Underwriting Guidelines for the Average Mortgage
Last Updated - May 25, 2010

Now that you have found your dream house, you are going to need to apply for a mortgage loan. Your realtor will either recommend a banking institution or you may already have one in mind. You will be dealing with a loan officer who will be compiling all the data on you to see if you qualify for a loan to pay for this house. All lending institutions have different Underwriting Guildelines set in place when reviewing a borrower's financial history to determine the likelihood of receiving on-time payments. The primary items reviewed are:

income

debt

credit

savings

ratios

Income

Income is one of the most important variables a lender will examine because it is used to repay the loan. Income is reviewed for the type of work, length of employment, educational training required, and opportunity for advancement. An underwriter will look at the source of income and the likelihood of its continuance to arrive at a gross monthly figure.

Salary and Hourly Wages - Calculated on a gross monthly basis, prior to income tax deductions.

Part-time and Second Job Income - Not usually considered unless it is in place for 12 to 24 straight months. Lenders view part-time income as a strong compensating factor.
Commission, Bonus and Overtime Income - Can only be used if received for two previous years. Further, an employer must verify that it is likely to continue. A 24-month average figure is used.
Retirement and Social Security Income - Must continue for at least three years into the future to be considered. If it is tax free, it can be grossed up to an equivalent gross monthly figure. Multiply the net amount by 1.20%.
Alimony and Child Support Income - Must be received for the 12 previous months and continue for the next 36 months. Lenders will require a divorce decree and a court printout to verify on-time payments.
Notes Receivable, Interest, Dividend and Trust Income - Proof of receiving funds for 12 previous months is required. Documentation showing income due for 3 more years is also necessary.

Rental Income - Cannot come from a Primary Residence roommate. The only acceptable source is from an investment property. A lender will use 75% of the monthly rent and subtract ownership expenses. The Schedule E of a tax return is used to verify the figures. If a home rented recently, a copy of a current month-to-month lease is acceptable.
Automobile Allowance and Expense Account Reimbursements - Verified with 2 years tax returns and reduced by actual expenses listed on the income tax return Schedule C.
Education Expense Reimbursements - Not considered income. Only viewed as slight compensating factor.
Self Employment Income - Lenders are very careful in reviewing self-employed borrowers. Two years minimum ownership is necessary because two years is considered a representative sample. Lenders use a 2-year average monthly income figure from the Adjusted Gross Income on the tax returns. A lender may also add back additional income for depreciation and one-time capital expenses. Self-employed borrowers often have difficulty qualifying for a mortgage due to large expense write offs. A good solution to this challenge used to be the No Income Verification Loan, but there are very few of these available any more given the tightened lending standards in the current economy. NIV loan programs can be studied in the Mortgage Program section of the library.

Debt

An applicant's liabilities are reviewed for cash flow. Lenders need to make sure there is enough income for the proposed mortgage payment, after other revolving and installment debts are paid.

All loans, leases, and credit cards are factored into the debt calculation. Utilities, insurance, food, clothing, schooling, etc. are not.
If a loan has less than 10 months remaining, a lender will usually disregard it.
The minimum monthly payment listed on a credit card bill is the figure used, not the payment made.
An applicant who co-borrowed for a friend or relative is accountable for the payment. If the applicant can show 12 months of on-time cancelled checks from the co-borrowee, the debt will not count.
Loans can be paid off to qualify for a mortgage, but credit cards sometimes cannot (varies by lender). The reasoning is that if the credit card is paid off, the credit line still exists and the borrower can run up debt after the loan is closed.
A borrower with fewer liabilities is thought to demonstrate superior cash management skills.

Credit

Most lenders require a residential merged credit report (RMCR) from the 3 main credit bureaus: Trans Union, Equifax, and Experian. They will order one report which is a blending of all three credit bureaus and is easier to read than the individual reports. This "blended" credit report also searches public records for liens, judgments, bankruptcies and foreclosures. See our credit report index.

Credit report in hand, an underwriter studies the applicant's credit to determine the likelihood of receiving an on-time mortgage payment. Many studies have shown that past performance is a reflection of future expectations. Hence, most lenders now use a national credit scoring system, typically the FICO score, to evaluate credit risk. If you're worried about credit scoring see our articles on it.

The mortgage lending process, once very forgiving, has tightened lending standards considerably. A person with excellent credit, good stability, and sufficient documentable income to make the payments comfortably will usually qualify for an "A" paper loan. "A Paper", or conforming loans, make up the majority of loans in the U.S. and are loans that must conform to the guidelines set by Fannie Mae or Freddie Mac in order to be saleable by the lender. Such loans must meet established and strict requirements regarding maximum loan amount, downpayment amount, borrower income and credit requirements and suitable properties. Loans that do not meet the credit and/or income requirements of conforming "A-paper" loans are known as non-conforming loans and are often referred to as "B", "C" and "D" paper loans depending on the borrower?s credit history and financial capacity.

Here are some rules of thumb most lenders follow:

12 plus months positive credit will usually equal an A paper loan program, depending on the overall credit. FHA loans usually follow this guideline more often than conventional loans.
Unpaid collections, judgments and charge offs must be paid prior to closing an A paper loan. The only exception is if the debt was due to the death of a primary wage earner, or the bill was a medical expense.
If a borrower has negotiated an acceptable payment plan, and has made on time payments for 6 to 12 months, a lender may not require a debt to be paid off prior to closing.
Credit items usually are reported for 7 years. Bankruptcies expire after 10 years.
Foreclosure - 5 years from the completion date. From the fifth to seventh year following the foreclosure completion date, the purchase of a principal residence is permitted with a minimum 10% down and 680 FICO score. The purchase of a second or investment property is not permitted for 7 years. Limited cash out refinances are permitted for all occupancy types.
Pre-foreclosure (Short Sale) - 2 years from the completion date (no exceptions or extenuating circumstances).
Deed-in-Lieu of Foreclosure - 4 year period from the date the deed-in-lieu is executed. From the fifth to the seventh year following the execution date the borrower may purchase a property secured by a principal residence, second home or investment property with the greater of 10 percent minimum down payment or the minimum down payment required for the transaction. Limited cash out and cash out refinance transactions secured by a principal residence, second home or investment property are permitted pursuant to the eligibility requirements in effect at that time.
Chapter 7 Bankruptcy - A borrower is eligible for an A paper loan program 4 years after discharge or dismissal, provided they have reestablished credit and have maintained perfect credit after the bankruptcy.
Chapter 13 Bankruptcy - 2 years from the discharge date or 4 years from the dismissal date.
Multiple Bankruptcies- 5 years from the most recent dismissal or discharge date for borrowers with more than one filing in the past 7 years.
The good credit of a co-borrower does not offset the bad credit of a borrower.
Credit scores usually range from 400 to 800. Changes to lending standards are occurring on a daily basis as a result of tightening lending standards, and can vary from lender-to-lender-- so this information should be considered simply a guideline. For conforming loans, most lenders will lend down to a FICO of 620, with additional rate hits for the lower-end credit scores and loan-to-values. When you are borrowing more than 80%, they typically will not lend if you have a FICO below 680. The FHA/VA program just changed their minimum required FICO to 620, unless you are qualifying a borrower with non-traditional credit. The few non-conforming loan programs that are still available typically require 30% down payment with a minimum FICO of 700 for self-employed and 650 for W-2 employees, and the loan-to-value will change with the loan amount.
A credit score below 600 may require an Alternative Credit mortgage program.
Misinformation on a credit report can be repaired! For more information see our section.
The FTC states, "Credit repair companies take your money and vanish." Anything a credit repair company does for a fee, a consumer can do for free. Be wary of these guys!
If a borrower falls behind on a payment, the creditor should be contacted as quickly as possible. Most creditors will work with a borrower who makes an initial good faith effort to communicate with them.

Savings

Lenders evaluate savings for three reasons.

The more money a borrower has after closing, the greater the probability of on-time payments.
Most loan programs require a minimum borrower contribution.
Lenders want to know that people have invested their own into the house, making it less likely that they will walk away from their life's savings. They analyze savings documents to insure the applicant did not borrow the funds or receive a gift.

Lenders look at the following types of accounts and assets for down payment funds:

Checking and Savings - 90 days seasoning in a bank account is required for these funds.
Gifts and Grants - After a borrower's minimum contribution, a gifts or grant is permitted.
Sale of Assets - Personal property can be sold for the required contribution. The property should be appraised and a bill of sale is required. Also, a copy of the received check and a deposit slip are needed.
Secured Loans - A loan secured by property is also an acceptable source of closing funds.
IRA, 401K, Keogh & SEP - Any amount that can be accessed is an acceptable source of funds.
Sweat Equity and Cash On Hand - Generally not acceptable. FHA programs allow it in special circumstances.
Sale Of Previous Home - Must close prior to new home for the funds to be used. A lender will ask for a listing contract, sales contract, or HUD 1 closing statement.

Ratios

The percentage of one's debt to income is one of the most important factors when underwriting a loan. Lenders have determined that a house payment should not exceed approximately 30% of Gross Monthly Income. Gross Monthly Income is income before taxes are taken out. Furthermore, a house payment plus minimum monthly revolving and installment debt should be less than 40% of Gross Monthly Income (this figure varies from 35%-41% contingent on the source of financing).

Example
An applicant has $4,500 gross monthly income. The maximum mortgage payment is:

$4500 X .30 = $1350
Their total debts come to:
$500 Car
$20 Visa
$30 Sears
$75 Master Card
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$625 per month.
Remember, their total debts (mortgage plus other debts) must be less than or equal to 40% of their gross monthly income.
$2,800 X .40 = $1800
$1800 is the maximum debt the borrower can have, debts and mortgage payments combined. Can the borrower keep all their debts and have the maximum mortgage payment allowed? NO!
In this case, the borrower, since they have high debts, must adjust the maximum mortgage payment downward, because:
$625 debts
$1350 mortgage
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$1975 - which is more than the $1800 (40% of gross debt) we calculated above.
The maximum mortgage payment is therefore:
$1800 - $625 (monthly debt) = $1175.
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FHA mortgages will soon allow fewer seller concessions

By Ken Harney | Columnist

Published: 5/28/2010 12:04 AM

WASHINGTON - One of the key attractions of FHA home mortgage financing is going, going - but not quite gone. Sellers and buyers who move fast can still make the most of it.
Sometime this summer, the Federal Housing Administration plans to slash maximum "seller concessions" from 6 percent of the home price to 3 percent. Seller concession rules allow buyers to look to the property seller to pay for a variety of services and taxes connected with the transaction - loan origination and local transfer fees, appraisals, inspections, closing and escrow costs among others - though not the down payment.

Say you're buying a $200,000 house. If you are using FHA financing under current rules, you can structure the contract so that the seller agrees to pay all closing costs and even some repairs the house needs at settlement, up to 6 percent of the price, or $12,000. On a $400,000 house, allowable concessions go to $24,000. That's huge, especially if you have to struggle to come up with a 3.5 percent down payment and you're not sure where you'll find the closing and repair money.

Contrast that with using Fannie Mae or Freddie Mac conventional financing, where seller concessions generally are limited to 3 percent. For many buyers, the extra negotiating flexibility built into the FHA program makes the choice between programs a no-brainer.

When FHA officials announced the policy change earlier this year, they said the long-standing 6 percent maximum "exposes the FHA to excess risk by creating incentives to inflate appraised value." That would occur when sellers agree to pay buyers' closing and other expenses but merely tack those costs onto the final sale price of the house. Rather than agreeing to a $200,000 price as in the example above with $12,000 worth of concessions, the final contract price of the house would instead be $212,000.

If an appraiser did not detect and report the price boost, FHA would effectively be insuring a mortgage on a house worth less than the sale price. In fact, since the rules allowed a 6 percent seller concession and the down payment was just 3.5 percent, FHA would be insuring an underwater loan from the start.

To limit further possible losses, FHA decided to cut the concessions limit in half. In its announcement, the agency said the change would occur in "early summer" after publication of a Federal Register notice and a public comment period. But Lemar C. Wooley, an FHA spokesman, confirmed May 19 that there has been no Federal Register announcement.
Since public comment periods frequently run for 60 days followed by a review period, it appears that any start date for the concessions change has slipped to late summer at the earliest.

Wooley said in an e-mail that "early summer may be stretching it, but I'm told that we do still expect it this summer." Why does the timing matter? Whatever you might think of FHA's existing seller concession rules, the fact remains: Concessions of 6 percent are still allowed, and will be until FHA announces they're not. Buyers and sellers who have a legitimate need to build concessions into their contracts can still do so, but they need to know that the clock is ticking.

Smart real estate agents and mortgage loan officers already are putting out the word: If a home sale deal needs the 6 percent FHA feature, get the contract put together as fast as possible. Abbie Higashi, national designated broker for ZipRealty Inc. of Emeryville, Calif., said she fully understands and supports the FHA move but until the change takes effect, agents should "do the deals now" if more than 3 percent concessions would help the sale go through.

Paul Skeens, president of Colonial Mortgage Group in Waldorf, Md., said he is advising loan applicants to request a "good faith estimate" upfront that provides for the seller to pay 100 percent of closing costs and prepaid fees "so that in cases where the buyer doesn't have much more than the down payment, that's the only cash they'll need to close" on an FHA loan before the policy change.

Skeens said he'd prefer that FHA adopt a "sliding scale" approach to concessions, with higher concessions allowed on lower priced homes, and the lowest concessions allowed on high-priced properties. Since closing and loan expenses generally represent a larger percentage of the total transaction on lower-priced houses, he believes the new 3 percent rule across the board "will have a much heavier impact on the people FHA traditionally has served," who are buying modest priced houses and have limited cash resources.

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Posted 5-26-2010

According to David Stevens, head of FHA, the U. S. housing market is on life support. In an article in Bloomberg Businessweek, Stevens is quoted as saying: “This is a market purely on life support, sustained by the federal government.” He went on to say that the FHA’s monopoly of residential lending is "a sign of a very sick system.”

We should all be concerned by the level of lending from FHA and the potential for disaster should large numbers of the loans default. Earlier this year an article in the Washington Post reported that FHA delinquencies had increased by more than a third in the past year, with more than 9 percent of borrowers at least 90 days behind in their mortgage payments. And while newer data indicates that number to be decreasing, the concerning factor is the tremendous exposure of FHA due to the sheer volume of loans guaranteed. Recent data indicates that FHA’s involvement in home purchase transactions appears to have surpassed that of both Fannie Mae and Freddie Mac.

Stevens has repeatedly tried to downplay the current risk by pointing out that the majority of the "problem" loans were originated in 2007 and 2008 when more lax lending standards were in place. New requirements, he points out, should significantly lower the default rate. But what FHA seems to be ignoring is the risk from continued sluggishness in the economy combined with high unemployment. Lacking a robust recovery, many of the borrowers who may have once been good credit risks may have difficulty remaining current on their mortgages.

The ultimate problem, however, isn't just one of the FHA; the dramatic increase in loan guarantees puts taxpayers on the hook for 100 percent of any losses the agency incurs.

Contributed by:

John Mulkey, Housing Guru-Waleska, GA-
TheHousingGuru.com
Address: P.O. Box 910, Waleska, GA, 30183
Office Phone: (678) 493-3432
Cell Phone: (404) 310-6015

CHANGES AT FHA

From: David H. Stevens:

Assistant Secretary - FHA Commissioner at HUD

January 24, 2010

I wanted to take a moment to make sure you are familiar with events surrounding a sweeping set of policy changes for FHA announced earlier this week. The announcement details the changes that Secretary Donovan promised to deliver by the end of January when he testified before Congress last month.

The new policies are designed to strengthen the FHA's capital reserves so we can continue to fulfill our mission of serving underserved communities. In addition, we were determined that these changes should support, not disrupt, the nation's housing market recovery. Bringing these changes to market has been the result of a lot of hard work and long hours. And, I am proud to have worked with so many of you on this initiative.

What changes will be implemented? We announced the following on January 20:

Increase the up-front mortgage insurance premium (MIP) to 2.25%;
Update credit score and down payment requirements for new borrowers;
Reduce seller concessions to three percent, from six percent; and
Implement a series of significant measures aimed at increasing lender enforcement.

When combined with the risk management measures announced in September of last year, these new changes are among the most significant steps ever taken by FHA to address risk. Additionally, by continuing to provide affordable, responsible mortgage products, FHA will support the housing market's recovery. Importantly, FHA will remain the largest source of home purchase financing for underserved communities.

Let's go into more detail:

Announced FHA Policy Changes:

1. Increase the MIP to build up capital reserves and bring back private lending.

o The first step will be to raise the up-front MIP by 50 basis points to 2.25% and request legislative authority to increase the maximum annual MIP that the FHA can charge.

o If this authority is granted, then the second step will be to shift some of the premium increase from the up-front MIP to the annual MIP.

o This shift will allow for the capital reserves to increase with less impact on the consumer because the annual MIP is paid over the life of the loan instead of at the time of closing.

o The initial up-front increase is included in Mortgagee Letter 2010-02 and will go into effect in the spring.

2. Update the combination of credit scores and down payments for new borrowers.

o New borrowers will now be required to have a minimum credit score of 580 to qualify for FHA's 3.5% down payment program. New borrowers with less than a 580 credit score will be required to put down at least 10%.

o This allows the FHA to better balance its risk and continue to provide access for those borrowers who have historically performed well.

o This change will be posted in the Federal Register in February and, after a notice and comment period, would go into effect in the early summer.

3. Reduce allowable seller concessions from 6% to 3%.

o The current level exposes the FHA to excess risk by creating incentives to inflate appraised value. This change will bring FHA into conformity with industry standards on seller concessions.

o The change will be posted in the Federal Register in February, and after a notice and comment period, would go into effect in the early summer.

4. Increase FHA lender enforcement.

o Publicly report lender performance rankings to complement currently available Neighborhood Watch data which will be accessible via www.hud.gov on February 1.

§ This is an operational change to make information more user-friendly and hold lenders more accountable; it does not require new regulatory action as Neighborhood Watch data is currently publicly available.

o Enhance monitoring of lender performance and compliance with FHA guidelines and standards.

§ Implement Credit Watch termination through lender underwriting ID in addition to originating ID.

§ This change is included in Mortgagee Letter 2010-03 and is effective immediately.

o Implement statutory authority through regulation of section 256 of the National Housing Act to enforce indemnification provisions for lenders using delegated insuring process.

§ Specifications of this change will be posted in March, and after a notice and comment period, would go into effect in early summer.

o HUD is pursuing legislative authority to increase enforcement on FHA lenders. Specific authority includes:

§ Amendment of section 256 of the National Housing Act to apply indemnification provisions to all Direct Endorsement lenders. This would require all approved mortgagees to assume liability for all of the loans that they originate and underwrite.

§ Legislative authority permitting HUD maximum flexibility to establish separate "areas" for purposes of review and termination under the Credit Watch initiative.

Note: This would provide authority to withdraw originating and underwriting approval for a lender nationwide on the basis of the performance of its regional branches.

In addition to the changes I have outlined, we are continuing to review FHA's overall response to housing market conditions, to evaluate its mortgage insurance underwriting standards, and to improve its measures to help distressed and underwater borrowers through FHA/HAMP and other FHA initiatives going forward.

I know this is a lot of information to absorb. Listed below are links to some of the major stories about the announcement. I promise to keep you aware as we implement these changes going forward.

Wall Street Journal (Nick Timiraos, 1/20) "FHA Sets Tighter Lending Requirements" The Federal Housing Administration is implementing more-stringent lending requirements and higher borrower fees to cushion against rising defaults and stave off the need for a taxpayer bailout of the agency. LINK

Washington Post (Dina ElBoghady, 1/20) "FHA plans to require borrowers to produce more cash for downpayments" The Federal Housing Administration plans to increase the amount of up-front cash paid by all new borrowers and to require higher down payments from those with the poorest credit, according to agency officials. LINK

Chicago Tribune (Mary Ellen Podmolick, 1/20) "FHA homeownership rules to change" The Federal Housing Administration announced changes Wednesday that will make it more expensive for homebuyers to secure agency-backed mortgages while some consumers will be priced out of the housing market. LINK

CNNMoney.com (Tami Luhby, 1/20) "FHA loan requirements will make it harder to get a mortgage" It's going to be harder to get a government-backed mortgage from now on. LINK

CNBC.com (Diana Olick, 1/20) "FHA Boosts Insurance Premiums to Cushion Defaults" In a move to shore up the FHA's beleaguered balance sheet, Commissioner David Stevens on Wednesday announced big changes at the government mortgage insurer that now backs about half of all home loans to the nation's minorities. LINK

I want to thank you for your efforts to keep this housing system on track. The role of the Real Estate Agent, Mortgage Lender, Settlement Service Provider, and all who make the dream of homeownership a reality, is critical to stabilizing this economy. Your work is for a good cause. We really are making a difference in people's lives. Thanks for the partnership!