Inside the country's fastest-growing home-mortgage program, the surprising answer is: People with lower incomes have slightly higher FICO scores. That finding, which emerged from a statistical analysis of all approved mortgages insured by the Federal Housing Administration during fiscal 2007, is buttressing a forthcoming major policy switch that could affect thousands of buyers and refinancers.
The FHA, which for decades has used a one-size-fits-all approach to price its insurance on home loans, plans to shift to a "risk-based" system keyed to FICO scores and down payments, beginning as early as mid-July. Private-sector lenders and insurers have priced interest rates and premiums using sliding scales of FICO scores and down payments since the mid-1990s.
The FHA's move, which will cover all new applications including "jumbo" loans up to $729,750 in high-cost markets through December, will bring the agency in line with the private sector's predominant approach.
FHA Commissioner Brian D. Montgomery outlined the impending change in a speech here May 8 to the annual conference of the National Association of Real Estate Editors. Under the old approach, he noted, buyers with stellar FICO scores paid the same premiums as borrowers with poor scores. That was a pricing inequity for applicants who presented low risk of default on their loans and an inappropriate subsidy of applicants who were likely to default.
A study of an entire year's applications turned up the additional fact that the FHA's lower-income borrowers typically had higher FICO scores than buyers with larger incomes.
"Is it counterintuitive? Yes," Montgomery said. According to the study, applicants with FICO scores of 680 to 850 had a median income of $48,756 last year, while those with scores of 500 to 559 had a median income of $53,388. Fair Isaac Corp.'s FICO scores range from about 300 to 850 -- the higher the better -- and are predictive of future defaults and foreclosures.
Even at rock-bottom down-payment levels of 3 percent, applicants with lower incomes had higher credit scores than applicants with bigger incomes making similar-size down payments.
All of which underlines the key reason for making the switch to risk-based pricing: Why should people who have demonstrated superior credit -- irrespective of their income levels -- pay the same mortgage insurance premiums as loan applicants who have seriously flawed credit histories?
Under the new system, according to the FHA's outline of its plan, "a larger number of low-income borrowers [will] benefit from premium reductions than . . . moderate-, middle- and upper-income borrowers combined." On 30-year loans with down payments of 10 percent or more, applicants with FICO scores above 680 will qualify for the lowest premiums -- 1.25 percent of the loan amount upfront and annual renewal premium payments of 0.5 percent. Borrowers with down payments under 5 percent and poor credit scores -- FICOs ranging from 500 to 559 -- will be charged premiums of 2.25 percent upfront and 0.55 percent annually. All borrowers will continue to receive the same market-based interest rate. Under the current system, borrowers pay uniform 1.5 percent premiums upfront and 0.5 percent annually.
To set premium rates by credit standing, the FHA plans to use the middle score of an applicant's three FICOs generated by the national credit bureaus -- Equifax, Experian and TransUnion. If only two scores are available, it will use the lower. For applicants with thin or "nontraditional" credit histories on file at the bureaus, the FHA will underwrite and price the loans without reference to FICOs, with heavier emphasis on rent and utility payments, among other measures of creditworthiness.
Though FHA mortgage volume has more than doubled in the past year, the move to risk-based pricing is expected to make it more attractive to buyers and refinancers. During the housing-boom years, the FHA lost much of its business to subprime lenders and insurers that offered zero-down, low- or no-documentation loans at high interest rates and fees, including prepayment penalties. The FHA, by contrast, always has required at least a 3 percent down payment and full documentation of income and assets, but it has never permitted prepayment penalties.
Since taking over as FHA commissioner in 2005, Montgomery has emphasized "modernizing" the administration and winning back market share. That has included pushing for higher loan limits to serve greater numbers of borrowers in high-cost areas such as California and along the East Coast. The FHA also is now the government's key vehicle for refinancing borrowers stuck with unaffordable -- and often toxic -- subprime mortgages.