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The Federal Housing Administration released  new rules on home purchases that ramp up how much home buyers will need to cough up for down payments along with closing costs.

As if banks and lenders weren’t tough enough on consumers looking to buy a new home, now the government is cracking down, too. Still, loose lending policies fueled the economic collapse, so any new restraints on new home purchases may help “protect” the housing market from another implosion.

The FHA  needed to reduce its portfolio of bad debt – in May it reported 8.97% of all of its home loans were seriously delinquent. That number was up from 7.93% in May 2009 and from 6.5% in December 2008.

As more FHA loans become delinquent, it sets off a chain reaction that essentially dries up the agency’s cash reserve below the government mandated 2% minimum. That scenario could force the FHA to ask the federal government for a taxpayer bailout –something it has never done. (Historically, the FHA earned revenue from home loan borrower’s insurance premiums.)

Now, Congress has thrown a monkey wrench into any potential bailout scenario. According to Section 26 of the 2010 FHA Reform Act, Congress has placed a “Prohibition on Taxpayer Bailout of FHA Program.” So the FHA is on its own, and has now developed new rules to protect itself from delinquent loan scenarios.

Here’s a quick look at what’s going on with the FHA’s three new loan restrictions, which were announced on July 15:

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  • Updated combination credit and down payment requirements. New borrowers seeking FHA-insured financing will need to have a minimum FICO score of 580 to qualify for FHA’s flagship 3.5% down payment program. New borrowers with credit scores of less than a 580 will be required to make a cash investment of at least 10%. Borrowers with credit scores of less than 500 will no longer qualify for an FHA-insured mortgage.
  • Reduced allowable seller concessions from 6% to 3%. Allowing sellers to contribute up to 6% of the home’s sale price to offset a buyer’s costs exposes the FHA to excess risk by potentially driving up the cost of the home beyond its appraised value. Reducing seller concessions to 3% lets the FHA conform with industry standards.
  • Tighten underwriting standards for manually underwritten loans. When using compensating factors in the underwriting process, lenders will be required to consider those factors that best predict loan performance, including the borrower’s credit history, loan-to-value (LTV) percentage, debt-to income ratio and cash reserves.

The FHA also announced a 30-day period for public comment, so expect the new rules to kick in by late 2010.

While most real estate professionals acknowledge the FHA had to put some new risk management protections in place, given the weakness in the real estate market, the changes will still have a big impact on home loan borrowers.

“These changes will reverberate throughout the entire housing market because the FHA insures approximately 30% of all home loans in the U.S. today,” says Gibran Nicholas, chairman of the CMPS Institute, an organization that trains and certifies mortgage bankers and brokers. “The required buyer contribution when buying a home will be nearly doubled to 6.5% from the current 3.5%. This will hurt the housing market by making it more difficult for qualified buyers with high credit scores to buy a home.

Nicholas urges any homebuyers in the market right now to speed things up before the new rules go into effect. “Homebuyers considering an FHA loan should get moving today in order to avoid getting blindsided by these new rules,” he adds.

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