FHA Toughened Standards on Manually Underwritten Loans Ahead of Today’s Shortfall


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

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
.  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,

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.

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