Study says FHA borrowers who receive counseling less likely to default on mortgage

July 16, 2014

It turns out that counseling is good for more than just shaky marriages and kids’ behavioral issues. A recent story in the New York Times real estate section discussed the positive benefits counseling has had on some homeowners.

Since the mortgage crisis, the nation’s financial institutions have tightened their belts and amped up their guidelines for financial scrutiny. According to the Times article, this has made it a bit more challenging for borrowers whose credit scores are under 640. Enter the Federal Housing Administration (FHA).

Created in 1934 this agency has helped millions of Americans realize the dream of home ownership by insuring loans from banks, credit unions, and mortgage companies. In recognition of the fact that times have been unusually tough for hopeful home buyers, the FHA took upon the task of extending credit to those in need. Of course, the agency realized that doing so could put them at risk should individuals default on those loans. So in early May, it announced its strategy.

The agency has decided to reduce the mortgage insurance premiums for those borrowers applying for FHA loans. The catch is that to receive the better price on their insurance, borrowers must agree to attend housing counseling.

The Times story noted that, “Borrowers who complete counseling before closing on a home will receive a 0.5 percentage-point reduction in their upfront insurance premium. Their annual premiums would also be reduced by 0.1 percentage points.”

To make the deal even sweeter and hopefully establish a pattern of regular payments, there is also a counseling program for after the closing process. Borrowers who decide to participate in the post-closing counseling and show documentation for a 2-year period of on time house payments stand to enjoy a further 0.15 percentage point reduction on their mortgage insurance premium.

The reason the FHA chose to heighten affordability this way is due to the fact that the cost of mortgage insurance has been on the steady rise. The agency believes this effort will open the door for millions of prospective home buyers who have been previously turned away. In fact, the agency estimated that, “for an average FHA loan balance of $180,000, a borrower who goes through counseling would be able to shave off nearly $325 a year in insurance costs.” Before you shrug that amount off as equivalent to mere peanuts, keep in mind that for the life of 30-year loan, it adds up to almost $10,000.

The FHA based this choice on research that revealed that prepurchase counseling lowers the rate of loan defaults. The Times article cites a survey conducted by the community development agency, NeighborWorks. Their findings showed that borrowers who received counseling prior to a home purchase were nearly a third less likely to get behind on their payments-at least for the first two years.

Jim Parrott, who is a senior fellow at the Urban Institute and a previous Obama administration housing advisor, reflected, “Counseling tends to make borrowers smarter about the debt they are taking on, so the FHA should make up their modest loss in fees by lower default rates.”

A number of factors affecting the financial well-being of the nation’s population of young adults spurred this action. One is the fact that information from the Urban Institute shows that around 13 million Americans have an average credit score between 560 and 680. In years past, the average borrower who was eligible for an FHA loan had a score closer to 700. The sluggish economy has also played a role in creating financial hardships. A slow job market and excessive debt brought on by student loans are cited as two big hurdles for today’s future homeowners. Harvard’s Joint Center for Housing Studies found that in 2012, nearly three million more young adults were living with their parents than in 2007.

This change should certainly help turn that situation around!

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