[Federal Register Volume 75, Number 135 (Thursday, July 15, 2010)]
[Notices]
[Pages 41217-41225]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-17326]
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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
[Docket No. FR-5404-N-01]
Federal Housing Administration Risk Management Initiatives:
Reduction of Seller Concessions and New Loan-to-Value and Credit Score
Requirements
AGENCY: Office of the Assistant Secretary for Housing--Federal Housing
Commissioner, HUD.
ACTION: Notice.
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SUMMARY: A recently issued independent actuarial study shows that the
Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below
its statutorily mandated threshold. Consistent with HUD's
responsibility under the National Housing Act to ensure that the MMIF
remains financially sound, this notice solicits public comment on three
proposed initiatives that will contribute to the restoration of the
MMIF capital reserve account. The changes proposed in this notice are
designed to preserve both the historical role of the Federal Housing
Administration (FHA) in providing a home financing vehicle during
periods of economic volatility and HUD's social mission of helping
underserved borrowers. FHA proposes to tighten only those portions of
its underwriting guidelines that have been found to present an
excessive level of risk to both homeowners and FHA. First, FHA proposes
to reduce the amount of closing costs a seller may pay on behalf of a
homebuyer purchasing a home with FHA-insured mortgage financing for the
purposes of calculating the maximum mortgage amount. This proposed cap
on ``seller concessions'' will minimize FHA exposure to the risk of
adverse selection. Secondly, FHA proposes to introduce a credit score
threshold as well as reduce the maximum loan-to-value (LTV) for
borrowers with lower credit scores, who represent a higher risk of
default and mortgage insurance claim. Finally, FHA will tighten
underwriting standards for mortgage loan transactions that are manually
underwritten. These transactions have resulted in high mortgage
insurance claim rates and present an unacceptable risk of loss.
DATES: Comment Due Date: August 16, 2010.
ADDRESSES: Interested persons are invited to submit comments regarding
this notice to the Regulations Division, Office of General Counsel,
Department of Housing and Urban Development, 451 7th Street, SW., Room
10276, Washington, DC 20410-0500. Communications must refer to the
above docket number and title. There are two methods for submitting
public comments. All submissions must refer to the above docket number
and title.
1. Submission of Comments by Mail. Comments may be submitted by
mail to the Regulations Division, Office of General Counsel, Department
of Housing and Urban Development, 451 7th Street, SW., Room 10276,
Washington, DC 20410-0500.
2. Electronic Submission of Comments. Interested persons may submit
comments electronically through the Federal eRulemaking Portal at
http://www.regulations.gov. HUD strongly encourages commenters to
submit comments electronically. Electronic submission of comments
allows the commenter maximum time to prepare and submit a comment,
ensures timely receipt by HUD, and enables HUD to make them immediately
available to the public. Comments submitted electronically through the
http://www.regulations.gov Web site can be viewed by other commenters
and interested members of the public. Commenters should follow the
instructions provided on that site to submit comments electronically.
Note: To receive consideration as public comments, comments must
be submitted through one of the two methods specified above. Again,
all submissions must refer to the docket number and title of the
rule.
No Facsimile Comments. Facsimile (FAX) comments are not acceptable.
Public Inspection of Public Comments. All properly submitted
comments and communications submitted to HUD will be available for
public inspection and copying between 8 a.m. and 5 p.m. weekdays at the
above address. Due to security measures at the HUD Headquarters
building, an appointment to review the public comments must be
scheduled in advance by calling the Regulations Division at 202-708-
3055 (this is not a toll-free number). Individuals with speech or
hearing impairments may access this number via TTY by calling the
Federal Information Relay Service at 800-877-8339. Copies of all
comments submitted are available for inspection and downloading at
http://www.regulations.gov.
FOR FURTHER INFORMATION CONTACT: Mark Ross, Office of Single Family
Program Development, Office of Housing, Department of Housing and Urban
Development, 451 7th Street, SW., Washington, DC 20410; telephone
number 202-708-2121 (this is not a toll-free number). Persons with
hearing or speech impairments may access this number through TTY by
calling the toll-free Federal Information Relay Service at 800-877-
8339.
SUPPLEMENTARY INFORMATION:
I. Background: FHA and the Housing Crisis
FHA was established by Congress in 1934 to improve nationwide
housing standards, provide employment and stimulate industry, to
improve conditions with respect to home mortgage financing, to prevent
speculative excesses in mortgage investment, and to eliminate the
necessity for costly secondary financing. As a governmental mortgage
insurance company with nationwide scope, FHA provided credit
enhancement to protect mortgage lenders from risk of loss, which
encouraged the banking community to extend credit to new homeowners and
those in need of refinance and home improvement loans. The result was
one of the most successful collaborations between the public and
private sectors in U.S. history. To this day, the FHA model, which
offers mortgage insurance for mortgage loans that meet FHA
requirements, reduces risk to mortgage lenders, thereby enabling them
to extend credit to homeowners and
[[Page 41218]]
homebuyers, even during periods of economic volatility.
The current state of the housing market validates the importance of
the historical role of FHA in stabilizing the mortgage market during
times of economic disruption. Over the last 2 years, FHA has resumed
its countercyclical position, supporting the private sector when access
to capital is otherwise constrained. The volume of FHA insurance
increased rapidly as private sources of mortgage finance retreated from
the market. FHA's share of the single-family mortgage market today is
approximately 30 percent--up from 3 percent in 2007, and the dollar
volume of insurance written has jumped from the $56 billion issued in
that year to more than $300 billion in 2009.
Managing Risk to the MMIF
The growth in the MMIF portfolio over such a short period of time
coincides with a set of difficult economic conditions. FHA is also
concerned with the issue of layering risk. Default risk is compounded
when there are low credit scores, high loan-to-value (LTV) ratios, high
debt-to-income ratios, and low or zero cash reserves associated with a
loan. Given these conditions and concerns, FHA, in managing the MMIF,
must be especially vigilant in monitoring the performance of the
portfolio, enhancing risk controls, and tightening standards to address
portions of the business that expose homeowners to excessive financial
risks. See section 202(a)(7)(A) of the National Housing Act, which
addresses the operational goals of the MMIF (12 U.S.C 1708(a)(7)(A)).
The proposals set forth in this Notice are representative of FHA's
focus on enhancing the agency's risk management practices, while
fulfilling FHA's mission to serve borrowers in a manner that is
financially sustainable for both FHA and borrowers. FHA's authorizing
statute, the National Housing Act, clearly envisions that FHA will
adjust program standards and practices, as necessary, to operate the
MMIF, with reasonable expectations of financial loss.
While the Federal Credit Reform Act of 1990 requires that FHA (and
all other government credit agencies) estimate and budget for the
anticipated cost of mortgage loan guarantees, the National Housing Act
imposes a special requirement that the MMIF hold an additional amount
of funds in reserve to cover unexpected losses. On November 13, 2009,
HUD released an independent actuarial study that reported that FHA will
likely sustain significant losses from mortgage loans made prior to
2009, due to the high concentration of seller-financed downpayment
assistance mortgage loans and declining real estate values nationwide,
and that the MMIF capital reserve relative to the amount of outstanding
insurance in force had fallen below the statutorily mandated 2 percent
ratio.\1\
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\1\ The capital ratio generally reflects the reserves available
(net of expected claims and expenses), as a percentage of the
current portfolio, to address unexpected losses. The report can be
found at: http://www.hud.gov/offices/hsg/fhafy09annualmanagementreport.pdf.
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FHA maintains the MMIF capital reserve in a special reserve
account. As with other federal credit agencies, FHA uses a financing
account to cover the current anticipated cost of its mortgage loan
guarantees. The MMIF capital reserve account serves as a back-up fund,
where FHA holds additional capital to cover unexpected losses. Funds
are transferred into this account only when FHA holds more cash in the
financing account than is necessary to cover projected costs. In recent
years, adverse market conditions, the poor performance of seller-
financed gift letter mortgage loans, and worsening economic projections
had substantially increased the estimated cost of outstanding single-
family mortgage loan guarantees, and large transfers of funds were made
from the reserve account into the primary financing account. As
previously noted, these withdrawals from the MMIF capital reserve fund
have resulted in its no longer complying with the minimum capital ratio
mandated by law. However, if the current estimate of these costs proves
excessive or if FHA implements policy changes that result in net income
to the Federal Government, excess funds will be moved from the
financing account back to the reserve account, thereby restoring the
capital reserves of the MMIF.
There are four primary policy changes that FHA can implement to
replenish the MMIF capital reserve account: (1) Increase the premium
income generated; (2) reduce losses by tightening underwriting
guidelines; (3) strengthen enforcement measures to reduce unwarranted
claim payments, and (4) improve avoidance of claim costs through
enhanced loss mitigation. FHA is engaged in efforts on all of these
fronts, exercising its full authority under the terms of the National
Housing Act, including new authorities provided in recently enacted
legislation.
History of FHA Loan-to-Value and Credit Score Requirements
In 1934, single-family mortgage insurance was available for loans
up to 80 percent of appraised value. In 1938, amendments to the
National Housing Act introduced a 90 percent LTV ratio as well as a
tiered approach that tied LTV to specific dollar amounts, e.g., 90
percent of the first $6,000 of value and 80 percent for the remainder,
depending on whether the property had been approved by FHA prior to
construction. By 1957, the permissible LTV had increased to 90 or 97
percent of the first $10,000 of value plus 85 percent of the next
$6,000 and 70 percent of the remainder, again depending on whether the
property had been approved prior to construction. LTVs in the mid 1990s
followed the same general tiered approach, with the first $25,000 of
value limited to 97 percent; 95 percent of value in excess of $25,000,
not to exceed $125,000; and 90 percent of value in excess of $125,000.
Under the amendments made by the Housing and Economic Recovery Act of
2008 (Pub. L. 110-289, 122 Stat. 2654, approved July 30, 2008) (HERA),
FHA implemented a 96.5 percent LTV for purchase transactions.
By contrast, the conventional mortgage market changes LTV
requirements based on current conditions in the market. In December
2007, Fannie Mae restricted the maximum LTV for properties located
within a declining market to 5 percentage points less than it would
otherwise permit for a given loan product, meaning that a 95 percent
LTV program would see availability restricted to 90 percent LTV. In May
2008, Fannie Mae returned to a national LTV as high as 97 percent for
conforming mortgages scored favorably by its automated underwriting
system, and 95 percent LTV for those underwritten manually.
As for a minimum credit score requirement, FHA did not introduce
such a requirement until July 2008 when borrowers with credit scores
below 500 were limited to 90 percent LTV. However, the large financial
institutions in the mortgage industry introduced a minimum credit score
of 580 in the first quarter of 2008, regardless of the type of
financing and LTV, and then raised it to 620 in the first quarter of
2009.
II. New Tools To Manage Risk--The Housing and Economic Recovery Act of
2008
HERA made significant and comprehensive reforms to the National
Housing Act (12 U.S.C. 1701 et seq.) and consequently reforms to FHA
programs. Section 2118 of HERA amended section 202 of the National
Housing Act (12 U.S.C. 1708), by amending several
[[Page 41219]]
provisions directed to both highlighting and strengthening FHA's
fiduciary responsibilities.
Section 202, as amended by HERA, provides in paragraph (a)(3),
entitled ``Fiduciary Responsibility,'' that the ``Secretary has a
responsibility to ensure that the Mutual Mortgage Insurance Fund
remains financially sound.'' Paragraph (a)(4) continues a pre-HERA
requirement, which is for the Secretary to provide, annually, for an
independent actuarial study of the Fund, and the study is to include a
review of risks to the Fund. Paragraph (a)(6) provides that if,
pursuant to the independent actuarial study of the Fund, the Secretary
determines that the Fund is not meeting the operational goals
established under paragraph (7) or there is substantial probability
that the Fund will not maintain its established target subsidy rate,
``the Secretary may either make programmatic adjustments under this
title as necessary to reduce the risk to the Fund, or make appropriate
premium adjustments.'' Paragraph (a)(7) provides that the operational
goals of the Fund include minimizing the default risk to the Fund and
to homeowners, while meeting the housing needs of the borrowers that
the single-family mortgage insurance program under this title is
designed to serve.
Consistent with these new obligations and authorities provided
under the National Housing Act, HUD has already undertaken several
measures to protect the FHA fund during the economic downturn, focusing
on programs and practices that resulted in poor loan performance. This
includes: Prohibition on seller-financed downpayment assistance and the
tightening of underwriting guidelines for both the streamline and cash-
out refinance products. FHA also implemented several changes to the
agency's appraisal standards, shortening the validity period and
reaffirming appraiser independence, to ensure that appraisals are as
up-to-date and accurate as possible.
In addition to program modifications, FHA has increased oversight
of lenders.\2\ FHA has terminated and suspended several lenders whose
default and claim rates were higher than the national default and claim
rate.
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\2\ See HUD press release of September 18, 2009, announcing FHA
credit policy changes to improve risk management functions at http://www.hud.gov/news/release.cfm?content=pr09-177.cfm, and the
individual Mortgagee Letters implementing these policy changes at
http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/index.cfm.
See also HUD's November 30, 2009, rule proposing to increase the net
worth of FHA-approved lenders at 74 FR 62521.
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FHA also announced and implemented an increase in the upfront
mortgage insurance premium. By Mortgagee Letter 2010-02, FHA notified
the industry that FHA will collect an upfront mortgage insurance
premium of 2.25 percent for FHA loans for which case numbers are
assigned on or after April 5, 2010. As the Mortgagee Letter provides,
the new upfront premium is applicable to mortgages insured under the
MMIF. The Mortgagee Letter advises that the new upfront premium is not
applicable to mortgages insured under the following programs: Title I
of the National Housing Act; Home Equity Conversion Mortgages (HECMs);
HOPE for Homeowners (H4H); Section 247 (Hawaiian Homelands); Section
248 (Indian Reservations); Section 223(e) (declining neighborhoods);
and Section 238(c) (military impact areas in Georgia and New York). The
Mortgagee Letter also advises that there is no change to the amount of
annual premiums.
III. Proposed Risk Management Initiatives
In addition to these measures--which address all four components of
FHA's enhanced risk management approach--this notice proposes to
tighten FHA's underwriting guidelines in a manner that balances FHA's
goals of protecting the MMIF's financial health, while continuing to
meet FHA's historic mission of providing a vehicle for mortgage lenders
to provide affordable mortgages. Given the importance of maintaining a
viable MMIF for existing and future homeowners, it is FHA's intent to
focus only on particular practices that have been found to result in
extremely poor mortgage loan performance. TABLE A shows that few
borrowers are served under the standards that FHA is proposing to
eliminate, relative to the total FHA portfolio.
Table A--FHA Single-Family Insurance Endorsement Shares in CY 2009 \a\
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Credit score ranges
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Loan-to-value range None 300-499 500-579 580-619 620-679 680-850
(percent) (percent) (percent) (percent) (percent) (percent)
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Up to 90%............................................... 0.03 0.01 0.12 0.48 2.28 3.51
Above 90%............................................... 0.34 0.02 1.39 7.24 35.80 48.77
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\a\ All fully underwritten loans, excluding streamline refinance loans (and reverse mortgages). Source: U.S. Department of Housing and Urban Development/
FHA; February 2010.
Table B clearly indicates, through the performance data provided,
that these borrowers are at significantly greater risk of losing their
homes.
Table B--FHA Single-Family Insurance
[Seriously Delinquent Rates \a\ by LTV and Credit Scores \b\ as of January 31, 2010]
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Credit score ranges
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LTV range None 300-499 500-579 580-619 620-679 680-850
(percent) (percent) (percent) (percent) (percent) (percent)
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Up to 90%............................................... 13.3 35.4 22.4 15.7 6.1 1.5
Above 90%............................................... 20.9 43.3 30.4 19.6 8.6 2.3
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\a\ Seriously delinquent rates measure the sum of 90\+\-day delinquencies, in-foreclosure, and in-bankruptcy cases, as a percent of all actively insured
loans on a given date.
[[Page 41220]]
\b\ Due to restrictions on the availability of loan-origination credit score data, this table includes only actively insured loans that were endorsed
for insurance starting in Fiscal Year 2005. This table does not include information on streamline refinance loans.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.
Given FHA's mission, allowing the continuation of practices that
result in such a high proportion of families losing their homes
represents a disservice to American families and communities. It is
FHA's intent to eliminate this portion of its business, and utilize
other established methods to reach and support these families, such as
through HUD's housing counseling program, which helps families prepare
for and achieve sustainable homeownership. The following presents the
practices that FHA plans to discontinue.
First, FHA proposes to reduce the amount of closing costs a seller
(or other interested party) may pay on behalf of a homebuyer financing
the purchase of a home with FHA mortgage insurance. Secondly, FHA
proposes to introduce a minimum credit score for eligibility, as well
as reduce the maximum LTV for borrowers with lower credit scores.
Finally, FHA proposes to tighten underwriting standards for mortgage
loans that are manually underwritten. These initiatives are intended to
reduce the risk to, and assist in the return of, FHA's MMIF capital
ratio to its mandated threshold. In addition, the initiatives will help
to continue FHA's traditional role as a stabilizing force in the
housing market during troubled economic times and remain a source of
mortgage credit for low- and moderate-income homebuyers. These new
guidelines are not applicable to mortgages insured under the following
programs: Title I of the National Housing Act; Home Equity Conversion
Mortgages (HECMs); HOPE for Homeowners (H4H); Section 247 (Hawaiian
Homelands); Section 248 (Indian Reservations); Section 223(e)
(declining neighborhoods); and Section 238(c) (military impact areas in
Georgia and New York).
A. Reduction of Seller Concession
When a home seller pays all or part of the buyer's closing costs,
such payments are referred to as seller concessions.\3\ HUD's existing
policy regarding concessions is found in Handbook 4155.1, section 2.A.3
and Handbook 4155.2, section 4.8, which define seller concessions and
provide that any concessions exceeding 6 percent must be treated as
inducements to purchase, resulting in a reduction in the FHA mortgage
amount. This notice proposes to reduce the 6 percent limitation defined
in the Handbooks to 3 percent. While HUD previously has allowed seller
concessions of up to 6 percent of the sales price, conventional
mortgage lenders have capped seller concessions at 3 percent of the
sales price on loans with LTV ratios similar to FHA. Loans guaranteed
by the Department of Veterans Affairs cap seller concessions at 4
percent of the sales price.
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\3\ Seller concessions include any payment toward the borrower's
closing costs by any third party with an interest in the
transaction, to include the seller, builder, developer, mortgage
broker, lender, or settlement company.
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FHA proposes to cap the seller concessions in FHA-insured single-
family mortgage transactions at 3 percent of the lesser of the sales
price or appraised value, for the purpose of calculating the maximum
mortgage amount. Table C shows that borrowers who received more than 3
percent in seller concessions had a significantly higher risk of losing
their homes. While seller concessions above 3 percent would not be
prohibited under this proposal, concessions that exceed FHA's 3 percent
cap would be required to result in a dollar-for-dollar reduction in the
sales price for the purpose of calculating the maximum FHA loan amount.
This proposed cap will not only align FHA's single-family mortgage
insurance programs to industry practice, but will help ensure that
borrowers who rely on FHA-insured financing have sufficient investment
in their home purchases and are less likely to default.
Table C--FHA Single-Family Insurance
[To-Date Claim Rates by Seller Concession Level--Percentage of Home Purchase Price as of January 31, 2010]
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Concession rates Comparative ratios
Endorsement fiscal year -------------------------------------------------------------------------------------------------
Zero Low: up to 3% High: above 3% Low/Zero High/Zero High/Low
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2003.................................................. 6.5% 6.2% 10.0% 0.96 1.55 1.61
2004.................................................. 6.3% 7.0% 11.0% 1.11 1.76 1.59
2005.................................................. 6.9% 7.9% 10.9% 1.14 1.58 1.38
2006.................................................. 6.3% 7.5% 9.5% 1.19 1.51 1.27
2007.................................................. 4.5% 5.3% 6.5% 1.19 1.46 1.23
2008.................................................. 1.0% 1.2% 1.7% 1.18 1.67 1.41
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Low = greater than zero and up to 3% of the sales price; High = greater than 3% of the sales price and up to 6%. Source: U.S. Department of HUD/FHA;
Home Purchase loans excluding HECM, February 2010.
B. New LTV Ratio and Credit Score Requirements
FHA is proposing to introduce a minimum decision credit score of no
less than 500 to determine eligibility for FHA financing and reduce the
maximum LTV for all borrowers with decision credit scores of less than
or equal to 579. Maximum FHA-insured financing (96.5 percent LTV for
purchase transactions and 97.75 percent LTV for rate and term refinance
transactions) would be available only to borrowers with credit scores
at or above 580. All borrowers with decision credit scores between 500
and 579 would be limited to 90 percent LTV.
The decision credit score used by FHA in this analysis is based on
methodologies developed by the FICO Corporation. FICO scores, which
range from a low of 300 to a high of 850, are calculated by each of the
three National Credit Bureaus and are based upon credit-related
information reported by creditors, specific to each applicant. Lower
credit scores indicate greater risk of default on any new credit
extended to the applicant. The decision credit score is based on the
middle of three National Credit Bureau scores or the lower of two
scores when all three are not available, for the lowest scoring
applicant. While FHA's historical data and analysis is derived from the
``FICO-
[[Page 41221]]
based'' decision credit score, it is not FHA's intent to prohibit the
use of other credit scoring models to assess an FHA borrower's credit
profile. In this notice, FHA seeks comment on the best means for FHA to
provide guidance to the industry on acceptable score ranges for other
scoring models, to ensure that the scales used for all scoring systems
are consistent and appropriate for an FHA borrower.
While FHA is serving very few borrowers with credit scores below
500, as shown in TABLE A, the performance of these borrowers is clearly
very poor, as reflected in TABLES B and D. TABLE D shows the serious
delinquency rates for borrowers with credit scores below 500,
demonstrating that these borrowers struggle to meet their mortgage
obligations. TABLE E demonstrates that the percentage of borrowers who
ultimately lose their homes is twice as high for borrowers with lower
credit scores. Similarly, FHA data demonstrates that borrowers with
decision credit scores below 580, who invest only a minimal amount of
funds into the transaction, struggle to make their mortgage payments
and ultimately lose their homes at a rate that is unacceptable to FHA.
Table D shows that borrowers affected by this notice have seriously
delinquent rates four to five times higher than those who remain
eligible.
Table D--FHA Single Family Insurance
[Seriously Delinquent Rates by Proposed Credit Score Floor\a\ January
31, 2010]
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Below 500 Floor Below 580 Floor
Above Floor (LTV up to 90) (LTV above 90) All Loans
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7.63% 35.38% 29.80% 9.29%
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\a\ On active insured cases meeting today's underwriting criteria, which
require 10% down for borrowers with credit scores below 500, excluding
streamline refinance loans, endorsements Fiscal Years 2005-2009.
Source: U.S. Department of Housing and Urban Development, Federal
Housing Administration; February 2010.
FHA data indicate that insured mortgages with decision credit
scores below 580 have significantly worse default and claim experience
than do loans at or above 580. As seen in Table D, the seriously
delinquent rate on actively insured mortgage loans in January 2010 was
more than three times as high for loans below the proposed floor versus
those above the floor. Higher delinquencies do translate into higher
insurance claims over time. Table E shows the to-date claim rate of
insured loans above and below the proposed floor, for Fiscal Years
(FYs) 2005--FY 2008 books of business. The claim rate of mortgage loans
below the floor is more than twice as high as those mortgage loans with
credit characteristics above the floor.
Table E--FHA Single Family Insurance
[To-Date Claim Rates on Fully Underwritten Loans\a\ by Proposed FICO Floor Restrictions (Above or Below)\b\ as
of January 31, 2010]
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Decision Credit Score Floor
Endorsement FY --------------------------------------------------------------------- Ratio Below/Above
Above Below All
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All Borrowers
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2005 5.76% 14.44% 7.28% 2.51
2006 5.42% 12.79% 6.59% 2.36
2007 3.74% 8.39% 4.65% 2.24
2008 0.97% 2.88% 1.20% 2.96
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The proposed restrictions are a minimum 500 FICO score for borrowers with loan-to-value ratios less than or
equal to 90%, and a minimum of 580 for borrowers with ratios above 90%.
Source: U.S. Department of Housing and Urban Development; February 2010.
FHA also must take measures that increase the likelihood that
borrowers who are offered FHA-insured mortgages are capable of repaying
these mortgages. The proposed changes announced in this notice address
these concerns.
Under this proposal, effectively, a borrower with a decision credit
score between 500 and 579 would be required to make a greater
downpayment [at minimum, 10 percent] than a borrower with a higher
score, for the purchase of a home with the same sales price.\4\
Borrowers with credit scores below 500 would not be eligible for FHA-
insured financing. The proposed new LTV and credit score requirements
will reduce the risk to the MMIF and ensure that home buyers are
offered mortgage loans that are sustainable.
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\4\ FHA will continue to allow borrowers to use permissible
sources of funds, as described in FHA Handbook 4155.1, paragraph
5.B.1, to meet the minimum cash investment in the form of a
downpayment. Gifts from family members, charitable organizations,
employers, and government entities are also permitted, provided that
none of the parties financially benefit from the sales transaction.
In addition, governmental entities, including instrumentalities
thereof, as described in Section 528 of the National Housing Act,
may offer secondary financing to cover the borrowers' cash
investment.
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Proposed Exemption for Borrowers Seeking to Refinance. While FHA
proposes to introduce a minimum decision credit score of no less than
500 to determine eligibility for FHA financing and to reduce the
maximum LTV for all borrowers with decision credit scores between 500
and 579, FHA is also considering a special, temporary allowance to
permit higher LTV mortgage loans for borrowers with lower decision
credit scores, so long as they involve a reduction of existing mortgage
indebtedness pursuant to FHA program adjustments announced on March 26,
2010. The program adjustments will be proposed under separate notice.
The current mortgage lender will need to agree to accept a short pay
off, accepting less than the full amount owed on the original mortgage
in order to satisfy the outstanding debt. This exemption will be
applicable only to borrowers with credit scores between 500 to 579.
Given the current economic conditions and the
[[Page 41222]]
need (and encouragement by federal and other governmental programs) to
refinance mortgages in order to obtain a more affordable mortgage
through lower monthly payments, the decision credit scores proposed by
this notice may be counterproductive in helping existing homeowners
save their homes. Existing homeowners have an established payment
history that can be taken into consideration in the underwriting
process, but FHA recognizes that even homeowners who have been able to
make their monthly payments may have had their credit scores negatively
impacted by the downturn in the economy which has so seriously affected
the housing market. FHA's consideration of different credit score
requirements for refinance transactions would only be temporary, and
would be applicable only to refinanced mortgages involving a short pay
off. FHA is not proposing this distinct criteria permanently for
refinance transactions, but rather only for such period as would help
existing homeowners maintain their homes during this current economic
downturn. FHA is proposing only different credit scores for refinance
transactions to continue through, but not beyond, December 31, 2012.
HUD specifically seeks comment on FHA's proposal.
C. Manual Underwriting
The purpose of mortgage underwriting is to determine a borrower's
ability and willingness to repay the debt and to limit the probability
of default. An underwriter must consider a borrower's credit history,
evaluate their capacity to repay the loan based on income and current
debt, determine if the cash to be used for closing is sufficient and
from an acceptable source, and determine if the value of the collateral
supports the amount of money being borrowed.
In cases where the borrower has very limited or nontraditional
credit history, a FICO credit score may not have been issued by the
credit bureaus, or the credit score may be based on references that are
few in number or do not effectively predict future credit worthiness.
Table F--Manual Underwriting Standards
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LTV Credit score Ratios Reserves
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90.00%....................... >= 500 to <= 579........ 31/43%--Cannot Exceed... 1 month PITI
96.50%*...................... >= 580 to 619........... 31/43%--Cannot Exceed... 1 month PITI
Nontraditional Credit...
96.50%*...................... >= 620 and above........ 31/43%--May Exceed...... 1 month PITI
----------------------------------------------------------------------------------------------------------------
* Cash-out refinance LTV limit is 85% and conventional-to-FHA refinance LTV limit is 97.75%.
Mortgage loans for borrowers in this category will need to be manually
underwritten as are all ``Refer'' risk classifications provided by
FHA's TOTAL Mortgage Score Card. Naturally, these categories of
borrowers present a higher level of risk and, as a result, manual
underwriting guidelines are generally more stringent to address that
higher risk level.
FHA has determined that factors concerning borrower housing and
debt-to-income ratios, along with cash reserves, are good predictive
indicators as to the sustainability of the mortgage. FHA is proposing
to implement additional requirements that will consider these factors
for manually underwritten mortgage loans, as seen in TABLE F.
These additional requirements will consider the borrower's credit
history, LTV percentage, housing/debt ratios, and reserves. On all
manually underwritten mortgage loans, borrowers will be required to
have minimum cash reserves equal to one monthly mortgage payment, which
includes principal, interest, taxes, and insurance(s). Maximum housing
and debt-to-income ratios will be set at 31 percent and 43 percent,
respectively. Borrowers with credit scores of 620 or higher may exceed
the qualifying ratios of 31/43 percent, not to exceed 35/45 percent
provided that they are able to meet at least one of the compensating
factors listed below. To exceed the qualifying ratios of 35/45 percent,
not to exceed 37/47 percent, borrowers must meet at least two
compensating factors listed below. Any other compensating factors are
not acceptable. Mortgage lenders cannot use compensating factors to
address unacceptable credit. While this notice does not address the
interplay of the housing and debt-to-income ratios, FHA is seeking
comment on how to serve borrowers with housing ratios above the
threshold and debt-to-income ratios below the threshold, i.e., 36/36
percent.
Acceptable compensating factors are:
The borrower will have a documented significant decrease
or a documented minimal change in housing expense AND a documented 12-
month housing payment history with no more than 1X30 late payments,
e.g., no more than one month late on all rental or mortgage payments
made within the month due.
Documented significant additional income that is not
considered effective income, e.g., part-time income that does not meet
the requirements in Handbook 4155.1, paragraph 4.D.2.d., and is not
reasonably expected to continue for the next 2 years.
Documented cash reserves in the amount of 3 total monthly mortgage
payments (principle, interest, taxes, insurance). The reserves,
consisting of the borrower's own funds, must be liquid or readily
accessible, and may not consist of gift funds.
Energy Efficient Mortgages, as well as those homes that
were built to the 2000 International Energy Conservation Code, formerly
known as the Model Energy Code, or are being retrofitted to that
standard, have ``stretch ratios'' up to 33/45 percent.
TABLE G shows that borrowers who met the proposed ratio and reserve
requirements performed considerably better than those borrowers who did
not meet the same guidelines. These proposed new requirements for
manual underwriting will reduce the risk to the FHA MMIF, by helping to
ensure that home buyers are financially capable of repaying the
mortgage loan to be insured by FHA.
[[Page 41223]]
Table G--FHA Single-Family Insurance
[Credit Risk Comparisons for Proposed Limits on Manual Underwriting Approvals Data as of January 31, 2010]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Seriously Seriously
To-date claim delinquent To-date claim delinquent Claim rate Seriously
Endorsement fiscal year rate (percent) rate \a\ rate (percent) rate \a\ ratio delinquent
(percent) (percent) rate ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
LTV up to 90, meeting ratio
and reserve limits
LTV up to 90, not meeting ratio and reserve limits
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004.................................................... 4.3 21.2 6.3 26.7 1.48 1.26
2005.................................................... 4.0 21.2 5.6 27.1 1.41 1.28
2006.................................................... 4.4 26.3 5.2 35.4 1.18 1.35
2007.................................................... 2.9 25.1 3.3 36.1 1.13 1.44
2008.................................................... 0.6 20.2 1.3 30.4 2.23 1.51
--------------------------------------------------------------------------------------------------------------------------------------------------------
Above 90 LTV, 580-619 FICO (or
nontraditional credit) meeting
ratio and reserve requirements
Above 90 LTV, 580-619 FICO (or nontraditional credit), not
meeting ratio and reserve requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004.................................................... 5.0 15.9 5.8 20.2 1.18 1.27
2005.................................................... 5.0 18.4 7.2 24.5 1.43 1.33
2006.................................................... 5.3 21.8 7.3 30.8 1.38 1.42
2007.................................................... 2.9 23.5 4.4 33.7 1.51 1.43
2008.................................................... 0.9 19.4 1.2 27.4 1.35 1.41
--------------------------------------------------------------------------------------------------------------------------------------------------------
Above 90 LTV, FICO > 620
meeting reserve limits
Above 90 LTV, FICO > 620, not meeting reserve requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004.................................................... 3.2 10.8 4.7 13.6 1.48 1.26
2005.................................................... 3.9 12.6 5.0 17.0 1.29 1.35
2006.................................................... 3.5 20.4 5.6 22.1 1.59 1.08
2007.................................................... 2.7 21.8 4.2 27.3 1.59 1.25
2008.................................................... 0.9 17.7 1.0 21.6 1.19 1.22
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ The seriously delinquent rate is the sum of all loans 3 or more months delinquent, plus all in-foreclosure and in-bankruptcy cases, as a ratio of
all active insurance in-force.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.
Table H shows that borrowers with credit scores below 620 who did
not meet the proposed ratio and reserve requirements performed
significantly worse than borrowers meeting those requirements.
Table H--FHA Single-Family Insurance
[Comparison of Seriously Delinquent Rates \a\--by Proposed Manual Underwriting Standards All Active Loans]
----------------------------------------------------------------------------------------------------------------
Loans that meet
proposed ratio Loans that do Ratio: not meet/
LTV ratio Credit score range and reserve not meet meet
limits \b\ proposed limits
----------------------------------------------------------------------------------------------------------------
Up to 90....................... 500-579.................. 22.02 30.06 1.37
Above 90....................... 580-619 or nontraditional 18.33 26.15 1.43
credit.
Above 90....................... 620 or above............. 12.01 17.05 1.42
----------------------------------------------------------------------------------------------------------------
\a\ The seriously delinquent rate is the sum of all loans 3 or more months delinquent, plus all in-foreclosure
and in-bankruptcy cases, as a ratio of all active insurance in force.
\b\ See Chart below for Proposed Ratio and Reserve Limits.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.
All borrowers with credit scores must be classified by FHA's TOTAL
Mortgage Scorecard to determine if manual underwriting is required. In
cases where TOTAL Scorecard refers the case for manual underwriting, or
in cases where the borrower(s) has no credit score, FHA is proposing
the additional requirements for manual underwriting as illustrated in
TABLE F. This table is applicable for purchase transactions, FHA cash-
out refinance transactions, and all conventional to FHA refinance
transactions. TABLE F is not applicable for FHA-to-FHA rate and term
refinance (no cash-out), FHA streamline refinance (including credit
qualifying), and HECM transactions.
The proposed changes announced in this notice will preserve both
the historical role of the FHA in providing liquidity to the housing
and mortgage markets during periods of economic volatility, as well as
HUD's social mission of helping underserved borrowers access capital
when the private sector needs additional credit enhancement to do so.
IV. Solicitation of Public Comments
FHA welcomes comments on the proposed risk management initiatives
for a period of 30 calendar days. All comments will be considered in
the development of the final Federal Register notice announcing the
risk management initiatives and providing their effective date.
[[Page 41224]]
V. Findings and Certification
Executive Order 12866, Regulatory Planning and Review
The Office of Management and Budget (OMB) reviewed this notice
under Executive Order 12866 (entitled ``Regulatory Planning and
Review''). The notice was determined to be a ``significant regulatory
action,'' as defined in section 3(f) of the Order (although not
economically significant, as provided in section 3(f)(1) of the Order).
In this notice, FHA proposes three policy changes that FHA can
implement to replenish the MMIF capital reserve account. First, FHA
proposes to reduce the amount of financing costs a property seller or
other interested party may pay on behalf of a homebuyer using an FHA-
insured mortgage. This proposed cap on ``seller concessions'' will more
closely align FHA's single family mortgage insurance programs with
standard industry practice and minimize FHA exposure to the risk of
adverse selection. Secondly, FHA proposes to introduce a two-part
credit-score threshold, with one lower bound for loans with loan-to-
value ratios of 90 percent or less, and a higher threshold for those
with loan-to-value ratios up to the statutory maximums. This will be
the first time that FHA has ever instituted an absolute lower-bound for
borrower credit scores. Borrowers with low credit scores present higher
risk of default and mortgage insurance claim. Third, FHA will tighten
underwriting standards for mortgage loan transactions that are manually
underwritten. Such transactions that lack the additional credit
enhancements proposed under this Notice result in higher mortgage
insurance claim rates and present an unacceptable risk of loss. The
benefit of these set of actions will be to reduce the net losses due to
high rates of insurance claims on affected loans, while the cost will
be the value of the homeownership opportunity denied to the excluded
borrowers. The total saving to the FHA would be $96 million in reduced
claim losses and the net cost to society of excluding reduced
homeownership rates could be as high as $82 million.
With respect to expected benefits of this policy change, as noted
earlier, the direct purpose of the policy change is to achieve the
statutorily mandated minimum capital reserve ratio of 2 percent. The
broader purpose of the policy change, however, and of the capital
reserve ratio requirement itself, is to ensure the financial soundness
of the FHA throughout a wide range of economic conditions. The current
financial crisis has led to a credit crunch in which FHA has become the
only source of mortgage credit for households who lack significant
funds for downpayments and who do not have pristine credit histories.
FHA's share of the single family mortgage market today is approximately
30 percent--up from a low point of just 3 percent in 2007. The dollar
volume of insurance written jumped from just $56 billion in 2007 to
over $300 billion in 2009. Facilitating the provision of credit during
a liquidity crisis is a welfare-enhancing activity and the FHA provides
such a public benefit. Quantifying the benefit involves measuring the
extent to which this Notice increases the abilities of the FHA to meet
its mission requirements without having to substantially increase
insurance premiums, and then estimating the value of the net economic
benefits provided to households by the housing options afforded them
through FHA insurance.
With respect to possible costs of this policy change, FHA
recognizes that tightening its underwriting guidelines will cause
excluded households to either delay transition to homeownership status
or else never make that transition. For refinance loans, the proposed
restrictions will cause higher housing costs until such time as the
excluded households can improve their credit histories and/or gain more
home equity through general market-level house price appreciation.
Individuals may face other costs from being excluded from an FHA-
insured loan, one of which is a search cost for an alternative.
However, an individual lender or broker will offer a wide variety of
products to a potential customer. An FHA loan is only one of many
products offered by the typical lender so that the typical potential
borrower is not likely to go to another lender. The lender would inform
the applicant that FHA guidelines have changed and that given their
credit score, there are no loans for that individual. Some consumers
may wish for a second opinion, however, in which case they would expend
additional resources and time. If for example, a consumer spent two
hours valued at $40 per hour and another $20 for an additional credit
report, then the search cost would be $100 for a fraction of the
excluded borrowers.
The foregoing provides only a brief overview of the analysis that
HUD undertook in assessing costs and benefits. HUD's full analysis can
be found at http://www.hud.gov/offices/hsg/sfh/hsgsingle.cfm.
The docket file is available for public inspection in the
Regulations Division, Office of General Counsel, Department of Housing
and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC
20410-0500. Due to security measures at the HUD Headquarters building,
please schedule an appointment to review the docket file by calling the
Regulations Division at 202-402-3055 (this is not a toll-free number).
Individuals with speech or hearing impairments may access this number
via TTY by calling the Federal Information Relay Service at 800-877-
8339.
Executive Order 13132, Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any policy document that has federalism implications if
the document either imposes substantial direct compliance costs on
state and local governments and is not required by statute, or the
document preempts state law, unless the agency meets the consultation
and funding requirements of section 6 of the Executive Order. This
notice does not have federalism implications and would not impose
substantial direct compliance costs on state and local governments or
preempt state law within the meaning of the Executive Order.
Unfunded Mandates Reform Act
Title II of the Unfunded Mandates Reform Act of 1995 (2 U.S.C.
1531-1538) (UMRA) establishes requirements for federal agencies to
assess the effects of their regulatory actions on state, local, and
tribal governments, and on the private sector. This notice would not
impose any federal mandates on any state, local, or tribal governments,
or on the private sector, within the meaning of UMRA.
Environmental Impact
A Finding of No Significant Impact (FONSI) with respect to the
environment has been made in accordance with HUD regulations at 24 CFR
part 50, which implement section 102(2)(C) of the National
Environmental Policy Act of 1969 (42 U.S.C. 4332(2)(C)). The Finding of
No Significant Impact is available for public inspection between the
hours of 8 a.m. and 5 p.m. weekdays in the Regulations Division, Office
of General Counsel, Department of Housing and Urban Development, 451
7th Street, SW., Room 10276, Washington, DC 20410. Due to security
measures at the HUD Headquarters building, please schedule an
appointment to review the FONSI by calling the Regulations Division at
202-708-3055 (this is not a toll-free number). Individuals with speech
or hearing impairments may access this number via TTY by calling the
Federal
[[Page 41225]]
Information Relay Service at 800-877-8339.
Dated: July 9, 2010.
David H. Stevens,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 2010-17326 Filed 7-14-10; 8:45 am]
BILLING CODE 4210-67-P