FHA to reject borrowers in minor credit disputes

by 01 Apr 2012

(CNNMoney) -- The Federal Housing Administration is about to make it even tougher to borrow money from Uncle Sam to buy a home.

Starting April 1, borrowers in ongoing disputes with creditors over debts of $1,000 or more may no longer qualify for FHA-insured loans. Even borrowers with perfect credit scores can be denied over a single $1,000 problem charge.

Before this, individual lenders decided whether debt disputes constituted grounds for denial. You could be fighting a charge, say a hospital bill, and your lender might still decide that your credit history merited an approval. Now, a lender will have to justify the approval to the FHA and back its decision with documentation.

The change is part of the agency's effort to reduce its risk as it grapples with a depleted reserve fund that has fallen below legally-mandated levels. The FHA insures mortgages which are originated by private lenders. To help bolster its capital reserves, FHA will also hike the insurance premiums it charges borrowers beginning in April.

The requirements are for the homebuyer's own good, said Tiffany Thomas Smith, deputy press secretary for the U.S. Department of Housing and Urban Development, FHA's parent agency.

"It's a way of protecting consumers from getting into loans they ultimately can't afford," she said.

The new rule requires borrowers with loans in collection that add up to at least $1,000 to either pay off the debt, prove they're making payments on the disputed loans or explain why the disputed loan is somehow wrong -- and document their case -- before they can close on a FHA loan.

Disputed accounts going back more than two years, along with those related to fraud or identity theft, will not count against borrowers, according to the FHA, but lenders must get evidence, such as police reports, that document client claims of identity thefts or fraud charges.

Such prohibitions could slow the housing market recovery if fewer borrowers can secure FHA mortgages.

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