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The poor fiscal health of the Federal Housing Administration (FHA) is expected to make getting home loans even more difficult as the agency responds to increasing legal costs that stem from loan servicing claims and insuring banks against loan defaults. Prior to the $26 billion mortgage settlement between banks and the government, the FHA had applied for a $688 million loan from the U.S. Treasury to cover its rising expenditures. High-risk borrowers who turn to the FHA for loans are likely to find them as unwilling as banks to extend credit due to banks’ demands that the agency cover their losses. With both banks and the FHA raising lending restrictions, many would-be borrowers will be left with nowhere to turn for financing. For more on this continue reading the following article from TheStreet.

Getting a home loan is only going to be tougher, as banks tighten standards for Federal Housing Administration (FHA) loans amid rising legal claims.

Analysts at FBR Capital have long been worried that the FHA's poor fiscal health will lead it to deny insurance claims and file lawsuits over servicing and origination of FHA loans.

The FHA insures banks against defaults on loans and has seen its share of the mortgage origination market rise from 3% in 2005 to 24% in 2011 in the wake of the sub-prime crisis. But the high default rate during the crisis has drained its resources.

The latest budget plan found that the FHA might need as much as $688 million from the U.S. Treasury to bridge a shortfall in its reserves. That problem was quickly resolved by the recent $26-billion mortgage settlement between the nation's largest servicers and the 49 states.

Under the settlement, the five banks would have to inject $1 billion into the agency's capital reserves to settle claims related to servicing.

Still, not all legal concerns have been put to rest. Analyst Paul Miller notes that the settlement only covers servicing violations and not origination violations. He cites the example of Flagstar Bancorp(FBC) which recently entered into a settlement with the Justice Department for $133 million related to fraudulent FHA lending practices.

Bank of America(BAC) also entered into a $1 billion settlement with the Justice Department over allegations that the bank's Countrywide Unit knowingly made loans insured by the FHA to unqualified home buyers.

Recent fines also include Citi Mortgage, a subsidiary of Citigroup(C) agreed to pay $158 million to settle a civil complaint by the Manhattan attorney's office, accusing the company of routinely certifying that loans qualified for FHA when they did not.

According to FBR, the fines imposed on banks could be quite severe, in some cases trebling damages for violations of FHA's "highly complicated and technical" rules.

The recent Flagstar settlement might just be a one-off, but the analysts believe that the "damage to lender confidence" has already been done. "We believe that this settlement could result in lenders reexamining their risk with respect to FHA lending and tightening standards for the FHA product. Our major concern is that the tightening credit policies could lead to fewer borrowers being able to qualify for an FHA mortgage," the analysts wrote in a note Monday.

Recent government measures have aimed at providing relief to the troubled borrower, but as the Federal Reserve frequently notes, the credit conditions for those seeking a fresh mortgage are still too tight.

One reason is banks have pulled back from lending to borrowers with riskier profiles because of rising putback claims from Fannie Mae and Freddie Mac.

Now, higher risk borrowers who have so far managed to avail of FHA loans might now find that even this source of credit is drying up.

Currently, less than 25% of all loans being purchased by Fannie Mae have a credit score below 740. Over the past 10 years, borrowers with FICO scores between 620 and 660 have fallen from 12% to less than 2% of loans purchased, while roughly 75% of loans have a FICO score over 740, according to the report.

This article was republished with permission from TheStreet.