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
[email protected].
