www.hudclips.org U. S. Department of Housing and Urban Development Washington, D.C. 20410-8000 June 10, 1997 OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER MORTGAGEE LETTER 97-26 TO: ALL APPROVED MORTGAGEES SUBJECT: Single Family Loan Production - Credit Policy Issues This Mortgagee Letter emphasizes current credit policy, and provides alternatives to several existing procedures. Unless otherwise indicated, its provisions become effective upon publication. BORROWER CREDIT AND CAPACITY ISSUES Qualifying Ratios, Compensating Factors, and Buydowns. Our local offices have advised us that an increasing number of loans are being submitted for endorsement with qualifying ratios in excess of our benchmark guidelines without the lender addressing which compensating factors justify the approval of that mortgage. Whenever payment- and/or debt-to-income ratios are exceeded, the lender must specify its rationale for approving the mortgage. While we agree there may be compensating factors such as cash reserves after closing, excellent credit histories and high credit bureau scores, large downpayments, and others as described in the mortgage credit analysis handbook (HUD Handbook 4155.1 REV-4, Chg 1 , paragraph 2-13), the lender is responsible for explaining why it believes the mortgage is an acceptable risk. We are also concerned with lenders offering "compressed" and other buydowns, especially on adjustable rate mortgages (ARMs), without considering the possible "payment shock" associated with such financing arrangements. Lenders are reminded that on ARMs, borrowers are to be qualified at the note rate exclusive of any buydown, ratios should rarely be exceeded, and consideration must be given to the ability of the borrower to absorb potential payment increases, especially if a buydown is used. Further, the only ARM product currently eligible for FHA mortgage insurance is a one-year ARM with one percent yearly and five percent lifetime caps. Lenders are advised that "3-1 ARMs" and other such products are not recognized by FHA and the lender is responsible for assuring itself that the manner in which the product is offered makes it eligible for FHA insurance. Advance Payments of Taxes and Home Owners Association Dues. Lenders have asked if builders and other sellers may pay, on behalf of the borrower, HOA dues or taxes that come due during the first year of the mortgage. Subject to the six percent limitation for financing concessions, as well as the conditions described below, we do not object to advance payments of these two recurring expenses. Compliance requires the following: o Reductions to the homebuyer's mortgage payment during the period covered by advance payment of HOA dues or real estate tax payments, which may not exceed one year, are not to be considered in qualifying the borrower, i.e., the borrower must qualify using the PITI and HOA fees associated with the mortgage and property. o In determining FHA's required cash investment, advance payments of prepaid expenses may not result in a reduction to the amount needed to close the transaction. As a practical matter, these funds will most likely either be added to the borrower's cash requirements with a seller payment shown on the HUD-1 or separately indicated on the seller's side of the HUD-1. In any event, the borrower's cash investment must not be reduced as the result of advance payments of these expenses. o The lender is responsible for ensuring that such advance funds are appropriately held in escrow or paid to the taxing authority or HOA. The lender must assure itself that the manner in which it participates in such transactions is in compliance with all servicing, escrow account, and RESPA requirements. If the property is sold or the mortgage is prepaid in full during the life of the advance payments, any undistributed funds may not revert to the provider. Premium Pricing. Premium pricing may be used to pay normal closing costs and prepaid expenses, but may not be used to fund mortgage payments (or the interest) or any portion of the downpayment. Lenders are also cautioned regarding our prohibition against "churning" of mortgages. If a lender uses premium pricing, it is not permitted to make advance arrangements with the borrower to refinance that mortgage. Automated Employment/Income Verification Systems. The number of providers of automated income and employment verification systems has been rapidly expanding, as have methodologies in some areas for obtaining IRS tax filing line-item as well as form IRS W-2 information. Some employment verification systems automate this process through access with the individual employer, while others access income information available from state unemployment offices. In any case, we have no objection to using any automated income and employment service that provides the same level of information and integrity as does traditional documentation. Since such systems are designed to save lender processing costs, borrowers are not to be charged for these services; exceptions may be made if the employer charges a fee to verify employment. The lender remains responsible for the quality and accuracy of all information used in obtaining a FHA-insured mortgage and must be satisfied that whatever verification system is used, be it traditional documentation or an electronic system, it effectively confirms the income used to qualify the borrower. The income of those borrowers who are commissioned, self-employed, or otherwise required to submit tax returns must be analyzed by using all applicable tax forms or electronic line-item verifications. Similarly, if the income stream fluctuates significantly for any reason, including overtime and bonuses, traditional income verification must be obtained. Telephone Employment Verification. Credit vendors may perform the telephone verification of current employment when the alternate income documentation procedure is used. This is acceptable provided that the vendor complies with all requirements described in paragraph 3-1E of the mortgage credit analysis handbook. The lender is held accountable for any failure on the part of the credit vendor to adequately comply with FHA policies. Refinance Information. Our definition of closing costs does not include discount points. Nevertheless, in computing maximum mortgage amounts on refinance transactions, some lenders have included discount points along with non-recurring closing costs before applying the maximum loan-to-value ratio. The following instructions are provided to clarify the proper mortgage calculation methodology: o Cash-Back Refinances: The maximum mortgage on a cash-back refinance is the sum of the property's appraised value plus actual borrower-paid closing costs multiplied by 85 percent. Discount points and prepaid expenses may not be included with closing costs nor otherwise added to the property's appraised value. o No Cash-Back Refinances (non-streamlined): The maximum mortgage on a no cash-back refinance is based on three calculations, the lowest of which is the maximum FHA will insure: 1. 97.75 percent (or 98.75 percent if $50,000 or less) of the property's appraised value exclusive of closing costs. 2. 97/95/90 percent (as appropriate) of the sum of the property's value and closing costs. Discount points are not to be included along with closing costs nor otherwise added to the property's appraised value. 3. Sum of existing first lien, closing costs, discount points, subordinate financing, etc., minus any refund of upfront MIP, as described in paragraph 1-11A of the mortgage credit analysis handbook. Non-Taxable Income. Lenders have the option of using either the published IRS tax tables for calculating the amount that may be "grossed up" or using the minimum current tax rate of 15 percent. The lender is responsible for justifying the amount used and ensuring that the income is in fact exempt from federal taxation. Subordination of Federal Tax Liens. Outstanding instructions permit Federal tax liens to remain unpaid provided that any IRS tax lien on the property be subordinated to the FHA insured mortgage. Since IRS routinely takes a second lien position without the necessity of independent documentation, eligibility for FHA mortgage insurance will not be jeopardized by outstanding IRS tax liens remaining on the property unless the lender has evidence that IRS has demanded a first-lien position. The creditworthiness of the borrower must, of course, be properly assessed and consideration given to the cause of the tax lien. Upfront MIP. The upfront mortgage insurance premium must be 100 percent financed into the mortgage (except for odd cents or any remaining amount if the lender chooses to round the mortgage amount down to the next $50 multiple) or paid entirely in cash. The upfront MIP may not be partially financed. If the seller pays the upfront MIP or any portion (subject to the six percent seller contributions limitation), or if the lender pays the UFMIP or any portion through premium pricing, then the entire upfront MIP must be paid in cash. Asset Verification. Our documentation requirements for verifying a borrower's assets to close include obtaining verification of deposits (VODs) backed up with the most recent bank statements, or, if using the alternate documentation procedures, original bank statements covering the most recent three month period; these requirements are further described in paragraph 3-1F of the mortgage credit handbook. These procedures do not, however, permit asset verification by the use of automated teller machine (ATM) slips. While ATM slips may have some limited use as "snapshots" of cash assets, they are insufficient in and of themselves for verifying both assets and that improperly borrowed funds are not being used for the cash investment. Lender Employees on Section 203(k). The identity-of-interest language referred to in Mortgagee Letter 95-40 was adopted to protect the Department's interest in cases where lender employees were also investors on multiple FHA Section 203(k) mortgages. Our experience necessitated an immediate and substantial change in policy to stem abuse. We recognize that such a broad-based policy may have the effect of blocking legitimate transactions whereby employees of lenders would be unable to obtain financing through their employers for principal residences under Section 203(k). Therefore, we will permit a lender employee to obtain a mortgage through his or her company provided that the property will be lived in by the employee. Expansion of this policy to investment properties will be considered if and when the moratorium on investors under the Section 203(k) program is lifted. PROPERTY/COLLATERAL ISSUES Eligible Properties (New Construction). Although paragraph 2-19 of the mortgage credit analysis handbook requires that all new construction completed after April 24, 1994 meet the Council of American Building Officials (CABO) 1992 Model Energy Code (MEC), some lenders and builders interpreted this to apply only to those properties to be insured with FHA mortgages with LTVs in excess of 90 percent. This requirement, however, applies to all new construction, regardless of the loan-to-value ratio. Form 92800.5B. The HUD Conditional Commitment/Direct Endorsement Statement of Appraised Value (form HUD 92800.5B) has been revised. The new form, dated November 1996, becomes mandatory after August 1, 1997. A copy of the revised form is attached. The form HUD 92800.5B is not to be confused with the HUD 92800 previously used to order the appraisal, which has been discontinued. Lenders are advised to provide the appraiser with sufficient information to perform the appraisal and to identify that the appraisal request is for FHA purposes. Local office valuation condition (VC) sheets are to be completed by the appraiser. LENDER PROCESSING AND ENDORSEMENT SUBMISSION Paperwork Reduction and Stacking Order. Mortgagee Letter 96-29 (ML 96-29 ) reduced the number of documents required in the endorsement binder under most insurance programs. The attachment to that letter lists the required documents but was never intended to convey a substitute stacking order in lieu of that described in HUD Handbook 4165.1 REV-1. Effective for all mortgages submitted for endorsement on or after August 1, 1997, the stacking order will be as described in the endorsement handbook. The stacking order is also shown as an attachment to this mortgagee letter. The documents listed are those typically required to make an insurance decision under most programs. However, eligibility for various programs, as well as underwriting criteria distinctive to a particular mortgage insurance program will, by their very nature, occasion additional documents beyond those listed in ML 96-29 . As examples, under Section 203(k) as well as our Energy Efficient Mortgage (EEM) program, the lender must provide the worksheets used to determine the mortgage amount; under Section 203(h) documentation attesting to the destruction of the previous residence must be submitted. Further, the lender must provide evidence that all valuation conditions have been acceptably completed. Also, several required documents, including the HUD-1 settlement statement, were inadvertently left off the list of required documents for HECM mortgages and must be included in the endorsement binder. Documents excluded as the result of FHA's paperwork reduction efforts will not be reimposed by any local office or processing center. More Than One Underwriter. Because we no longer issue individual "report cards" on underwriters, and since an increasing number of lenders are applying automated technologies to credit and capacity assessment, it is not necessary to have the same individual underwrite both the borrower and the collateral. While each underwriter must separately identify that portion of the mortgage application he or she underwrote, only the underwriter identification number shown on the mortgage credit analysis worksheet will be recorded in CHUMS. Interviewer signatures. In many cases, the final application is signed by the borrower outside the presence of the loan officer or other lender employee who took the application. It is not necessary, therefore, for the final application to identify the interviewer or contain that individual's signature. The initial URLA that the lender retains must, of course, show the interviewer's name and signature. Face-to-face Interview. For those first-time homebuyers eligible for the reduced upfront mortgage insurance premium, i.e., those that have received homeownership counseling meeting the requirements described in ML 96-48, the face-to-face interview requirement with the mortgage lender is waived. HUD-1 Addendum for Purchase Transactions Only. Because the HUD-1 Addendum (see Mortgagee Letter 91-9) is designed to ensure that all aspects of the purchase transaction are disclosed to the lender, this document is not required on any refinance transactions. If you have any questions regarding these issues, please contact your local FHA Office. Sincerely yours, Nicolas P. Retsinas Assistant Secretary for Housing- Federal Housing Commissioner Attachments Click Here to Download PDF Attachments The Revised FHA Case Binder The Revised FHA Case Binder for Home Equity Conversion Mortgages Go to the HUD Forms Warehouse and download the HUD Conditional Commitment/Direct Endorsement Statement of Appraised Value(form HUD 92800.5B) in PDF format