So, the big news this week was that HUD Secretary Shaun Donovan told the House Committee on Financial Services during a hearing Wednesday that there would be a few more rules related to FHA lending come the end of January 2010. He might as well have just told builders that it's going to get even harder for them to do their jobs, selling and building homes--or rather building and then selling homes, as the case may be these days.

The down and dirty of what he said was that because the FHA's secondary reserves have fallen below the required level (2% of the total dollar value of all the mortgage loans the FHA insures), the agency needed to find ways to both reduce its exposure to defaulting mortgage loans, which are also on the rise, while rebuilding its reserve stockpile. So, here are the possible ways Donovan said the FHA could accomplish that task:

1. Hold lenders accountable for their origination quality and compliance with FHA policies. This measure gives the FHA more teeth by both forcing lender partners to indemnify the FHA in cases of loan failures where the lender was out of compliance with FHA requirements and also allowing the FHA to go after lenders engaging in improper activities on a national basis, rather than at a branch level.
2. Create a lender scorecard. Essentially a ranking or scoring of FHA lender partners, this list will be published on the FHA Web site for total public consumption.
3. Reduce the maximum permissible seller concession from its current 6% level to 3%. Similar to the efforts behind the elimination of down payment assistance programs à la Nehemiah and AmeriDream, this proposal aims to remove incentives to inflate home values.
4. Raise the minimum credit score for new FHA borrowers. Donovan failed to indicate a specific credit score number, saying, "We are currently analyzing what this floor should be, including the relationship between FICO scores and down payments."
5. Require new borrowers to put more "skin in the game."  Donovan tiptoed around the specifics by saying, "We have made the decision to exercise our authority to increase the up-front cash that a borrower has to bring to the table in an FHA-backed loan." However, with a bill proposing to up the FHA down payment requirement to 5% of purchase price, from the current 3.5%, under consideration on Capitol Hill, it's clear this larger down payment requirement is squarely one of what Donovan called the "several ways to accomplish this."
6. Increase mortgage insurance premiums. Donovan said HUD was requesting authority from Congress to raise annual insurance premiums to help pad the reserve fund, also mentioning that an increase in up-front insurance premiums is on the table.  

The mainstream press latched on to Donovan's new credit score requirement provision, pointing out that for every jump in minimum score requirements, a percentage of potential home-buyers-slash-borrowers are knocked out of the running. And for builders, particularly those who are firmly entrenched in the entry-level market, the effects are often significant.

Eric Lipar, CEO of Texas-based entry-level builder LGI Homes, for example, said that his staff recently did some analysis to find out how many of their buyers this would've been unable to qualify for FHA financing if the required minimum credit score had been 640 rather than 620. The answer was 7% would not be able to close under those more stringent credit requirements. Not an overwhelming percentage but hardly insignificant either. I'm not sure any builder would be psyched about that much of their business being eliminated in one stroke of a pen.

"Every time that [credit score] number jumps, you take potential borrowers out of the market," he said.

However, Lipar wasn't sweating that part of Donovan's testimony. After all, FHA's underwriting guidelines have never spelled out a minimum credit score; lenders--and investors in the secondary mortgage markets--have largely called the shots when it comes to minimum credit scores through the establishment of credit overlays. In fact, according to Lipar, the bar on minimum credit score has been steadily rising since 2008, so Donovan's pronouncement appeared to him more as a formalization of what was already happening in the marketplace.

However, what does worry Lipar and others like him is the idea that some of Donovan's other proposals--specifically the increase in a down payment requirement, the reduction of seller concessions at closing, and the increase in insurance premiums--might go into effect in conjunction with one another at precisely the wrong time. Wrong time, of course, meaning just as the federal home buyer tax credit is set to expire.

Take for example, a buyer that wants to purchase a $200,000 home. Today, under current rules, she would have to come up with a $7,000 down payment. However, if the down payment requirement was to increase to 5%, she would need an additional $3,000 for a down payment.

Now, assume that typical seller concessions at closing are somewhere around 4.5% (although several builders have said the typical range is more like 4% to 6%). Reducing the concession to 3% really means that the buyer has to now bring another $3,000 to the closing table that they weren't necessarily having to fork over today.

And then assume that the FHA's up-front insurance premium goes from the current 1.75%, as Donovan mentioned, to 3%, which he said was the statutory cap, and that's another $2,500 that the buyer needs at closing. (I won't even get into what an annual increase in insurance premiums would do to a buyer's monthly payment.)

Just those simple increases mean that the typical buyer of a $200,000 home would have to come up with roughly $8,500 more at closing than they do today.

"Can they save it? Can they borrow it from their parents? Some of them will be able to; some of them won't," said Lipar.

However, others in the industry didn't see some of Donovan's points in quite so dire a light. For example, Josh Denney, associate vice president of public policy for the Mortgage Bankers Association, said that several of the proposed changes, namely the higher credit score requirement and the reduction of seller concessions at closing, really are just "bringing the FHA more into the norm of lending."

However, when it came to possibly increasing the down payment requirement, he said, "Down payment is the last thing you want to mess with." The No. 1 barrier for people to buy a home is a down payment, he noted.

But like Lipar, I have a hard time imagining that any of these proposed changes, much less a number of them happening simultaneously, could mean anything good for home building. I think the market is paying for its past sins of loose lending and further government regulatory intervention could mean an overcorrection at a time when the industry, the engine of the economy, is particularly vulnerable.

Moreover, aside from the insurance premiums, which I can see as being a viable way to refill the FHA's reserves, I don't fully grasp how these measures will solve the FHA's current problems; as best I can see, they mostly correct, or safeguard, FHA activity going forward. After all, Donovan himself told the House that, "The actuary projects that even with growing volumes, more than 71% of FHA's losses over the next five years will come from loans already on its books."