

Disclaimer:We make no assertions or guarantees about the forward-looking statements made by the MBA. We have provided this information for educational purposes only. There are many variables that could render their predictions inaccurate. No one can predict the mortgage market with 100% accuracy. Additionally, the rate you receive on a home loan will vary from the average rate, based on your credentials as a borrower (credit score, down payment, debt level, etc.).