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What's the Score?

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Posted On: 11/11/2009

Q: I want to finance a home with an FHA loan. I understand that the FHA does not require a particular credit score, but my lender says I need a score of at least 620. How can a lender require that if the FHA does not?

A: The FHA is not actually a lender; it's an insurance program. The actual lender might be a bank, credit union, insurance fund or whatever.

The result is that when you get an FHA insured loan the financing must satisfy two parties -- the lender and the FHA.

The FHA certainly has loan qualification standards. HUD spokesman Lemar Wooley tells me that the FHA doesn't "really have a hard minimum score requirement. We ask our lenders to look at the entire credit picture, with the major requirement being the ability to repay the loan." The exception is when an individual has a credit score of less than 500. In that case a borrower must put down at least 10 percent rather than 3.5 percent.

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The FHA requires that lenders rely on traditional underwriting standards. This means the lender must get a fully documented loan application and review such basics as assets, income, debts and employment. The lender also must have a full appraisal of the property.

The FHA approach makes a lot of sense, but the catch is that not all loan officers, underwriters and lenders have been following FHA guidelines. In fact, in May the FHA removed more than 100 lenders from the system, meaning they can no longer make FHA loans. "Violations," said HUD, "range from failure to conduct sufficient quality control, to failure to continue to meet FHA recertification requirements, to falsifying loan documents."

Other lenders got the hint. FHA loan applications must follow the rules or lenders will face penalties. This is a big deal for lenders because FHA loans represent more than one-third of all the mortgages now originating. A lender without the ability to make FHA loans is like a gas station that can't sell unleaded gas.

So how can lenders make sure their loan officers and underwriters are following the rules? Stricter oversight is one approach, but another is to toughen in-house standards, and that's why a number of lenders have begun to insist on minimum credit scores.

From a borrower's perspective the new use of credit scores for FHA financing means that some loans won't be made, but that's not unfair or unreasonable. Borrowers who do not meet program standards represent too much risk -- both to themselves and in terms of claims against FHA reserves.

Q: I just moved to the Bay Area from Orange County. Because I intend to keep my home in Orange County, I can't afford a good-sized home here. My mother plans to move in with me in the future and she's willingly to give me the cash to purchase a home now while prices are lower. Is giving a family member cash to purchase a home considered a gift?

A: For 2009 there's a $13,000 tax-free annual gift exclusion, otherwise a wad of cash big enough to buy a house is surely a gift that raises significant tax and estate questions.

Let's talk about the idea of buying now "while prices are lower." Lower than during the past few years? In most markets, sure. Lower than prices will be in the future? That we don't know.

Here are some approaches you may want to consider:

• You buy the property together with both names on the title. You later inherit Mom's interest via her will.

• The property is bought in your name and you get financing from the First Bank of Mom. Mom gets a life estate allowing her to stay in the property plus income from the loan.

• Mom buys the property in her name and you live there with her. She leaves the house to you in her will.

• Mom buys the house and each year gives you an equity interest that does not exceed the annual gift exclusion. Over time your tax-free interest in the property grows.

To go further with such ideas you should speak with tax professionals and a real estate attorney. You and mom will also need wills and living wills to protect your individual interests.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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