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New Minimum Credit Score not Enough, Analysts Say

By Sally Maison
Published: Monday, March 1st, 2010

Industry analysts were glad when the Federal Housing Administration had finally taken measures to prevent more borrowers from defaulting on federal-backed loans. If the FHA does not stop the growing number of defaults, it may no longer be able to secure home loans in the long run. However, some analysts are not satisfied with the new rules since they believe the new credit score minimum is still quite low. Additionally, they do not think it is fair to require higher down payments from low-credit score borrowers.

New Minimum Credit Score not Enough, Analysts SayHomebuyers who are able to qualify for FHA-backed loans can make as little as a 3.5 percent down payment upon their purchase. This is because the FHA reduces risks for lenders by insuring those loans. However, in the past couple of years, the agency has seen an alarming increase in number of defaults for government-insured loans, prompting it to establish new approval standards, including a new credit score minimum of 580.

The FHA says it will still back loans for individuals whose ratings are below 580, but they will have to pay down 10 percent of their mortgage amount. While raising the credit score bar can keep the riskiest borrowers from availing a mortgage loan, some analysts say the FHA has not done enough.

Critics explained that credit scores ranging from 620 to 659 were already considered subprime, traditionally. With a credit score of 580, a person will most likely find it difficult to get a line of credit, even from a subprime lender. Consumers whose ratings fall within the 330 to 619 range are termed “credit lepers” in banker jargon. This means their ratings are considered by lenders too risky to merit any loan.

Analysts criticize the FHA’s new rules for having a political rather than a financial basis. They believe that the agency merely imposed this 10 percent down payment on a certain credit score range so it can get rid of loans it wants to turn away. They add that they see no connection between a 580 credit score and a 10 percent down payment. Analysts suggest placing a sliding scale instead of imposing a new all-or-nothing credit score cutoff.

As they see it, credit ratings are not absolute predictors of a borrower’s chances of default, adding that it is only a relative measure of the likelihood of a default. People with higher credit scores are actually less likely to default than people with lower ratings, but consumer scores cannot absolutely predict default.

Since scores are not absolute predictors, analysts say requiring higher down payments from borrowers with lower ratings is not rational. They suggest that the FHA review its new lending standards.

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