How FHA Can Expand Your Purchase Business Today: Two FHA Experts Share Their Insights

April 9, 2014

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Welcome and Introductions

Jeff MifsudFormer DE Underwriter

trained by HUD and Senior Writer

for Vantage Production

Linda DavidsonVice President and

DE Underwriter, ServiceFirst Mortgage

HUD Mortgagee Letter 2014-02 On January 21, 2014 HUD announced Mortgage Letter 2014-02

Based on the Final Notice, this Mortgagee Letter explained the maximum qualifying ratios for manually underwritten loans, and revised and clarified the compensating factors that must be cited in order to exceed FHA’s standard qualifying ratios for manually underwritten loans.

This Mortgagee Letter also explains the new reserve requirement for manually underwritten loans for one and two unit properties.

This Mortgagee Letter is not applicable to: Non-credit qualifying FHA to FHA streamline refinance mortgages; Refinances of Borrowers in Negative Equity Positions (ADP Codes 821, 822, 831 832); Section 255 Home Equity Conversion Mortgages; or Title I loans.

Effective Date This guidance is effective for case numbers assigned on or after April 21, 2014.

Manually Underwritten Loans include: Loans involving borrowers without a credit score which were not scored against FHA’s

TOTAL Scorecard; Loans receiving a Refer scoring recommendation from FHA’s TOTAL Scorecard; and/or Loans receiving an Accept scoring recommendation from FHA’s TOTAL Scorecard but

which have been downgraded to a Refer by the underwriter.* When a loan receiving an Accept scoring recommendation is downgraded to a

Refer, the loan must be underwritten in accordance with all provisions of this Mortgagee Letter.

*Examples of a Downgrade to a Refer by the Underwriter (not inclusive) Borrower(s) have disputes that do not follow the Dispute Exception Guidelines (ML 2013-25) Borrower(s) do not have a YTD on paystubs Borrower(s) do not have 30 days of paystubs Borrower(s) cannot provide specific documentation per FHA TOTAL Scorecard findings Underwriter discretion (i.e., the credit scores are made up of only authorized user accounts;

specific and blatant manipulation of credit scores; insufficient credit, etc.)

Definition: Manually Underwritten Loans

Definition: Minimum Decision Credit Score A minimum decision credit score is determined for each borrower according to the guidance

provided in HUD Handbook 4155.1, Chapter 4, Section.A.1.j. When three scores are available (one from each repository), the median (middle) value is used; when only two are available, the lesser of the two is chosen; when only one is available, that score is used.

Where the loan involves multiple borrowers, the mortgagee must determine the minimum decision credit score for each borrower, and then select the lowest minimum decision credit score for all borrowers.

Where the loan involves multiple borrowers and one or more of the borrowers do not have a credit score (non-traditional or insufficient credit), mortgagees shall select the lowest minimum decision credit score of the borrower(s) with credit score(s).

Example: The borrower has a minimum decision credit score of 637. One co-borrower has a minimum decision credit score of 619 and the other co-borrower has no credit. The minimum decision credit score of 619 must be used o determine the maximum ratios.

Definition: Reserves Reserves are defined as:

The sum of verified and documented borrower funds; minus the following: The sum the borrower is required to pay at closing, including the cash investment, closing costs,

prepaid expenses, any payoffs that are a condition of loan approval, and any other expense required to close the

loan;

But not including: The amount of cash taken at settlement in cash-out transactions or incidental cash received at

settlement in other loan transactions, gift funds in excess of the amount required for the cash investment and other expenses, equity in another property, and borrowed funds from any source.

Definition: Reserves (cont’d) Note: A portion of a borrower’s retirement account (IRA, Thrift Savings Plan, 401k

and Keogh accounts) can be used to calculate cash reserves, subject to the following conditions: To account for withdrawal penalties and taxes, only 60% of the vested amount of the account, less

any outstanding loans, may be used. The mortgagee must document the existence of the account with the most recent depository or brokerage account statement. In addition, evidence must be provided that the retirement account allows for withdrawals under conditions other than in connection with the borrower’s employment termination, retirement, or death.

If withdrawals can be made only in connection with the borrower’s employment termination, retirement, or death, the retirement account may not be used to calculate the borrower’s cash reserves. If any of these funds are also to be used for loan settlement, that amount must be subtracted from the amount included as cash reserves.

Reserve Requirement All manually underwritten loans must meet or exceed the following minimum

reserve requirements: 1 and 2 Unit Properties. Reserves must equal or exceed one total monthly mortgage

payment. 3 and 4 Unit Properties. Reserves must equal or exceed three total monthly mortgage

payments.

This new policy replaces the current 2-month minimum reserve requirement for one and two unit properties for borrowers with insufficient credit.

Calculating Residual Income Residual income is calculated in accordance with the following:

Calculate the total gross monthly income of all occupying borrowers. Deduct from gross monthly income the following items:

Residual Income, Deductions From Gross Monthly Income State income taxes Federal income taxes Municipal or other income taxes Retirement or Social Security Proposed total monthly fixed payment Estimated maintenance and utilities ****Job related expenses (e.g., child care)**** LOOK!

Subtract the sum of the deductions from the table above from the total gross monthly income of all occupying borrowers.

The balance is residual income. Reference: Total monthly fixed payment is defined in HUD Handbook 4155.1,

Chapter 4, Section F.2.c.

Calculating Residual Income (cont’d) Calculating Gross Monthly Income

Gross monthly income should be calculated only for the occupying borrowers consistent with the requirements of HUD Handbook 4155.1, Chapter 4, Section D.

Do not include bonus, part-time or seasonal income that does not meet the requirements for effective income as stated in HUD Handbook 4155.1, Chapter 4, Section 2.b-e.

Do not include income from non-occupying co-borrowers, co-signers, non-borrowing spouses, or other parties not obligated on the mortgage.

Because taxes are taken into account in the calculation of residual income, non-taxable income may not be “grossed up.”

Calculating Monthly Expenses If available, mortgages must use Federal and state tax returns from the most recent tax year to

document state and local taxes, retirement, Social Security and Medicare. If tax returns are not available, mortgagees may rely upon current pay stubs.

For estimated maintenance and utilities in all states, mortgagees should multiply the living area of the property (square feet) by $0.14. For example, if a property is 1,500 square feet then 1,500 x .14= $210.00 per month for maintenance.

Using Residual Income as a Compensating Factor To use residential income as a compensating factor, count all members of the

household of the occupying borrowers without regard to whether they are joining on title or the note.

Exception: As stated in the VA Guidelines, the mortgagee may omit any individuals from “family size” who are fully supported from a source of verified income which is not included in effective income in the loan analysis. These individuals must voluntarily provide sufficient documentation to verify their income to qualify for this exception.

From the table, select the applicable loan amount, region and household size. If residual income equals or exceeds the corresponding amount on the table, it may be cited as a compensating factor.

Note: HUD is adopting this VA guidance solely for the purposes of calculating residual income for only to use as a compensating factor on manually underwritten loans. Other VA underwriting policies cannot be used in connection with FHA loans, or cited as compensating factors.

Table of Residual Incomes by Region

Maximum Allowable Qualifying Ratios Recurring Liabilities Include

All Installment Loans; Revolving Charge Accounts; Real Estate Loans; Alimony; Child Support; Other Continuing Obligations

Projected Obligations Debt payments, such as a student loan or balloon note scheduled to begin or come

due within 12 months of the mortgage loan closing, must be included by the lender as anticipated monthly obligations during the underwriting analysis.

Debt payments do not have to be classified as projected obligations if the borrower provides written evidence that the debt will be deferred to a period outside the 12 month timeframe.

Balloon notes that come due within one year of loan closing must be considered in the underwriting analysis.

Maximum Allowable Qualifying Ratios (cont’d) Contingent Liabilities

A contingent liability exists when an individual is held responsible for payment of a debt if another party, jointly or severally obligated, defaults on the payment.

Contingent liability applies, and the debt must be included in the underwriting analysis, if an individual applying for an FHA-insured mortgage is a cosigner/ co-obligor on a car loan; student loan; mortgage, or any other obligation.

If the lender obtains documented proof that the primary obligor has been making regular payments during the previous 12 months, and does not have a history of delinquent payments on the loan during that time, the payment does not have to be included in the borrower’s monthly obligations.

Note: It is important to watch that if an obligation is being paid by another party, but only your borrower is responsible for the liability (i.e., they are the only one on the note). In this case, the debt must be included in the underwriting analysis regardless if documentation can be provided that someone else is making the payment.

Maximum Allowable Qualifying Ratios (cont’d) Other Liabilities

Effective for FHA Case Numbers* assigned on or after October 15th, 2013 Handling of Collections and Judgments

Changes below apply to all FHA programs except FHA Non-Credit Qualifying Streamline Refinances and the HECM- Reverse Mortgages. 1. Judgments must be paid off or the borrower must have a payment arrangement

that has at least a 3 month payment history prior to the loan application and paid according to terms. If there is a payment arrangement, that amount will be counted in the DTI (Debt to Income) ratios. Documentation will be required to show a minimum of three months paid (and those three months cannot be prepaid).

2. On manually underwritten loans** with collections totaling less than $2,000, FHA does not require resolution of the accounts. However, the underwriter must document an acceptable reason for approving the loan and the borrower must provide a letter of explanation and supporting documentation if necessary.

Maximum Allowable Qualifying Ratios (cont’d) 3. For loans with Collections or Judgments that receive a FHA TOTAL Mortgage Scorecard

(AUS) decision of ‘Accept/Approve’, the lender DOES NOT have to provide a letter of explanation or documentation from the borrower. If TOTAL generates a ‘Refer’ decision, the loan must be manually underwritten.

4. In all cases, if the total outstanding balance of all collection accounts for all borrowers is equal to or greater than $2000, the lender must perform a “capacity analysis”. Unless excluded under state law, collection accounts of a non-purchasing spouse in a community property state are included in the cumulative balance. Under the “capacity analysis”, FHA will require one of the following: A. Pay off collections in full (funds must be verified) OR B. Make payment arrangements with the creditors (the monthly payment to be

included in the DTI ratios) OR C. If no payment arrangement is made, then 5% of the balance(s) must be included

in the ratios (borrower must qualify with this additional payment in the DTI ratios).

Maximum Allowable Qualifying Ratios (cont’d) It is important to note that medical collections are excluded from the above

guidelines and DO NOT require resolution in the $2000 capacity analysis. In addition, all charge offs are also excluded from the $2000 capacity analysis. It is further important to verify with your company of their overlay/guideline on this exclusion. Accounts showing “charged to P&L” are NOT excluded and are considered collections.

Maximum Allowable Qualifying Ratios (cont’d) Obligations Not Considered Debt Obligations not considered debt, and therefore not subtracted from gross income,

include: Federal, state, and local taxes (Note this IS included in calculating Residual) Federal Insurance contributions Act (FICA) or other retirement contributions, such as

401(k) accounts (including repayment of debt secured by these funds) Commuting costs Union dues Open accounts with zero balances Automatic deductions to savings accounts Child care (Note Child Care IS included in calculating Residual), AND Voluntary deductions.

Maximum Allowable Qualifying Ratios (cont’d) Tip: If a buyer is purchasing in a Community Property State, is married and the

spouse is not on the loan (i.e., Non-Purchasing Spouse- NPS), FHA still requires the lender to count the NPS’s debt against the income vs. expense debt ratio. For example, let’s say that a buyer is married, lives in a Community Property State, but the husband’s credit is not good and cannot be on the loan (and therefore cannot count his income in qualifying ratios). However, because the property is in a Community Property State, the husband’s debt must be counted against the spouse when calculating debt to income ratios.

Two exceptions to this is if the husband is paying child support- which does not have to be counted in the wife’s ratios and/or an installment loan in which the lender can determine that the debt originated prior to the marriage (will need documentation of marriage date, note date and an attorney opinion letter). It is further important to verify with your company of their overlay/guideline on this exclusion.

Maximum Allowable Qualifying Ratios (cont’d) Housing (Front Ratio) The Total Monthly Payment includes:

Principal and interest Real Estate Taxes Hazard Insurance Mortgage Insurance Premium Homeowner’s Association Dues Ground Rent Special assessments Payments for any acceptable secondary financing

Maximum Allowable Qualifying Ratios (cont’d) Income

The income of each borrower who will be obligated for the mortgage debt must be analyzed to determine whether his/her income level can be reasonably expected to continue through at least the first three years of the mortgage loan. Income may not be used in calculating the borrower’s income ratios if it comes from any source that cannot be verified; is not stable; or will not continue for a minimum of the first three years (36 months) going forward.

Calculating Gross Monthly Income Gross monthly income should be calculated only for the occupying borrowers

consistent with the requirements of HUD Handbook 4155.1, Chapter 4, Section D. Do not include bonus, part-time or seasonal income that does not meet the

requirements for effective income as stated in HUD Handbook 4155.1, Chapter 4, Section 2.b-e.

Do not include income from non-occupying co-borrowers, co-signers, non-borrowing spouses, or other parties not obligated on the mortgage.

Borrowers with Minimum Decision Credit Scores of 580* or More and No Compensating Factors Ratios: 31/43 The maximum allowable qualifying ratios for borrowers with minimum decision

credit scores of 580 or more and no compensating factors are as follows: Total monthly mortgage payment may not exceed 31% of gross effective monthly

income (33% for Energy Efficient Homes); and Total monthly fixed payment may not exceed 43% of gross effective monthly income

(45% for Energy Efficient Homes). *It is important to note that while FHA places the lowest credit score as 580,

industry overlays typically will put these scores between 600-640.

Borrowers with Minimum Decision Credit Scores of 580* or More and One Compensating Factor Ratios: 37/47 The maximum allowable qualifying ratios for borrowers with minimum decision

credit scores of 580 or more provided they meet one of the compensating factors specified below are as follows: Total monthly mortgage payment not exceed 37% of gross effective monthly income;

and Total monthly fixed payment may not exceed 47% of gross effect monthly income.

Borrowers with Minimum Decision Credit Scores of 580* or More and One Compensating Factor Ratios: 37/47 (cont’d) Acceptable compensating factors are limited to the following:

Verified and documented cash reserves that equal or exceed three total monthly mortgage payments (one and two units) or that equal or exceed six total monthly mortgage payments (three and four units);

New total monthly mortgage payment is not more than $100 or 5% higher than previous total monthly housing payment, whichever is less, and there is a documented twelve month housing payment history with no more than one 30 day late payment.

Residual income. *It is important to note that while FHA places the lowest credit score as 580,

industry overlays typically will put these scores between 600-640.

Borrowers with Minimum Decision Credit Scores of 580* or More and Two Compensating Factors Ratios: 40/50 The maximum allowable qualifying ratios for borrowers with minimum decision

credit scores of 580 or more provided they meet two of the compensating factors specified below are as follows: Total monthly mortgage payment may not exceed 40% of gross effective monthly

income; and Total monthly fixed payment may not exceed 50% of gross effective monthly income.

Borrowers with Minimum Decision Credit Scores of 580* or More and Two Compensating Factors Acceptable compensating factors are limited to the following:

Verified and documented cash reserves that equal or exceed three total monthly mortgage payments (one and two units) or that equal or exceed six total monthly mortgage payments (three and four units);

New total monthly mortgage payment is not more than $100 or 5% higher than previous total monthly housing payment, whichever is less, and there is a documented twelve month housing payment history with no more than one 30 day late payment. In cash-out transactions all payments on the mortgage being refinanced must have been made within the month due for the previous twelve months.

Residual income and Verified and documented significant additional income that is not considered effective

income.

*It is important to note that while FHA places the lowest credit score as 580, industry overlays typically will put these scores between 600-640.

Borrowers with Minimum Decision Credit Scores of 580* or More with No Discretionary Debt Ratios: 40/40 The maximum allowable qualifying ratios for borrowers with minimum decision

credit scores of 580 or more with established credit lines in their own name open for at least six months who carry no discretionary debt (housing payment is only account with an outstanding balance and borrower can document that revolving credit has been paid off in full monthly for at least the previous six months) are follows: Total monthly mortgage payment not exceed 40% of gross effective monthly income;

and Total monthly fixed payment may not exceed 40% of gross effective monthly income.

For borrowers meeting this criterion no other compensating factors are required. *It is important to note that while FHA places the lowest credit score as 580,

industry overlays typically will put these scores between 600-640.

Q & A

Jeff MifsudFormer DE Underwriter

trained by HUD and Senior Writer

for Vantage Production

Linda DavidsonVice President and

DE Underwriter, ServiceFirst Mortgage

Want to learn more? Call (800) 963-1900 or visit VantageProduction.com

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