FHA Tightens Credit Requirements

FHA changed it’s underwriting criteria for mortgage loan approval earlier this month. The changes are designed to limit the AUS approvals of borrowers with lower credit scores, high debt ratio borrowers, cash out borrowers and particularly, a borrower with multiple layers of risk.  We are going to try and answer questions about what it means to our Borrowers when FHA Tightens Credit Requirements.

AUS TOTAL Scorecard for FHA Mortgage Loans

To understand the changes, you might need to learn a little about the “foreign language” spoken in Mortgage World. AUS TOTAL Scorecard is, quite literally: Automated Underwriting System that has been developed by FHA as Technology Open To Approved Lenders. The best way for me to explain it is to say that this is AI (artificial intelligence) underwriting.

We use AUS for virtually all loans that are approved of ANY kind. Behind that Automated approval, an Underwriter reviews the documents we submit to support the AUS Findings.

What FHA is saying with the newest publication for “FHA Tightens Credit Requirements,” is that they want more of the loans that are a little “tougher,” and have more risk, to be manually underwritten. That is to say, that a REAL person, (not just a computer program) has to approve the “risk” of loaning money to buy the house.

This could be great – or this could be disastrous. That’s what I want to try and explain.

FHA Tightens Credit Requirements 

A little more mortgage world language you might want to understand… REFER or ACCEPT. With an AUS system, we don’t get a flat out “denied.” It takes an IRL Underwriter to do that. So, it’s important to understand that in the past a Loan Officer might put all of your information into the system and then we hit “submit” for an AUS finding. When that finding came back ACCEPT we would write a pre-approval letter. You would go find a house, knowing that your pretty well sure it’s a done deal as far as getting your loan.

NOW, there’s a better than 40% chance we will get findings from AUS of REFER. So what does THAT mean? For our Team, it means we are going to ask you for all of your documentation, and we are going to submit your loan for a pre-approval from an Underwriter. We have 48 hour guaranteed response time from our Underwriting Group, so we are delaying issuing that approval for 2 days – but your will still get a pre-approval letter, and be sent on your way to buy a house.

Sounds pretty good, right? Well, our Team has decades of experience. Yes we are likely as old as your parents, but we KNOW our stuff – I’m a Delegated FHA Underwriter. Even without submitting it to the Underwriting Department, we know what we can likely do, and what we can’t.

So why the worry about how FHA Tightens Credit Requirements, if it just means an Underwriter should approve your loan upfront – before you write a contract… especially if you get a REFER from the AUS system? (because that IS what I’m saying)

I’m concerned about a couple of things here. One, I’m concerned that people will be told by mortgage loan officers in NC that they don’t qualify for a FHA loan, because the findings from the AUS system come back as a REFER. That was not the intent of the FHA Message about this credit tightening. What FHA said is that they want a REAL PERSON to make the “risk” decision.

TBH, you might not qualify – every case is different. But in most of these cases, we won’t get as far as submitting your loan to the AUS, if you need to wait to buy a house. Normally, we just need to take the documentation, and submit it to an actual Underwriter.

If you decide to use a loan officer, who may only have a few years of experience, or if that company isn’t set up to accept manual underwrites for FHA loans – then people could be denied a home loan when in reality they should be able to buy.

My other concern is about the Underwriters. Many mortgage companies are not set up to do Manually Underwritten FHA Loans – especially loans with lower credit scores and high debt to income ratios. In the past, mortgage companies could just “pass” on these more difficult loans and not take the risk.

The risk (of course) for the mortgage company is that FHA would not accept the Underwriter’s approval – and refuse to cover the loan for FHA Mortgage Insurance. Having a loan you can’t sell on the Secondary Market, is a big risk. But with this new message, and FHA Tightens Credit Requirements, there could be more than 50,000 mortgage loans that now require Manual Underwriting.

My point being, there are not that many Underwriters out there who have had to manually underwrite FHA mortgages in the past 10 years… because of that, you might find more conditions than we normally see – and you might see fewer loans like these approved in the next few months as Underwriters become more confident with what FHA is looking for.

FHA Manual Underwriting Documentation Requirements

Here are the items we believe you should be gathering if you have a credit score below 640, and or you have a debt-to-income ratio greater than 41% on a FHA Mortgage Loan:

1. Derogatory credit explanation letter: The borrower needs to explain any derogatory credit that appears on their credit report. These need to be factual. In most cases, you are better off submitting these directly to a loan officer for review – I don’t suggest that you “upload” a derogatory credit letter into a Mortgage Portal – as there maybe more information the Loan officer suggests that you include.
2. Verification of Rent: we must determine the Borrower’s Housing Obligation payment history through one of the following:
   •     the credit report; 
   •     verification of rent received directly from the landlord (for landlords with no Identity of Interest with the Borrower);
   •     verification of mortgage received directly from the Servicer; or
   •     a review of canceled checks that cover the most recent 12-month period. READ: If a borrower has been living at home, and not paying rent of any kind – it’s gong to be tough to get a Manual Underwriting Approval.
3. Ratios Matter: Please see this chart showing you what the maximum ratios are on a manual underwrite per credit score. These are FHA Manual Handbook 4000.1 Guidelines, not something that changes from one company to another.
4. Compensating Factors: Please see the chart showing you the exact requirement per compensating factor.
   1. Reserves – meaning are you going to have any money left over after closing? A couple of months will help!
   2. Minimal Increase in Housing Payment
   3. No Discretionary Debt – meaning if you don’t have any outstanding debt (or VERY LITTLE), which would cause a lower credit score BTWs – this could be a positive factor.
   4. Significant Additional Income Not Reflected in Effective Income – maybe we document that you get commissions, or you have a part time job, but we can’t count it because you haven’t gotten it for 2 years.
   5. Residual Income – normally means you have a chunk of money after paying your bills to live on – which would mean your debt to income ratios are close to being in line.

I know this is a ton of information. My intent is to explain the rules, and the LANGUAGE that someone might use to describe what is happening in the Underwriting / Mortgage Process. If you want more specific guidance about FHA Tightens Credit Requirements and what that means to you – please contact Steve and Eleanor Thorne at 919 649 5058. We specialize in First Time Home Buyers, and would love to help you be a Home Owner this year!!