[Federal Register Volume 73, Number 93 (Tuesday, May 13, 2008)]
[Notices]
[Pages 27704-27711]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-10625]



[[Page 27703]]

-----------------------------------------------------------------------

Part IV





Department of Housing and Urban Development





-----------------------------------------------------------------------



Federal Housing Administration (FHA) Single Family Mortgage Insurance: 
Implementation of Risk-Based Premiums; Notice

  Federal Register / Vol. 73, No. 93 / Tuesday, May 13, 2008 / 
Notices  

[[Page 27704]]


-----------------------------------------------------------------------

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Docket No. FR-5171-N-02]


Federal Housing Administration (FHA) Single Family Mortgage 
Insurance: Implementation of Risk-Based Premiums

AGENCY: Office of the Assistant Secretary for Housing--Federal Housing 
Commissioner, HUD.

ACTION: Notice.

-----------------------------------------------------------------------

SUMMARY: This notice provides for FHA's implementation of risk-based 
premiums for most of its Title II single family mortgage insurance 
programs, enabling mortgage lenders to offer borrowers FHA-insured 
financing with a range of mortgage insurance premiums based on the risk 
the insurance contract represents. This notice follows a September 20, 
2007, notice that solicited public comment on the proposal to implement 
risk-based premiums. This notice makes certain changes, in response to 
public comment, to FHA's risk-based premium structure and implements 
risk-based premiums in accordance with those changes.

DATES: Effective Date: July 14, 2008.

FOR FURTHER INFORMATION CONTACT: Margaret E. Burns, Director, Office of 
Single Family Program Development, Department of Housing and Urban 
Development, 451 Seventh 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--September 20, 2007, Notice

    By notice published by HUD in the Federal Register on September 20, 
2007 (72 FR 53872), FHA announced its plan to implement risk-based 
premiums for FHA loans which, under that proposal, would apply to case 
numbers assigned on or after January 1, 2008. Section 203(c)(2) of the 
National Housing Act (12 U.S.C. 1709(c)(2)) provides for upfront and 
annual mortgage insurance premiums for most FHA single family programs. 
Such upfront and annual insurance premiums are set at levels not to 
exceed 2.25 percent and 0.50 percent (0.55 percent for mortgages 
involving an original principal obligation that is greater than 95 
percent of the appraised value of the property), respectively, with a 
discount available on the upfront premiums for some mortgagors who are 
first-time homebuyers and who successfully complete pre-purchase 
homeownership counseling approved by the Secretary.
    In the September 20, 2007, notice, FHA advised that, by offering a 
range of premiums based on risk, it would be able to offer options to: 
(1) Mortgagees serving borrowers who were previously underserved, or 
not served, by the conventional marketplace; and (2) mortgagees serving 
those borrowers wishing to lower their premiums by, for example, 
increasing their downpayment or by improving their credit scores. 
Additionally, offering a range of premiums based on risk helps to 
ensure the future financial soundness of FHA programs that are 
obligations of the Mutual Mortgage Insurance Fund (MMIF or the Fund). 
The September 20, 2007, notice emphasized that under risk-based 
premiums, no qualified borrower will be charged by the mortgagee in 
excess of the current statutory upfront and annual mortgage insurance 
premium limits.
    The September 20, 2007, notice solicited public comment for a 
period of 30 days. Although, as more fully discussed in Sections III 
and IV of this notice, a number of public commenters opposed HUD's 
proposal to implement risk-based premiums but did not fully explain the 
reasons for the opposition, other commenters raised important issues 
for HUD's consideration and offered suggestions that HUD should adopt. 
Therefore, after careful review and consideration of the public 
comments, HUD will implement risk-based premiums, as provided in this 
notice, with certain revisions made after consideration of public 
comments. HUD is proceeding to implement risk-based premiums for the 
reasons expressed in the September 20, 2007, notice; namely, that such 
a pricing mechanism will allow FHA to serve a range of borrowers and 
will help ensure the financial soundness of FHA programs that are 
obligations of the MMIF. These policy reasons are more fully discussed 
in Section III of this notice.

II. This Notice--Changes Made After Consideration of Public Comments

    After consideration of public comments, this notice makes the 
following changes to the September 20, 2007, proposal:
     The effective date is changed from January 1, 2008, to 
July 14, 2008, for FHA loans for which case numbers are assigned on or 
after that date.
     The classifications used in the upfront premium rate table 
are changed from minimum downpayment to loan-to-value (LTV) ratio.
     Source of downpayment is eliminated as a factor in 
determining the borrower's mortgage insurance premium.
     Borrowers with nontraditional credit are eligible for 97 
percent LTV financing.
     The September 20, 2007, notice's provision on averaging 
the borrower's credit scores has been removed and replaced with the 
lowest-decision credit score.
     A revised matrix shows both upfront and annual premiums 
for loans with terms in excess of 15 years, and another matrix shows 
premiums for loans with terms of 15 years or fewer.
     The minimum upfront premium is raised from 75 basis points 
to 125 basis points for mortgages in excess of 15 years, and from 75 
basis points to 100 basis points for mortgages of 15 years or fewer.

III. Overview of Key Public Comment Concerns and the Importance of 
Implementation of Risk-Based Premiums

    At the close of the public comment period on October 22, 2007, HUD 
received 176 public comments. These public comments came from a variety 
of sources, including the general public, loan officers, mortgage 
companies, regional and national banks, state housing finance agencies, 
various organizations representing the interests of the mortgage 
lending and home building industries, private mortgage insurers, 
seller-funded downpayment assistance providers, and companies providing 
information management systems services.
    While many of the commenters opposed risk-based premiums, the 
majority did not clearly express the basis for their opposition. Some 
of these commenters stated that risk-based premiums would hurt the very 
persons FHA was established to serve, but provided no information or 
explanation to support this claim. One commenter stated that if risk-
based premiums are implemented, FHA will offer only more expensive, 
conventional-type loans and will cease to assist lower-income borrowers 
who represent the target audience for FHA insurance. Other commenters 
stated that HUD did not need to implement risk-based premiums and 
eliminate downpayment assistance; that is, that one or the other should 
be sufficient to address higher risk mortgages. (These comments and 
others are more fully addressed in Section IV of this notice.)

[[Page 27705]]

    FHA is implementing risk-based premiums in support of its mission 
to promote homeownership among first-time and minority homebuyers. 
While the conventional market regularly uses risk-based premiums to 
price insurance risk, FHA, to date, continues to charge a one-size-
fits-all premium to mortgagees, resulting in lower-risk borrowers 
paying a higher premium than necessitated by their risk, and higher-
risk borrowers paying a lower premium relative to their risk. The 
criteria that FHA proposes to use for risk-based premiums--credit 
scores and LTV ratios--are strongly associated with claim rates and 
have become the primary risk factors used in conventional market 
pricing of mortgage credit risk. FHA has a legitimate business basis 
for charging higher premiums to higher-risk borrowers. Indeed, it has a 
business imperative, because the current FHA method of average-risk 
pricing is no longer sustainable.
    Risk-based premiums expand FHA's ability to serve borrowers whom it 
would otherwise have to turn away. By charging them a slightly higher 
insurance premium, FHA can assist underserved borrowers with fewer 
monetary resources or impaired credit to become homeowners while 
protecting the MMIF with the higher premium. Many homebuyers, who were 
steered to subprime products, paid substantially more for access to 
homeownership. As the 2004, 2005, and 2006 Home Mortgage Disclosure Act 
(HMDA) data show, many of these homebuyers were minorities. FHA can 
potentially lower the cost to borrowers because it is actually less 
costly for borrowers to pay for their credit risk in a mortgage 
insurance premium than what is charged to them through a higher 
subprime mortgage interest rate. For example, if a borrower with 
imperfect credit used an FHA-insured loan rather than a subprime loan 
for a $200,000 mortgage used to purchase a $225,000 home, the borrower 
would typically qualify for a 3 percentage point-lower mortgage 
interest rate. Assuming a 6.5 percent mortgage interest rate, a 10 
percent downpayment, financing of a 1.75 percent upfront mortgage 
insurance premium, and payment of a 0.50 percent annual premium on the 
declining principal balance, a borrower would still save nearly $4,000 
in monthly payments in the first year alone with an FHA-insured loan 
compared to a 9.5 percent subprime loan. After 10 years, the borrower 
would experience a total of nearly $40,000 of savings in monthly 
payments. Not only would the borrower benefit from lower loan costs 
with an FHA-insured loan, but FHA requires FHA-approved mortgagees to 
take measures designed to provide foreclosure alternatives that may not 
be offered with a subprime loan. FHA requires loan servicers to offer 
an array of loss mitigation options that may result in defaulting 
borrowers being able to stay in their homes.
    In addition, as the accompanying Appendix chart shows, substantial 
shares of FHA's lower-income borrowers have FICO \1\ scores above 680 
and would qualify for premium reductions relative to today's premium 
levels. In fact, as a result of the predominantly low- and moderate-
income character of FHA borrowers, a larger number of low-income 
borrowers would benefit from premium reductions than would moderate-, 
middle-, and upper-income borrowers combined. See the Appendix for a 
chart showing the distribution of FY 2007 homebuyers by FICO category 
and income group.
---------------------------------------------------------------------------

    \1\ FICO is a credit score developed by Fair Isaac Corporation.
---------------------------------------------------------------------------

    Risk-based premiums enable FHA to respond to changes in the market, 
like the recent implosion of subprime lending, by reaching out to 
higher-risk borrowers without having to raise premiums for all 
borrowers. Borrowers are better off, even with higher mortgage 
insurance premiums, because FHA insurance gives borrowers access to 
substantially lower interest rates than are charged for subprime loans, 
thereby lowering borrowers' overall borrowing costs.
    Risk-based premiums do not end the cross-subsidization that has 
always existed within the MMIF programs, but, by implementing risk-
based premiums FHA can better manage the cross-subsidization. At 
present, some segments of the borrowers served by FHA have very high 
default and foreclosure rates. Ultimately, if FHA did not implement 
risk-based premiums, FHA would have to raise premiums for all borrowers 
and impose new underwriting restrictions. Increasing premiums for all 
borrowers would drive away more of the lower-risk borrowers who are 
needed to provide cross-subsidies to higher-risk borrowers and would 
only increase any adverse selection. As a result, FHA would serve fewer 
borrowers than it does now, and more borrowers would be left with 
either a higher-cost and higher-risk subprime option, or no access to 
mortgage credit.

IV. Discussion of Public Comments

Authority to Implement a Credit-Score Based Premium Structure, and 
Effectiveness of Such Structure in Achieving Stated Goals

    Comment--FHA Should Not Be Exercising Risk-Based Premium Authority 
Now: One commenter challenged the authority of FHA to implement a 
credit-score premium structure at this point in FHA's history. The 
commenter stated: ``Congress gave FHA the authority to risk-base price 
its premium according to the initial LTV of the loan and for the past 
six and one-half years FHA chose not to exercise that authority.'' The 
commenter continued, ``However, FHA never fully implemented a risk-
based premium based on the initial LTV of the loan and significantly 
reduced its common up-front premium. The result has been an inadequate 
premium structure that has contributed to FHA's current financial 
problems.''
    HUD Response: HUD disagrees with the commenter's statement. 
Inherent in the insurance function is the management of risk. FHA, as a 
mortgage insurer, is charged with managing risk, and risk-based 
premiums help FHA manage risk.
    FHA is provided with flexible authority in section 203 of the 
National Housing Act (12 U.S.C. 1709) to charge an upfront premium not 
exceeding 2.25 percent of the mortgage balance and an annual premium 
not exceeding 50 basis points on the declining mortgage balance, but 
not exceeding 55 basis points for mortgages with LTVs greater than 95 
percent. This authority has been implemented by HUD through regulations 
at 24 CFR 203.284 and 203.285. Therefore, HUD has discretion to charge 
an upfront and an annual insurance premium that are greater than 0 
percent but do not exceed the respective statutory limits. The range of 
insurance premiums in this notice is consistent with, and supported by, 
the statutory authority in section 203(c)(2) of the National Housing 
Act (12 U.S.C. 1709(c)(2)). FHA also is authorized to discount the 
upfront premiums for some mortgagors who are first-time homebuyers and 
who successfully complete pre-purchase homeownership counseling 
approved by HUD. Notwithstanding the date of enactment of its statutory 
authority, FHA is not prohibited from trying new and different 
approaches from the one originally chosen, consistent with its 
statutory authority, to improve its financial management and to make 
its programs more available to the

[[Page 27706]]

populations they are intended to benefit.
    Comment--Over-Reliance on Credit Scores to Assess Risk: With regard 
to FHA's proposed approach to risk-based premiums, the same commenter 
above stated that it is concerned that FHA is over-relying on the 
predictive power of credit scores to pinpoint likely future borrower 
claims. The commenter said credit scores have proven to have a weak 
correlation to real risk during periods of economic or housing market 
stress and, as bank regulators have correctly determined, lenders 
should not over-rely on credit scores as a substitute for careful 
analysis of the multiple risk factors associated with mortgage risk. 
The commenter further stated that the proposed over-reliance on credit 
scores would lead FHA to repeat the same mistakes now creating major 
losses throughout the subprime mortgage arena. The commenter elaborated 
as follows: ``For example, the recent guidance on nontraditional 
mortgages notes that 'the analysis of repayment capacity should avoid 
over-reliance on credit scores as a substitute for income verification 
in the underwriting process'.''
    HUD Response: FHA disagrees with this comment. First, FHA is not 
replacing its strict underwriting criteria. FHA has avoided the major 
losses now being suffered in the subprime mortgage arena because FHA 
requires, and will continue to require, full documentation of a 
borrower's income and credit. Second, FHA recognizes that credit scores 
matter, but does not intend to over-rely on a borrower's credit score. 
FHA assesses the borrower's credit using its TOTAL \2\ mortgage 
scorecard that takes into account multiple, statistically significant 
credit characteristics in approving a borrower's credit or referring 
the borrower for manual underwriting where the underwriter may 
determine that compensating factors exist that warrant the borrower's 
approval for credit. Finally, similar to all other industry 
organizations, including private mortgage insurers, lenders, and the 
Federal Reserve, FHA considers credit scores to be highly predictive of 
borrower performance, even during this period of economic and housing 
market stress. One demonstration of the predictive power of credit 
scores comes from the actuarial reviews of the FHA MMIF that are 
conducted annually by independent contractors for congressional review 
and are in the public domain. The FY 2006 and FY 2007 actuarial reviews 
incorporated credit scores as explanatory variables in their loan 
performance models, which use the most recent 30 years of FHA's actual 
historical experience and critical economic variables to model loan 
performance. The correlation between credit scores and loan performance 
shown by these reviews highlights the importance of credit scores in 
managing risk. (The FY 2006 actuarial review is available at http://www.hud.gov/offices/hsg/comp/rpts/actr/2006actr.cfm. The FY 2007 
actuarial review is available at http://www.hud.gov/offices/hsg/comp/rpts/actr/2007actr.cfm.)
---------------------------------------------------------------------------

    \2\ TOTAL is the acronym for Technology Open to Approved 
Lenders, which is a mathematical equation to use with an automated 
underwriting system (AUS). FHA's TOTAL Mortgage Scorecard evaluates 
the overall creditworthiness of the applicants based on a number of 
credit variables and, when combined with the functionalities of the 
AUS, indicates a recommended level of underwriting and documentation 
to determine a loan's eligibility for insurance by FHA.
---------------------------------------------------------------------------

    Comment--Loss of Cross-Subsidization: The same commenter and other 
commenters expressed the fear that FHA would be prevented by a risk-
based premium structure from practicing the cross-subsidization 
traditionally associated with FHA mortgage insurance programs. For 
example, one of the commenters stated that there is concern ``that the 
credit score related portion of the proposed upfront premium as set 
forth in the proposal will undermine the cross balancing of multiple 
mortgage risk factors that makes FHA, as a government program, 
accessible to low and moderate income borrowers and broadly available 
to areas with large concentrations of minority borrowers.'' Another 
commenter urged that: ``FHA should consider other premium pricing 
differentials based on credit risk elements such as mortgage terms and 
loan-to-value ratios. To the greatest extent possible, the FHA should 
preserve cross-subsidization of premium pricing in the prime mortgage 
market. Individual borrower credit scores may be an appropriate element 
of premium pricing in the subprime market.''
    HUD Response: FHA rejects the implication of these comments that 
FHA is moving away from cross-subsidization. In fact, FHA is seeking to 
implement risk-based premiums in order to improve its management of 
cross-subsidization. FHA disagrees with the view that credit scores 
should be used for establishing premiums in the subprime market but not 
in the prime market where FHA operates. FHA serves borrowers from the 
full range of the credit scores. Like any insurance company, FHA must 
assess and manage its business risk on the basis of the actual 
characteristics of its borrowers and other factors that have been 
demonstrated to affect loan performance. In FHA's historical 
experience, credit scores have proven to be statistically significant 
indicators of additional risk, while the type of the mortgage--fixed 
versus adjustable--has not.
    FHA's adjustable rate mortgages (ARMs) do not bear the risk 
characteristics of subprime ARMs because FHA does not permit initial 
teaser rates, and it underwrites the borrower's credit on the basis of 
the maximum second-year rate to avoid ``payment shock.'' As a result, 
the performance of FHA's ARMs does not differ sufficiently from the 
performance of its fixed-rate mortgages to justify a premium 
differential.
    In managing risk, however, FHA will continue cross-subsidization by 
charging higher than break-even premiums to borrowers with better 
credit scores and lower LTVs so that it can serve some borrowers whose 
premiums do not cover their full risk to the Fund. Such cross-subsidies 
have been normal and subject to study within the MMIF, and FHA plans to 
analyze them even more intensely in the future with the implementation 
of risk-based pricing.
    Comment--Fewer Borrowers Would Qualify for FHA-Insured Mortgages: 
Several commenters cite the June 2007 study of the Government 
Accountability Office (GAO) on ``Modernization Proposals Would Have 
Program and Budget Implications and Require Continued Improvements in 
Risk Management,'' to argue that risk-based pricing would bar an 
excessive number of borrowers from qualifying for a FHA-insured 
mortgage. For example, one commenter reprinted Figure 4 from the report 
and stated: ``As is clearly evidenced above, the imposition of risk-
based pricing will arbitrarily redline out 20% of all current FHA users 
and a full 32% of African-American families and 20% of Latino families 
currently utilizing FHA.''
    HUD Response: FHA provided the data used in the GAO analysis and 
does not dispute its findings. Some categories of loans have 
excessively high expected claim rates. While FHA is committed to 
expanding homeownership, it is also committed to sustainable 
homeownership. It is FHA's position that expected claim rates above 25 
percent are too high, even for a small percentage of borrowers. 
Consequently, FHA is tightening its underwriting standards resulting in 
a restriction that requires borrowers with credit scores below 500 to 
have a 90 percent or lower LTV ratio in order to be eligible for a FHA-
insured mortgage.

[[Page 27707]]

    While the percentage of borrowers obtaining FHA-insured mortgage 
financing that will be affected by this restriction is small, this 
restriction is imposed to serve the public purpose of avoiding 
excessive foreclosures and to ensure the sustainability of the 
insurance fund. Due to statutory ceilings, FHA is not authorized to 
charge premium rates high enough to cover the costs of foreclosures on 
these loans, and high foreclosure rates adversely impact neighborhoods 
and communities, as well as the individual families. FHA holds the view 
that borrowers who lack sufficient credit quality to qualify for 
immediate homeownership will be best served if they are referred to 
mortgage counseling, and if they can focus on improving their credit 
scores or saving for a larger downpayment and, thereby, increase their 
chances of sustainable homeownership in the future.
    Comment--Proposal Will Not Resolve MMIF Solvency Concern: Similar 
to the preceding comments, two commenters stated that HUD's risk-based 
premium proposal would not improve the ``financially precarious 
position'' of the MMIF and would instead negatively impact both the 
MMIF and the much larger market for prime mortgages, by eliminating the 
cross-subsidization of premium pricing in the prime mortgage market. 
One commenter believed it is ``inappropriate for FHA, as a government 
program, to implement a premium structure that would effectively deny 
access to low income and minority groups who have traditionally relied 
on this program.''
    HUD Response: HUD disagrees with the commenters' statements. First, 
as discussed in the response to the previous comment, HUD has 
documented from its own experience, and using loan-performance 
forecasts from the annual independent actuarial studies of the MMIF, 
that this proposal will improve FHA's financial and actuarial solvency. 
That analysis has been verified by the Office of Management and Budget. 
Second, HUD is denying access to no one based on income or race. Rather 
HUD is establishing reasonable parameters for the levels of cross-
subsidies that are appropriate within the FHA insurance programs, based 
on its own historical experience.
    By implementing risk-based premiums, HUD is preserving and 
enhancing its ability to serve low-income and minority groups that 
represent FHA's traditional borrowers. HUD is doing so by improving its 
management of--not eliminating--cross-subsidization. Risk-based 
premiums offer a balanced approach that will permit FHA to reach more 
potential homebuyers, an objective that is necessary to continue to 
provide cross-subsidies to targeted groups. Furthermore, because risk-
based premiums will also apply to the refinancing of loans, borrowers 
who improve their creditworthiness through regular mortgage payments or 
through increases in home value can lower the insurance premiums they 
pay to FHA, when refinance opportunities present themselves.
    Comment--Other and Better Proposals Will Achieve FHA Goals: Two 
commenters suggested that HUD, instead of implementing risk-based 
pricing premiums, use other methods for achieving the stated goals of 
increasing market share, improving competition with the subprime 
market, and avoiding the need for a credit subsidy. As examples, the 
commenters cited better marketing of FHA loans and expanded use of loss 
mitigation.
    HUD Response: While serving borrowers who were previously 
underserved or not served by the conventional market is a goal of this 
notice, FHA's objectives in implementing risk-based premiums are not to 
increase market share, nor to compete with the private sector. FHA must 
engage in a range of appropriate practices that will best serve the 
needs of homebuyers while protecting the financial soundness of the 
MMIF. FHA continues to operate its comprehensive loss mitigation 
program, but these activities do not serve the same objectives as risk-
based premiums.

Process for Implementing Risk-Based Premiums

    Comment: One commenter stated that HUD failed to follow 
Administrative Procedure Act (APA) notice and comment rulemaking 
requirements. The commenter stated that the ``risk-based premium 
proposal is clearly a ``substantive rule of general applicability''' 
and, as such, formal rulemaking under the APA is required.
    HUD Response: The National Housing Act authorizes FHA to establish 
mortgage insurance premiums. For FHA single family programs, the 
National Housing Act directs that the upfront and annual premiums to be 
established by FHA may not exceed statutorily set maximum levels. The 
National Housing Act, however, gives FHA flexibility to set premiums 
within those maximum levels. On the basis of this statutory foundation, 
FHA may set premiums as it determines to be appropriate within the 
statutory parameters, to maintain the financial soundness of the MMIF. 
The September 20, 2007, notice presented FHA's proposal to establish 
premiums commencing in calendar year 2008 that would maintain the 
financial soundness of the MMIF.
    The key element of APA notice and comment rulemaking is ``notice 
and comment''; that is, advance notice and the opportunity to comment 
prior to agency action. HUD has provided such advance notice and 
opportunity to comment through the September 20, 2007, notice. What HUD 
has not undertaken at this point is codification, which is not a matter 
covered by or subject to the APA. Codification presents a convenient 
organization for rules with some degree of permanence. However, when 
agencies are charged with setting prices or costs, such as insurance 
premiums, interest rates, fees or rents, which are based on market or 
other changing conditions that may necessitate periodic changes, then 
codification is less convenient. In such cases, what is important is 
that an agency provides advance notice and the opportunity to comment, 
and HUD has provided such notice and opportunity for comment in this 
matter.

Complexity of Proposal

    Comment: Three commenters stated that the risk-based premium 
proposal is too complex and complicated. One commenter specified that 
the chart outlining the proposed risk-based premiums was ``too 
complicated and needs to be simplified.'' One commenter noted that HUD 
should provide, in the final, published notice or in the ensuing 
mortgagee letter, concrete examples on how to do calculations for 
determining the borrower's decision credit score and the insured 
property's base LTV ratio.
    HUD Response: In this notice, FHA has made changes that simplify 
the upfront premium rate table. Moreover, as is FHA's practice, FHA 
will issue a mortgagee letter that will provide examples of how to 
perform calculations, as well as additional practical information that 
may be helpful to assist FHA-approved lenders with risk-based premiums.

Determination of the Borrower's Decision Credit Score

    Comment: Several commenters questioned the decision to determine 
the decision credit score by averaging the scores of multiple borrowers 
on the loan. The commenters urged FHA to clarify the method of 
determination or to adopt current industry practice.
    HUD Response: FHA agrees with this comment and will determine the 
decision credit score according to standard industry practice. See 
footnote

[[Page 27708]]

3 of the risk-based premium chart in Section V of this notice for a 
more detailed description of how decision credit scores for multiple 
borrowers will be determined.

Multiple Sources of Downpayment

    Comment: Two commenters asked FHA to clarify the guidelines for 
borrowers who receive gifts from multiple sources. One commenter 
suggested that HUD regulations should either prohibit multiple gifts 
per loan transaction or permit such multiple gifts and update the TOTAL 
Scorecard system to accept additional data on the gifts. Another 
commenter stated that the proposal does not adequately assess and price 
the risk associated with multiple gift sources depending on the type of 
mortgage product offered or the type of gift provided (i.e., amortized 
second mortgage; deferred payment zero-interest; deferred payment 
loans; seller-funded downpayment assistance, etc.).
    HUD Response: FHA will allow all permissible sources of downpayment 
assistance to be added together to determine the appropriate LTV.

Use of Manual Underwriting

    Comment: Some commenters stated that a ``major benefit'' of FHA is 
the ability to manually review and examine all aspects of a borrower's 
credit profile. They also stated that the risk-based premiums will only 
make it harder for individuals to obtain a mortgage with favorable 
terms. By requiring the use of credit scores, commenters stated that 
FHA is removing the ability of a trained underwriter to estimate the 
risk of providing mortgage insurance. One commenter suggested that HUD 
allow underwriters to exercise discretion when approving a loan with 
low or no credit scores, and to issue guidance that such loans be 
underwritten with ``extreme caution and possibly subject to FHA 
review.''
    HUD Response: The risk-based premium structure does not replace 
FHA's existing underwriting criteria. Eligibility for an FHA-insured 
loan is first determined by FHA's TOTAL Scorecard, which relies on 
credit scores, LTV ratio, and several additional factors to determine a 
borrower's credit quality.
    For borrowers that receive a ``Refer'' decision from TOTAL, FHA 
will continue to require manual underwriting, which allows an 
underwriter to consider additional compensating factors beyond the 
credit and application factors considered in TOTAL. Further, FHA may 
accept loans underwritten using nontraditional credit sources where 
borrowers have insufficient experience with traditional credit.
    FHA has made the decision to establish risk-based premiums using 
credit scores as a principal determinant because a borrower's credit 
score provides the most important single measure of the willingness and 
ability of any single borrower to be successful under the borrower's 
debt obligations. A home loan is the most significant debt obligation 
that most households will ever enter into. In statistical models used 
to predict mortgage performance, credit scores and LTV ratios are the 
most important determinants. They, therefore, provide the best basis 
for establishing mortgage insurance premiums.
    The premiums charged by FHA are independent of the interest rates 
charged by lenders on the insured loans. FHA provides lenders with 100 
percent insurance on the principal balance of the loan. Therefore, the 
interest rates charged for FHA-insured loans are very close to those 
charged for prime, conventional loans purchased by Fannie Mae or 
Freddie Mac. That would not change regardless of what premiums FHA 
might charge for the insurance.

Borrowers With Nontraditional Credit

    Comment: Several commenters expressed concern about borrowers 
without credit histories or borrowers with primarily nontraditional 
credit sources. The commenters stated that, in many instances, such 
borrowers prove more creditworthy than borrowers with low credit 
scores. One commenter suggested that the problem lies with HUD's 
failure to enforce policies requiring sufficient documentation of 
nontraditional credit sources.
    HUD Response: HUD agrees that lenders should be encouraged to 
underwrite borrowers with no credit histories or borrowers who use 
nontraditional credit, to determine if such borrowers can qualify for 
FHA-insured mortgage financing. FHA issued guidance on this subject in 
Mortgagee Letter 2008-11, which was published on April 29, 2008.

Other Downpayment Concerns

    Comment--Provide Zero Downpayment Product: Two commenters noted 
that the risk-based premium schedule does not allow for the possibility 
of a ``zero-downpayment'' insured product.
    HUD Response: HUD does not currently have the statutory authority 
to offer a zero-downpayment product to FHA customers.
    Comment--State Housing Finance Agencies Should Not Be Categorized 
as ``Other Sources of Funds'': Several commenters, primarily 
representing state housing finance agencies (HFAs) and other state and 
local government entities, expressed concern that the proposal, as 
published in September 2007, would place downpayment and closing cost 
assistance packages offered by HFAs in the ``Other Sources of Funds'' 
category. The commenters stated that this categorization would add 50 
basis points to the upfront mortgage insurance premium charged to HFA 
clients. The commenters stated that there should be an exception in the 
``Other Sources of Funds'' category for downpayment assistance programs 
provided or funded by instrumentalities of state and local government. 
The commenters cautioned HUD against ``lumping in,'' under the ``Other 
Sources of Funds'' category, downpayment assistance provided by HFAs 
and other state and local government entities with seller-funded 
downpayment assistance, which was categorized, in HUD's final rule 
published on October 1, 2007, as an impermissible source of downpayment 
assistance for FHA-insured mortgages. The commenters stated that 
borrowers receiving downpayment assistance from HFAs and other state or 
local government entities generally have lower default or delinquency 
rates than borrowers receiving assistance from other organizations.
    HUD Response: HUD agrees and has removed source of downpayment 
assistance as a basis for premium determination. Whatever downpayment 
assistance is provided, however, it must be from a permissible source.
    Comment--Borrowers with Government-Funded Downpayment Assistance 
Should Not Be Categorized as ``High Risk'': One commenter noted that 
most state and local governments and instrumentalities of these 
governments use, as their source of downpayment assistance to qualified 
borrowers, funds from various HUD programs designed to increase 
homeownership opportunities, including the Community Development Block 
Grant (CDBG) program, HOME program, and American Dream Downpayment 
Initiative (ADDI). The commenter suggested that classifying borrowers 
who receive funds from HFAs or instrumentalities of government as 
``high risk'' completely contradicts the goals and purposes of programs 
such as HOME and ADDI.
    HUD Response: HUD agrees and has removed source of downpayment as a 
factor in determining the borrower's mortgage insurance premium.
    Comment--LTV, Not Downpayment, Should Be the Benchmark for Risk-

[[Page 27709]]

Based Premiums: Several commenters urged FHA to use LTV ratio as the 
appropriate benchmark for establishing risk-based premiums. One 
commenter stated that there is a discrepancy between the minimum 3 
percent downpayment requirement in the risk-based premium chart in the 
proposed notice and FHA's current maximum LTV ratios, which are greater 
than 97 percent. The commenter requested that this discrepancy be 
addressed.
    HUD Response: By law, FHA must require a minimum investment of 3 
percent cash in the property in a purchase transaction to be FHA-
insured. However, the National Housing Act also permits an LTV that is 
above 97 percent when the borrower wishes to finance closing costs in 
the mortgage. To avoid any confusion, HUD is changing the 
classifications used in the upfront premium rate table from 
``downpayment'' to ``LTV,'' as shown in the new risk-based premium 
chart published herein.

Effective Dates

    Comment: Several commenters noted that the proposed effective date 
for risk-based premiums of January 1, 2008, is not feasible. One 
commenter stated that compliance with the Sarbanes-Oxley Act 
necessitates that end-of-year freezes are in place to meet the 
statute's requirement that internal controls and systems be operating 
effectively at year end; thus, the commenter's company instituted a 
policy of not permitting programming changes during the fourth quarter. 
The commenters also stated that lenders would not be able to update 
their software systems in time to meet the implementation date of 
January 1. Various commenters suggested alternative effective dates 
such as: March 1, 2008; April 1, 2008; June 30, 2008; July 1, 2008; and 
12 months from the date the final risk-based premium notice has been 
published. One commenter suggested that lender systems could be ready 
for risk-based premium pricing 90 days from the date the mortgagee 
letter is issued by FHA. Another commenter requested that HUD defer the 
implementation of risk-based premiums until automated underwriting 
systems that employ the TOTAL Scorecard, such as Fannie Mae's Desktop 
Underwriter, are revised to calculate the appropriate risk-based 
upfront and annual mortgage insurance premiums.
    HUD Response: Although most commenters did not oppose the proposed 
January 1, 2008, implementation date, HUD is nevertheless changing the 
implementation date from January 1, 2008, to July 14, 2008, for FHA 
loans for which case numbers have not been assigned. HUD believes that 
the July 14, 2008, date will provide adequate time for mortgagees to 
update computer systems to accommodate risk-based premiums. 
Furthermore, FHA has, in response to public comments, simplified the 
upfront premium rate table in the notice by eliminating the source of 
downpayment as a variable in determining the appropriate insurance 
premium.

Two- to Four-Unit Dwellings

    Comment: One commenter stated that the September 20, 2007, notice 
did not address pricing mechanisms for properties with two- to four-
units, even though, historically, two- to four-unit family dwellings 
have a higher risk for default. The commenter suggested that FHA charge 
a 25 basis point premium for these properties.
    HUD Response: At this time, FHA is not moving to develop risk-based 
premiums for two- to four-unit dwellings because FHA's overall 
portfolio includes very few loans secured by multi-unit properties.

Mortgages With 15-Year (or Less) Terms

    Comment: Two commenters asked for clarification on how mortgages 
with 15-year terms or less would be addressed under the proposal. One 
commenter asked whether such mortgages would be subject to risk-based 
premiums under the proposal. Another commenter urged HUD to maintain 
the current practice of waiving the annual premium for loans of 15-year 
amortizations or less and loans with an LTV ratio of 89.99 percent or 
less.
    HUD Response: FHA is not changing the maximum or minimum annual 
premiums on 15-year loans at this time. However, 15-year loans with low 
LTV ratios will have the advantage of the lower upfront premiums as 
provided in FHA's risk-based premium structure, and as described in 
Section V of this notice.

Homeownership Counseling

    Comment: Two commenters requested that FHA more clearly define 
``pre-purchase homeownership counseling acceptable to the Secretary.'' 
One commenter suggested that all homebuyers who complete pre-purchase 
homeownership counseling should be eligible for the 25 basis point 
reduction that is currently made available only to first-time 
homebuyers who would otherwise pay a 225 basis point premium.
    HUD Response: Pre-purchase homeownership counseling must be 
obtained from a HUD-approved housing counseling agency, and must be 
completed up to one year before the homebuyer signs a purchase 
agreement for the property. Subsequent to the publication of this final 
notice, FHA will publish a standard homebuyer counseling certificate 
that will be used to document the provision of services. The 200 basis 
point cap on the upfront premium payment for first-time homebuyers is 
consistent with and reflects the language of section 203(c)(2) of the 
National Housing Act (12 U.S.C. 1709(c)(2)).

Relationship to FHASecure Temporary Initiative (FHASecure)

    Comment: Five commenters suggested that the Department's risk-based 
premium proposal is inconsistent or incompatible with FHASecure, which 
is designed to help current homeowners avoid foreclosure by refinancing 
their conventional mortgage with an FHA-insured mortgage. The 
commenters stated that homeowners who refinance under FHASecure should 
be exempt from the premium pricing schedule outlined in the September 
20, 2007, notice.
    HUD Response: FHA's risk-based premium proposal is not inconsistent 
or incompatible with FHASecure, and, therefore, an exemption is not 
needed for FHASecure customers. The slightly higher premium for 
FHASecure customers will be more than offset by the substantially 
reduced mortgage payment they will achieve by refinancing into an FHA-
insured mortgage. The slightly higher premium that may be paid by a 
borrower whose credit score has been impaired by defaulting on the 
borrower's conventional mortgage will have no effect on the borrower's 
eligibility for FHA refinancing, pursuant to FHASecure underwriting 
criteria. Furthermore, the difference between the existing 150 basis 
point upfront premium and the highest proposed upfront premium of 225 
basis points for a $150,000 mortgage is approximately $7 per month. 
Therefore, the proposal should not have a significant impact on those 
borrowers covered by FHASecure.

Other FHA-Insured Programs

    Comment: Two commenters noted that other FHA-insured programs, such 
as for adjustable rate mortgages (ARMs), condominiums, and mortgages 
insured under section 203(h) of the National Housing Act (12 U.S.C. 
1709(h)), were not mentioned in the September 20, 2007, notice. The 
commenters asked whether these and other FHA-insured programs will be 
affected by the new

[[Page 27710]]

risk-based premium pricing structure. One commenter asked whether 
military impact zones, which currently do not require the payment of an 
upfront insurance premium, would be included in the risk-based pricing 
proposal.
    HUD Response: The risk-based premium rates apply to those forward 
mortgages insured under FHA's MMIF, the Section 203(k) rehabilitation 
mortgage insurance program, and individual condominium units insured 
under Section 234(c). Risk-based premiums do not apply to reverse 
mortgages under FHA's Home Equity Conversion Mortgage (HECM) program. 
Risk-based premiums also do not apply to Section 223(e) (declining 
neighborhoods), Section 238(c) (military impact areas in Georgia and 
New York), Section 247 (Hawaiian Homelands), and Section 248 (Indian 
Reservations).

Upfront Mortgage Insurance Premiums (UFMIPs)

    Comment: Six commenters asked whether current policies regarding 
upfront mortgage insurance premiums would carry over under the new 
risk-based pricing scheme. For example, one commenter asked whether 
mortgage insurance premiums could still be financed by the borrower. 
Two commenters urged HUD to keep the ``78 percent'' and the ``5-year'' 
rules in effect.
    HUD Response: FHA agrees that the existing policies concerning 
mortgage insurance premium financing, and the 78 percent and 5-year 
termination of mortgage insurance premiums should continue to apply. 
FHA will reiterate these policies in a future mortgagee letter.

Annual Mortgage Insurance Premiums

    Comment: One commenter asked for HUD to clarify the downpayment 
thresholds for determining the annual mortgage insurance premiums. The 
commenter noted that the proposed risk-based premium calculations do 
not address the annual mortgage insurance premium rates for a 
downpayment amount other than 3, 5, or 10 percent.
    HUD Response: All borrowers qualifying for an FHA-insured mortgage 
will pay an annual premium rate equal to 50 basis points, unless the 
LTV is greater than or equal to 95.01 percent. For loans with an LTV of 
greater than or equal to 95.01 percent, the annual premium rate will be 
equal to 55 basis points. No borrower who qualifies for an FHA-insured 
mortgage will pay more than 55 basis points for the annual premium.

V. Risk-Based Premiums--Effective July 14, 2008

    This notice replaces FHA's Mortgagee Letter 00-38, which identifies 
the current mortgage insurance premiums for FHA's single family 
programs. The risk-based premium structure, as provided in this Section 
V, is effective for new FHA case number assignments made on or after 
July 14, 2008.
    Risk-based premiums will utilize the following schedule for upfront 
and annual mortgage insurance premium rates:

                  FHA Single Family Mortgage Insurance
 
             Upfront and Annual Mortgage Insurance Premiums
 
                         (Loan Terms > 15 years)
 
                      Effective as of July 14, 2008
 
           All premiums are specified in basis points (0.01%)
------------------------------------------------------------------------


                                          Decision Credit Score (FICO)
----------------------------------------------------------------------------------------------------------------
                                                                                                       Non-
                 LTV                   850-680   679-640   639-600   599-560   559-500   499-300    traditional
----------------------------------------------------------------------------------------------------------------
<= 90.00............................    125/50    125/50    125/50    150/50    175/50    175/50          150/50
90.01-95.00.........................    125/50    125/50    150/50    175/50    200/50       n/a          175/50
> 95................................    125/55    150/55    175/55    200/55   225\a\/       n/a          200/55
                                                                                    55
----------------------------------------------------------------------------------------------------------------
a A first-time homebuyer, with HUD-approved counseling, will pay only 200 basis points for the upfront mortgage
  insurance premiums.


Notes

    1. Annual premium rates are: 50 basis points for loans with a 
loan-to-value (LTV) ratio of less than or equal to 95 percent; and 
55 basis points for loans with an LTV ratio of 95.01 percent and 
higher.
    2. The LTV ratio, computed to two decimals (e.g., 95.65) is 
calculated by dividing the mortgage amount prior to adding on any 
upfront mortgage insurance premium by the property's sale price or 
appraised value, whichever is lower.
    3. Eligibility for the mortgage insurance premiums listed in the 
chart above is based on an applicant's decision credit score. A 
``decision credit score'' is determined for each applicant according 
to the following guidelines: when three scores are available (one 
from each national consumer reporting agency: Equifax, TransUnion, 
and Experian[supreg]), the middle value is used; when only two are 
available, the lesser of the two is chosen; when only one is 
available, then that score is used. If more than one individual is 
applying for the same mortgage, the lender should determine the 
decision credit score for each individual borrower and then use the 
lowest score to determine the final decision credit score for the 
application. That application ``decision'' credit score is then used 
as part of underwriting to determine if the mortgagor is considered 
an acceptable risk.
    4. Except as provided below, eligibility for these insurance 
premiums is dependent upon borrower acceptance by TOTAL (Technology 
Open to Approved Lenders). Therefore, all borrowers with valid 
credit scores must be scored by TOTAL.
    5. Borrowers not scored by TOTAL or with insufficient trade 
lines to generate credit bureau scores will fall in the ``non-
traditional'' column in the premium chart and are priced 
accordingly. Borrowers falling into cells with no premium price 
shown are not eligible for FHA-insured financing. Note that a 
minimum decision credit score of 500 will be required for FHA-
insured mortgages with an LTV ratio in excess of 90 percent.
    6. If TOTAL refers a loan for manual underwriting and the 
underwriter deems that there are sufficient compensating factors to 
create an acceptable risk to FHA, then the upfront insurance premium 
charge will be as shown on the premium chart.
    7. These premiums apply to all purchase loans and to fully 
underwritten (non-streamline) refinance loans. Cash-out refinance 
loans must meet a minimum 5 percent equity requirement, based on the 
appraised value of the property.
    8. Streamline refinance of an existing FHA loan for which a case 
number was assigned prior to July 14, 2008, will have an upfront 
premium of 100 basis points and an annual premium of 50 basis 
points.
    9. The risk-based premium rates established in this notice apply 
to those forward mortgages insured under FHA's Mutual Mortgage 
Insurance (MMI) fund, the Section 203(k) rehabilitation mortgage 
insurance program, and individual condominium units insured under 
Section 234(c). Risk-based premiums do not apply to mortgages 
insured under Title I of the National Housing Act, nor to reverse 
mortgages under FHA's Home Equity Conversion Mortgage (HECM) 
program. Risk-based premiums also do not apply to Section 223(e) 
(declining neighborhoods), Section 238(c) (military impact areas in 
Georgia and New York), Section 247 (Hawaiian

[[Page 27711]]

Homelands), and Section 248 (Indian Reservations).

    The following matrix shows upfront and annual mortgage insurance 
premiums for loan terms with 15 or fewer years.

                  FHA Single Family Mortgage Insurance
 
         Upfront Mortgage and Annual Mortgage Insurance Premiums
 
                     Loan Terms of 15 Years or Fewer
 
                      Effective as of July 14, 2008
 
           All premiums are specified in basis points (0.01%)
------------------------------------------------------------------------


                                                              Decision Credit Score (FICO)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                 Non-
                             LTV                                 850-680      679-640      639-600      599-560      559-500      499-300    traditional
--------------------------------------------------------------------------------------------------------------------------------------------------------
<= 90.00.....................................................        100/0        100/0        125/0        150/0        175/0        175/0        150/0
90.01-95.00..................................................       100/25       125/25       150/25       175/25       200/25          n/a       175/25
> 95.........................................................       125/25       150/25       175/25       200/25       200/25          n/a       200/25
--------------------------------------------------------------------------------------------------------------------------------------------------------

VI. Findings and Certifications

Environmental Review

    A Finding of No Significant Impact is not required for this notice. 
Under 24 CFR 50.19(b)(6), the subject matter of this notice is 
categorically excluded from the requirements of the National 
Environmental Policy Act (42 U.S.C. 4332 et seq.).

    Dated: May 5, 2008.
Brian D. Montgomery,
Assistant Secretary for Housing--Federal Housing Commissioner
[GRAPHIC] [TIFF OMITTED] TN13MY08.001

 [FR Doc. E8-10625 Filed 5-12-08; 8:45 am]
BILLING CODE 4210-67-P