Before today's news of a shortfall in its Mutual Mortgage Insurance Fund, The Federal Housing Administration (FHA) issued new guidelines for lenders who manually underwrite FHA-backed mortgage loans. The new underwriting requirements are intended to encourage lenders to use what FHA described as a defined set of objective standards and compensating factors to make responsible, risk-based underwriting decisions. The Agency said the new rules should also increase the pool of eligible borrowers.
Most FHA-insured loans are approved through automated underwriting systems that score applications using FHA's TOTAL Mortgage Scorecard. This evaluates borrowers based on credit scores and other loan factors. When TOTAL delivers a Refer scoring recommendation or when borrowers were not scored because they do not have credit scores, lenders are required to manually underwrite the loan. This manual underwriting allows use of compensating factors to help borrowers qualify for loans outside of automated standards.
The new guidelines issued today are among those contained in a document issued on July 15, 2010 in which the Department of Housing and Urban Development (HUD) solicited comments on three proposals designed to address features that had resulted in high losses to FHA's Mutual Mortgage Insurance Fund capital reserve account. There were 902 public comments received, the majority of which concerned the proposal to reduce allowable seller concessions. Because of the volume of comments and the issues raised HUD decided to separately implement each of the three initiatives in the 2010 notice.
The final initiative to be implemented after incorporating the public comments are revisions to the manual underwriting requirements. Specific policy revisions included in this regulation are reserve requirements for all manually underwritten borrowers, establishing maximum qualifying ratios based on credit score and compensating factors; and providing a revised list of acceptable compensating factors with objective documentation requirements for assessing these factors.
For borrowers who exceed the 31 percent housing-to-income ratio yet carry little or no discretionary debt and thus do not exceed the maximum 43 percent debt to income ratio, compensating factors have been allowed. The new guidelines establish maximum front and back end rations that may not be exceeded based on the borrower's credit score. Borrowers with no score or with scores below 580 may not exceed the 31/43 maximums. Borrowers with credit scores of 580 or higher may be approved for ratios as high as 37/47 with one compensating factor and 40/50 with two. The new guidelines also restrict the use of compensating factors to borrowers with credit scores of 580 or higher unless they meet the Energy Efficient Mortgage Requirements which permit maximum stretch ratios of 33/45.
Manually underwritten loans are required to have reserves equal to at least one full monthly mortgage payment for single family and duplex properties and three full months for buildings with three or four units.
HUD has not yet established an effective date for the new regulations but says it will not be earlier than March 11, 2014. In the interim the Department is inviting public comment on one aspect of the new regulations; the lowering of the credit score level under which compensating factors cannot be cited from 620 to 580. Comments must be received by February 10, 2014.
HUD said the new requirements are intended to encourage lenders to use a defined set of objective standards and 'compensating factors' in order to make responsible, risk-based underwriting decisions. In addition, FHA's manual underwriting guidance addresses loan characteristics such as high debt-to-income ratios and a lack of financial reserves that can result in high rates of default and foreclosure.
The new regulations are applicable to all purchase transactions and credit qualifying FHA refinances. FHA will shortly publish a Mortgagee Letter that will provide additional operational information for lenders.