Want that exception with an FHA loan? Jeff Mifsudhigh ratios, compensating factors, debt-to-income ratio, HUD, refinancing, conventional loan Have your "docs" in a row When I was a Federal Housing Administration (FHA) underwriter, one of the biggest challenges I faced on borderline loans was whether or not to grant an exception when a guide was not met. What follows are some of the core FHA guides that will help increase the odds of getting these loans approved and some accepted compensating factors that are needed for an underwriter to approve a loan that has high ratios. Q: What are the official FHA debt-to-income ratios? A: The housing expense ratio is 31 percent, and the total debt-to-income ratio is 43 percent. Q: Can the ratios be exceeded? A: Yes, if compensating factors exist. Keep in mind that compensating factors are to help the underwriter make a decision on the loan when the ratios are exceeded and are not a guarantee of an approval. The factors listed in the U.S. Department of Housing and Urban Development (HUD) 4155.1 guidelines are: A. The borrower has successfully demonstrated the ability to pay housing expenses equal to or greater than the proposed monthly housing expense for the new mortgage over the past 12-24 months. For a manually underwritten loan, it seems the national threshold for high ratios is around 34/46. Of course, the automated underwriting systems can exceed the benchmark guidelines. B. The borrower makes a large downpayment (10 percent or more) toward the purchase of the property. C. The borrower has demonstrated an ability to accumulate savings and a conservative attitude toward the use of credit. Dont underestimate this guideline. I have gotten many borderline loans approved with the help of this factor. Even if it's only a couple thousand dollars, this means a lot, especially if he has moderate income. This savings behavior is an indication of fiscal responsibility, and the FHA views this favorably. Now, this doesn't mean that if you have an essentially bad loan, you can go to an underwriter and say, "Look! I think you should approve this loan. After all, he's managed to save $150 in savings with more than 10 years in the workforce!" This won't work. It can work with a borrower who lacks credit. D. Previous credit history shows that the borrower has the ability to devote a greater portion of income to housing expenses. The highest ratio I ever got approved with compensating factor was 36/51. The borrower's new house payment was decreasing by about 10 percent, and his ratios were actually improving. He used credit sparingly and, overall, the file was a good credit risk. E. The borrower receives documented compensation or income not reflected in effective income, but directly affecting the ability to pay the mortgage, including food stamps and similar public benefits. F. There is only a minimal increase in the borrower's housing expense. G. The borrower has substantial documented cash reserves (at least three months' worth) after closing. In determining if an asset can be included as cash reserves or cash to close, the lender must judge whether or not the asset is liquid or readily convertible to cash, even after retirement or job termination. Funds borrowed against these accounts may be used for loan closing, but are not to be considered as cash reserves. "Assets," such as equity in other properties and the proceeds from a cash-out refinance, are not to be considered as cash reserves. Similarly, funds from gifts from any source are not to be included as cash reserves. H. The borrower has substantial non-taxable income (if no adjustment was made previously in the ratio computations). I. The borrower has a potential for increased earnings, as indicated by job training or education in the borrower's profession. If your ratios are high, be sure to look on the verification of employment in the "date of next pay increase" section. Files can be rejected and a person denied homeownership because someone failed to discover the borrower was going to be getting a raise of $2 per hour the next month that would have brought him within ratios. J. The home is being purchased as a result of relocation of the primary wage-earner, and the secondary wage-earner has an established history of employment and is expected to return to work, and reasonable prospects exist for securing employment in a similar occupation in the new area. In a case like this, you will need to provide the underwriter with documentation to help him make a decision. Youll have to be creative and utilize sources like newspaper articles, statistics from job search Web sites or reports from employment agencies. Q: If a borrower's spouse is not on the loan, can we still use the income? A: No. However, I have used this as a compensating factor for many years and have had a lot of success with it. Although it is not listed in the FHA guides, I teach loan officers to collect the spouses' last two years of W2s and last month of pay stubs and put them in the file with a note highlighting the fact that the spouse contributes X amount toward the household income. If, for example, the ratios are 34/45 and the non-borrowing spouse has $3,000 in income, this can make a huge difference in the overall scenario. Remember, the underwriter is trying to determine whether or not the borrower will make the payment! Do you think making them aware that there's an additional $3,000 of monthly income might help the underwriter feel more confident that the payment will be made? Definitely, yes. Q: When refinancing a borrower from a conventional loan to FHA, can the closing costs and prepaid expenses be rolled into the loan? A: Yes, provided the maximum loan-to-value (LTV) limits are not exceeded. In most cases, this will be either 97.15 percent or 97.75 percent, depending on whether you are a in a low- or high-cost state. Check with your underwriter or account executive, if you aren't sure which category you're in. This is the loan of choice today for high-LTV lending, and this product can make a significant impact on your borrower's quality of life and your income, as well. With all the adjustable-rate mortgages (ARMs) out there, this segment of FHA financing will remain healthy for the next five to seven years. Q: I realize the great revenue that can be generated from taking people out of ARMs and into FHA, but how do I get these loans? A: This is a common question. You may want to refer to my earlier articles for more detail, but here is a brief summary of possible avenues for acquiring these loans. 1. Start with your current database first. If you have lost touch with your past clients, it's time to reconnect with them. The biggest challenge for the loan officer is to create a system for database mailings. I suggest that you sit down one Sunday morning and create a series of six letters that will be sent out every other month in 2008. Then, you can pay a high school student $20 per mailing. Now, you have your whole year of mailings set for the year. To get FHA refinance loans, include in each of the aforementioned letters a short paragraph about how someone could benefit from an FHA refinance. 2. Co-market to real estate agents' databases. In the joint piece, aside from the purchase finance information, include how FHA refinancing can help people. 3. Create a direct mail targeting people in ARMs and send them on a periodic basis (depending on your budget). You can acquire hundreds of leads from the county register of deeds if you are able to search by company. For example, you can search for all the loans closed by X sub-prime company and recorded during a range of dates. Target the loans that will be coming up for adjustment. Because the loans you're searching for are ARMs, the Adjustable Rate Note Rider will be recorded with the mortgage, so you will be able to see what the current rate is and calculate what it will adjust to. Tailor your message in a personal way and focus on the fact that you are local (if you are). You will be able to hand-select these leads and be able to send a more compelling message than other companies that buy their leads from list brokers. Choose the number of pieces that works with your budget and make a commitment to be consistent in sending them out. If you need to delegate this, then do so. Just make sure it gets done! As your knowledge of FHA guides increases, your ability to get these loans through increases. There is no magic with FHA loans; it takes know-how and attention to detail, to be sure. However, once you get into these loans, you may just learn to love the challenge, how much you can help people and, of course, the great financial benefits that come as a result. Go FHA! Jeff Mifsud founded Mortgage Seminars LLC in 2004, has been an FHA originator for 12 years, is a faculty member of LoanToolBox.com and is a former FHA underwriter. He may be reached at (877) 342-9100 or e-mail [email protected]. For upcoming FHA Webinars, visit www.mseminars.com.