Although FHA loan originations have recently declined, HUD issued Mortgagee Letter 2013-24 on August 15, tightening (with the stated purpose of clarifying and amending previous guidance) FHA borrower restrictions effective with all case numbers assigned on or after October 15, 2013. This guidance applies to all FHA programs with the exception of non-credit qualifying streamline refinances and the Home Equity Conversion Mortgage.
FHA raised upfront and monthly mortgage insurance premiums (and made monthly MIP effective for the life of the loan) earlier this year, leaving FHA loans far less desirable for many buyers. These new guidelines will likely most affect buyers with credit issues, i.e., those least likely to qualify for loans outside the FHA program.
FHA has declared that collections and judgments may indicate a borrower’s disregard for credit obligations and must be considered in the creditworthiness analysis. The guidance below applies to loans with collection accounts and all judgments. Medical collections and charge off accounts are excluded from this guidance and do not require resolution.
Applicable to Loans Run Through TOTAL Mortgage Scorecard:
TOTAL Mortgage Scorecard "Accept/Approve"
There are no documentation or letter of explanation requirements for loans with collection accounts or judgments run through TOTAL Mortgage Scorecard receiving an “Accept/Approve”, despite the presence of collection accounts or judgments. These accounts have been already taken into consideration in the borrower’s credit score. If TOTAL Mortgage Scorecard generates a “Refer,” the lender must manually underwrite the loan in accordance with the guidance applicable to manually underwritten loans with collection accounts and judgments.
FHA does not necessarily require collection accounts to be paid off in full as a condition of mortgage approval; however, FHA does recognize that collection efforts by the creditor for unpaid collections could affect the borrower’s ability to repay the mortgage. To mitigate this risk, FHA is requiring a "Capacity Analysis", as detailed below, for loan applicants having collection accounts with a cumulative balance equal to or greater than $2,000, as described below.
Unless excluded under state law, collection accounts of a non-purchasing spouse in a community property state are included in the cumulative balance.
"Capacity Analysis" includes any of the following actions:
- At the time of or prior to closing, payment in full of the collection account (verification of acceptable source of funds required).
- The borrower makes payment arrangements with the creditor. If the borrower has entered into a payment arrangement with the creditor, a credit report or letter from the creditor verifying the monthly payment is required. The monthly payment must be included in the borrower’s debt-to-income ratio, which could potentially prevent some borrowers from qualifying for the loan.
- If evidence of a payment arrangement is not available, the lender must calculate the monthly payment using 5% of the outstanding balance of each collection, and include the monthly payment in the borrower’s debt-to-income ratio, which could potentially prevent some borrowers from qualifying for the loan.
Regardless of the Accept/Approve/Refer recommendation by TOTAL Mortgage Scorecard, the lender must include the payment amount in the calculation of the borrower’s debt-to-income ratio.
FHA requires judgments to be paid off before the mortgage loan is eligible for FHA insurance. An exception to the payoff of a court ordered judgment may be made if the borrower has an agreement with the creditor to make regular and timely payments. The borrower must provide a copy of the agreement and evidence that payments were made on time in accordance with the agreement, and a minimum of three months of scheduled payments have been made prior to credit approval.
Borrowers are not allowed to prepay scheduled payments in order to meet the required minimum of three months of payments. Furthermore, lenders are instructed to include the payment amount in the agreement in the calculation of the borrower’s debt-to-income ratio.
FHA requires judgments of a non-purchasing spouse in a community property state to be paid in full, or meet the exception guidance for judgments above, unless excluded by state law.
Applicable to Manually Underwritten Loans:
Guidelines for loans underwritten manually are even more stringent, requiring the lender to document reasons for approving a mortgage when the borrower has collection accounts or judgments. The borrower must provide a letter of explanation with supporting documentation for each outstanding collection account and judgment. The explanation and supporting documentation must be consistent with other credit information in the file.
Regardless of the amount of outstanding collection accounts or judgments, the lender must determine if each collection account or judgment was as a result of:
- The borrower’s disregard for financial obligations;
- The borrower’s inability to manage debt; or
- Extenuating circumstances.
Minimum payments must still be added to debt ratios, whether the charge offs/collections total $2000 or not.
As a result of these continued guideline changes by HUD, many FHA borrowers, particularly those with lower credit scores and higher debt ratios, will have more difficulty in qualifying for a loan. Some will seek alternative means of financing, such as Fannie Mae's program requiring a minimum down payment of 5%. It is suggested that borrowers examine their credit reports carefully and do whatever is necessary to remove any derogatory information that is in error; in addition, borrowers should obtain pre-approval letters as soon as possible to avoid potential delays during the loan process.
While accurate at the time of this writing, it is advised that the borrower, if considering purchasing or refinancing a home, verify that the information provided herein is still current by contacting a licensed mortgage professional, in order to discuss this or any other program, and to get fully pre-qualified.