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What the hell are you doing?

National Mortgage Professional
Aug 19, 2008

FHA implements use of credit scoresJeff MifsudFHA, credit scoring underwriting model, non-traditional credit verification and evaluation The time has finally come: The Federal Housing Administration (FHA) has moved to a credit scoring underwriting model. Given the importance credit scores have attained in our industry, it seemed only a matter of time before the FHA would introduce a risk-based model based on credit scores. I would like to clarify for you the two most recent FHA updates. Non-Traditional Credit Verification and Evaluation (ML 08-11) These changes established guidelines for borrowers with limited or no traditional credit. The guidelines for the use of non-traditional credit (NTC) are as follows: &38226;The FHA now requires that a borrower with no traditional credit have a minimum of three trade lines. Allowable trade lines are separated into two groups of NTC: Group I 1. Rent payments. If the borrower rents from a family member, youll need to show 12 months of cancelled checks 2. Utility payments, including gas, electricity, water, landline home telephone service, cable, etc. Group II 1. Insurance coverage (i.e., medical, auto, life, renters, etc.) 2. Childcare payments (made to a business) 3. School tuition 4. Retail store payments (i.e., department, furniture, appliance stores, specialty stores, etc.) 5. Rent to own (furniture or appliances) 6. Medical bills not covered by insurance 7. Internet service 8. Cell phone bill 9. History of saving over the last 12 months by regular deposits 10. Automobile leases 11. Personal loan from an individual, with documented repayment terms along with cancelled checks • When qualifying a borrower, remember that these underwriting changes are directed at borrowers with limited or no traditional credit, where the use of non-traditional credit, i.e., rent and utility payments, is used to give a better picture of the borrower's payment history with creditors. Please note that the definition of "limited traditional credit" will vary among underwriters. •Remember that borrowers with limited or no traditional credit must have a minimum of three alternative trade lines with a 12-month history. One of the three must be rent or housing utility payments, i.e., gas, electric, water, cable, landline phone, etc. The other thing you need to keep in mind is that borrowers with no traditional credit and no rent or utility accounts will need (A) Two months worth of cash reserves from their own funds, gifts are not allowed to meet this requirement; and (B) Ratios of 31 percent (for housing expense to income ratio) and 43 percent (for total debt-to-income ratio) cannot be exceeded. No exceptions will be granted. •There are additional underwriting criteria for non-traditional credit you need to know, and they are as follows: (A) No history of delinquency on rent payments; (B) No more than one 30-day late payment in the last 12 months on all other alternative trade lines; and (C) No collection or judgments filed within the last 12 months (excludes medical collections, which are evaluated by the underwriter). •All alternative trade lines must have a 12-month history. The new credit score guidelines for FHA loans (ML 08-16) This is the first time in FHA history that credit scores are being taken into account. These guidelines were effective as of July 14, 2008. The 10 primary guideline changes are as follows: 1. Borrowers need either no score or at least a score of 500 to get a loan-to-value (LTV) greater than 90 percent (see matrix below); 2. Borrowers with a score of less than 500 get a maximum LTV of 90 percent; 3. Borrowers without scores will require manual underwriting; 4. Upfront mortgage insurance premiums (UFMIP) will range from 1.25 percent to 2.25 percent, based on score; 5. The monthly mortgage insurance (MMI) will range from 0.50 percent to 0.55 percent, depending on score; 6. The premium is based on the borrower with the lowest score; 7. If one of the borrowers has no score, then the non-traditional credit grade is used; 8. Credit rescoring is allowed to improve a borrower's credit grade; 9. All FHASecure refinances greater than 95 percent LTV with delinquencies have a 2.25 percent UFMIP and 0.55 percent MMI; and 10. Cash-out, rate and term, and non-delinquent FHASecure refinances are included in this change. The shift to credit scoring is important to loan officers for two reasons. First, it will help the FHA gain more success in the secondary market and make it more attractive to investors who use mortgage-backed securities as an investment vehicle. This will, in turn, mean continued stable yield spread premiums. And secondly, it will help to prevent consumers from becoming homeowners before they are truly ready. Lending institutions establish guidelines as a way to predict the borrower's future performance on the loan. Just as the bank funding the loan wants to protect their investment (the home), so too should you work to protect your investment (the client). Set your client up for success in his home. You do this by determining whether he will be able to comfortably make his payment or not. FHA guidelines are very forgiving, and you may come across loans that look great on paper and get approved. But if you were given information by the borrower or even just have a strong feeling that leads you to believe that the client will not be able to afford the home, it's to everyone's best interest not to force the loan through. For example, I was referred a couple wanting to buy a home. Because of the couple's schedules, I had to interview them separately. When speaking with her, I listened to how excited and motivated she was to buy a homeshe couldn't wait. Based on this interview, it sounded like a very good FHA loan, both income and credit-wise. However, when I spoke with him, I got a very different picture. In the end, I advised them to hold off for a while. Although they did qualify and I was confident I could get them approved for their FHA loan, I advised this because of what he relayed to me when we spoke. He told me that he was not happy at his current job and that he wanted to get his old job back; therefore, he felt uneasy about taking on the obligation of a house payment. Because of his dissatisfaction with his job, it was clear to me that in this case, it wouldn't have been the right time to buy a home. I tell borrowers, "The right house at the wrong time is the wrong house." When you encounter situations like this, don't be afraid to give them the option of continuing to rent for another six to 12 months, or maybe consider a lower loan amount. Your client is potentially worth thousands of dollars to you in referrals, and you only tap into this income stream by doing what's right for the borrower. In summary, the implementation of FHA's use of credit scores is an important move that will help make FHA stronger financially and position itself as one of the most important loan products for loan officers, as well as for consumers. As always, I strongly encourage all of you to use these FHA updates as an opportunity to provide ongoing training to local real estate offices that you have existing relationships with. Use this as an opportunity to develop partnerships with new offices as well! Go FHA! Jeff Mifsud founded Mortgage Seminars LLC in 2004, has been an FHA originator for 12 years, is a contributor to LoanToolbox.com and is a former FHA underwriter. Jeff may be reached at (877) 342-9100 or e-mail jeff@fhasuccessdesk.com.
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