The Federal Housing Administration has increased its all-important benchmark qualifying ratios by two full percentage points.

Effective immediately on all manually underwritten mortgages, the government will accept a payment-to-income ratio of 31 percent and a debt-to-income ratio of 43 percent. For borrowers whose homes qualify as energy efficient, the new "stretch" ratios are 33 percent and 45 percent, respectively.

And as always, underwriters can approve loans with even higher ratios if they are justified by what's known in the trade as "compensating factors."

Previously, the ratios were 29 percent and 41 percent for standard FHA-backed loans and 31 and 43 percent for government-insured loans on energy efficient houses.

About half of all FHA mortgages are approved by human underwriters. The rest are approved electronically with software programs that are said to already incorporate the higher ratios.

The changes are designed to boost the ownership aspirations of low and moderate-income borrowers, said FHA Commissioner John Weicher, who pointed out that the old ratios are no longer valid because of the recent federal income tax cuts.

"Most borrowers seeking FHA mortgage insurance have enjoyed a reduction to their federal income tax during the last several years, thus increasing their buying power and disposable income," Weicher said in a letter to lenders outlining the higher ratios.

"This change will allow a larger number of deserving families to purchase their first home while not increasing the risk of default."

In another step aimed at helping single parents, the agency will also now permit "properly documented child support" to be counted as income under the same terms and conditions as other nontaxable sources of income. Previously, the FHA would not allow lenders to "gross up" child support income in figuring qualifying ratios.

The expanded guidelines come on the heels of an unusual interim rule put in place by the FHA late last month, when it said it would begin insuring five-year adjustable rate mortgages which cap annual rate increases at no more than two percentage points and limit rate hikes to no more than six points over the life of the loan.

The FHA anticipates that the new ceilings -- up from one and five points, respectively -- will generate significant demand for five-year hybrid ARMs. Such loans are the most popular form of adjustables in the conventional market. But the agency also expects that five-year FHA adjustables with one and five-point caps will remain available for borrowers who seek greater protections against rising interest rates in the future.

The change, which takes effect April 28, does not effect three-year hybrids, which can have rate change ceilings of no more than one percentage point annually and five points over the loan's term.

As always, on seven and ten-year hybrids, the interest rate can be adjusted up to two percentage points annually with a lifetime cap of six percentage points.

The change is being put into effect by an interim rule before the public has had an opportunity to comment. But Commissioner Weicher said such a step was necessary because it would be contrary to the public interest to delay the effective date any longer. However, a final rule won't be issued until comments are received and reviewed.

Published: April 20, 2005

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