[Federal Register Volume 75, Number 135 (Thursday, July 15, 2010)]
[Notices]
[Pages 41217-41225]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-17326]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Docket No. FR-5404-N-01]


Federal Housing Administration Risk Management Initiatives: 
Reduction of Seller Concessions and New Loan-to-Value and Credit Score 
Requirements

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

ACTION: Notice.

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SUMMARY: A recently issued independent actuarial study shows that the 
Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below 
its statutorily mandated threshold. Consistent with HUD's 
responsibility under the National Housing Act to ensure that the MMIF 
remains financially sound, this notice solicits public comment on three 
proposed initiatives that will contribute to the restoration of the 
MMIF capital reserve account. The changes proposed in this notice are 
designed to preserve both the historical role of the Federal Housing 
Administration (FHA) in providing a home financing vehicle during 
periods of economic volatility and HUD's social mission of helping 
underserved borrowers. FHA proposes to tighten only those portions of 
its underwriting guidelines that have been found to present an 
excessive level of risk to both homeowners and FHA. First, FHA proposes 
to reduce the amount of closing costs a seller may pay on behalf of a 
homebuyer purchasing a home with FHA-insured mortgage financing for the 
purposes of calculating the maximum mortgage amount. This proposed cap 
on ``seller concessions'' will minimize FHA exposure to the risk of 
adverse selection. Secondly, FHA proposes to introduce a credit score 
threshold as well as reduce the maximum loan-to-value (LTV) for 
borrowers with lower credit scores, who represent a higher risk of 
default and mortgage insurance claim. Finally, FHA will tighten 
underwriting standards for mortgage loan transactions that are manually 
underwritten. These transactions have resulted in high mortgage 
insurance claim rates and present an unacceptable risk of loss.

DATES: Comment Due Date: August 16, 2010.

ADDRESSES: Interested persons are invited to submit comments regarding 
this notice to the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 7th Street, SW., Room 
10276, Washington, DC 20410-0500. Communications must refer to the 
above docket number and title. There are two methods for submitting 
public comments. All submissions must refer to the above docket number 
and title.
    1. Submission of Comments by Mail. Comments may be submitted by 
mail to the Regulations Division, Office of General Counsel, Department 
of Housing and Urban Development, 451 7th Street, SW., Room 10276, 
Washington, DC 20410-0500.
    2. Electronic Submission of Comments. Interested persons may submit 
comments electronically through the Federal eRulemaking Portal at 
http://www.regulations.gov. HUD strongly encourages commenters to 
submit comments electronically. Electronic submission of comments 
allows the commenter maximum time to prepare and submit a comment, 
ensures timely receipt by HUD, and enables HUD to make them immediately 
available to the public. Comments submitted electronically through the 
http://www.regulations.gov Web site can be viewed by other commenters 
and interested members of the public. Commenters should follow the 
instructions provided on that site to submit comments electronically.

    Note: To receive consideration as public comments, comments must 
be submitted through one of the two methods specified above. Again, 
all submissions must refer to the docket number and title of the 
rule.

    No Facsimile Comments. Facsimile (FAX) comments are not acceptable.
    Public Inspection of Public Comments. All properly submitted 
comments and communications submitted to HUD will be available for 
public inspection and copying between 8 a.m. and 5 p.m. weekdays at the 
above address. Due to security measures at the HUD Headquarters 
building, an appointment to review the public comments must be 
scheduled in advance by calling the Regulations Division at 202-708-
3055 (this is not a toll-free number). Individuals with speech or 
hearing impairments may access this number via TTY by calling the 
Federal Information Relay Service at 800-877-8339. Copies of all 
comments submitted are available for inspection and downloading at 
http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Mark Ross, Office of Single Family 
Program Development, Office of Housing, Department of Housing and Urban 
Development, 451 7th Street, SW., Washington, DC 20410; telephone 
number 202-708-2121 (this is not a toll-free number). Persons with 
hearing or speech impairments may access this number through TTY by 
calling the toll-free Federal Information Relay Service at 800-877-
8339.

SUPPLEMENTARY INFORMATION:

I. Background: FHA and the Housing Crisis

    FHA was established by Congress in 1934 to improve nationwide 
housing standards, provide employment and stimulate industry, to 
improve conditions with respect to home mortgage financing, to prevent 
speculative excesses in mortgage investment, and to eliminate the 
necessity for costly secondary financing. As a governmental mortgage 
insurance company with nationwide scope, FHA provided credit 
enhancement to protect mortgage lenders from risk of loss, which 
encouraged the banking community to extend credit to new homeowners and 
those in need of refinance and home improvement loans. The result was 
one of the most successful collaborations between the public and 
private sectors in U.S. history. To this day, the FHA model, which 
offers mortgage insurance for mortgage loans that meet FHA 
requirements, reduces risk to mortgage lenders, thereby enabling them 
to extend credit to homeowners and

[[Page 41218]]

homebuyers, even during periods of economic volatility.
    The current state of the housing market validates the importance of 
the historical role of FHA in stabilizing the mortgage market during 
times of economic disruption. Over the last 2 years, FHA has resumed 
its countercyclical position, supporting the private sector when access 
to capital is otherwise constrained. The volume of FHA insurance 
increased rapidly as private sources of mortgage finance retreated from 
the market. FHA's share of the single-family mortgage market today is 
approximately 30 percent--up from 3 percent in 2007, and the dollar 
volume of insurance written has jumped from the $56 billion issued in 
that year to more than $300 billion in 2009.

Managing Risk to the MMIF

    The growth in the MMIF portfolio over such a short period of time 
coincides with a set of difficult economic conditions. FHA is also 
concerned with the issue of layering risk. Default risk is compounded 
when there are low credit scores, high loan-to-value (LTV) ratios, high 
debt-to-income ratios, and low or zero cash reserves associated with a 
loan. Given these conditions and concerns, FHA, in managing the MMIF, 
must be especially vigilant in monitoring the performance of the 
portfolio, enhancing risk controls, and tightening standards to address 
portions of the business that expose homeowners to excessive financial 
risks. See section 202(a)(7)(A) of the National Housing Act, which 
addresses the operational goals of the MMIF (12 U.S.C 1708(a)(7)(A)).
    The proposals set forth in this Notice are representative of FHA's 
focus on enhancing the agency's risk management practices, while 
fulfilling FHA's mission to serve borrowers in a manner that is 
financially sustainable for both FHA and borrowers. FHA's authorizing 
statute, the National Housing Act, clearly envisions that FHA will 
adjust program standards and practices, as necessary, to operate the 
MMIF, with reasonable expectations of financial loss.
    While the Federal Credit Reform Act of 1990 requires that FHA (and 
all other government credit agencies) estimate and budget for the 
anticipated cost of mortgage loan guarantees, the National Housing Act 
imposes a special requirement that the MMIF hold an additional amount 
of funds in reserve to cover unexpected losses. On November 13, 2009, 
HUD released an independent actuarial study that reported that FHA will 
likely sustain significant losses from mortgage loans made prior to 
2009, due to the high concentration of seller-financed downpayment 
assistance mortgage loans and declining real estate values nationwide, 
and that the MMIF capital reserve relative to the amount of outstanding 
insurance in force had fallen below the statutorily mandated 2 percent 
ratio.\1\
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    \1\ The capital ratio generally reflects the reserves available 
(net of expected claims and expenses), as a percentage of the 
current portfolio, to address unexpected losses. The report can be 
found at: http://www.hud.gov/offices/hsg/fhafy09annualmanagementreport.pdf.
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    FHA maintains the MMIF capital reserve in a special reserve 
account. As with other federal credit agencies, FHA uses a financing 
account to cover the current anticipated cost of its mortgage loan 
guarantees. The MMIF capital reserve account serves as a back-up fund, 
where FHA holds additional capital to cover unexpected losses. Funds 
are transferred into this account only when FHA holds more cash in the 
financing account than is necessary to cover projected costs. In recent 
years, adverse market conditions, the poor performance of seller-
financed gift letter mortgage loans, and worsening economic projections 
had substantially increased the estimated cost of outstanding single-
family mortgage loan guarantees, and large transfers of funds were made 
from the reserve account into the primary financing account. As 
previously noted, these withdrawals from the MMIF capital reserve fund 
have resulted in its no longer complying with the minimum capital ratio 
mandated by law. However, if the current estimate of these costs proves 
excessive or if FHA implements policy changes that result in net income 
to the Federal Government, excess funds will be moved from the 
financing account back to the reserve account, thereby restoring the 
capital reserves of the MMIF.
    There are four primary policy changes that FHA can implement to 
replenish the MMIF capital reserve account: (1) Increase the premium 
income generated; (2) reduce losses by tightening underwriting 
guidelines; (3) strengthen enforcement measures to reduce unwarranted 
claim payments, and (4) improve avoidance of claim costs through 
enhanced loss mitigation. FHA is engaged in efforts on all of these 
fronts, exercising its full authority under the terms of the National 
Housing Act, including new authorities provided in recently enacted 
legislation.

History of FHA Loan-to-Value and Credit Score Requirements

    In 1934, single-family mortgage insurance was available for loans 
up to 80 percent of appraised value. In 1938, amendments to the 
National Housing Act introduced a 90 percent LTV ratio as well as a 
tiered approach that tied LTV to specific dollar amounts, e.g., 90 
percent of the first $6,000 of value and 80 percent for the remainder, 
depending on whether the property had been approved by FHA prior to 
construction. By 1957, the permissible LTV had increased to 90 or 97 
percent of the first $10,000 of value plus 85 percent of the next 
$6,000 and 70 percent of the remainder, again depending on whether the 
property had been approved prior to construction. LTVs in the mid 1990s 
followed the same general tiered approach, with the first $25,000 of 
value limited to 97 percent; 95 percent of value in excess of $25,000, 
not to exceed $125,000; and 90 percent of value in excess of $125,000. 
Under the amendments made by the Housing and Economic Recovery Act of 
2008 (Pub. L. 110-289, 122 Stat. 2654, approved July 30, 2008) (HERA), 
FHA implemented a 96.5 percent LTV for purchase transactions.
    By contrast, the conventional mortgage market changes LTV 
requirements based on current conditions in the market. In December 
2007, Fannie Mae restricted the maximum LTV for properties located 
within a declining market to 5 percentage points less than it would 
otherwise permit for a given loan product, meaning that a 95 percent 
LTV program would see availability restricted to 90 percent LTV. In May 
2008, Fannie Mae returned to a national LTV as high as 97 percent for 
conforming mortgages scored favorably by its automated underwriting 
system, and 95 percent LTV for those underwritten manually.
    As for a minimum credit score requirement, FHA did not introduce 
such a requirement until July 2008 when borrowers with credit scores 
below 500 were limited to 90 percent LTV. However, the large financial 
institutions in the mortgage industry introduced a minimum credit score 
of 580 in the first quarter of 2008, regardless of the type of 
financing and LTV, and then raised it to 620 in the first quarter of 
2009.

II. New Tools To Manage Risk--The Housing and Economic Recovery Act of 
2008

    HERA made significant and comprehensive reforms to the National 
Housing Act (12 U.S.C. 1701 et seq.) and consequently reforms to FHA 
programs. Section 2118 of HERA amended section 202 of the National 
Housing Act (12 U.S.C. 1708), by amending several

[[Page 41219]]

provisions directed to both highlighting and strengthening FHA's 
fiduciary responsibilities.
    Section 202, as amended by HERA, provides in paragraph (a)(3), 
entitled ``Fiduciary Responsibility,'' that the ``Secretary has a 
responsibility to ensure that the Mutual Mortgage Insurance Fund 
remains financially sound.'' Paragraph (a)(4) continues a pre-HERA 
requirement, which is for the Secretary to provide, annually, for an 
independent actuarial study of the Fund, and the study is to include a 
review of risks to the Fund. Paragraph (a)(6) provides that if, 
pursuant to the independent actuarial study of the Fund, the Secretary 
determines that the Fund is not meeting the operational goals 
established under paragraph (7) or there is substantial probability 
that the Fund will not maintain its established target subsidy rate, 
``the Secretary may either make programmatic adjustments under this 
title as necessary to reduce the risk to the Fund, or make appropriate 
premium adjustments.'' Paragraph (a)(7) provides that the operational 
goals of the Fund include minimizing the default risk to the Fund and 
to homeowners, while meeting the housing needs of the borrowers that 
the single-family mortgage insurance program under this title is 
designed to serve.
    Consistent with these new obligations and authorities provided 
under the National Housing Act, HUD has already undertaken several 
measures to protect the FHA fund during the economic downturn, focusing 
on programs and practices that resulted in poor loan performance. This 
includes: Prohibition on seller-financed downpayment assistance and the 
tightening of underwriting guidelines for both the streamline and cash-
out refinance products. FHA also implemented several changes to the 
agency's appraisal standards, shortening the validity period and 
reaffirming appraiser independence, to ensure that appraisals are as 
up-to-date and accurate as possible.
    In addition to program modifications, FHA has increased oversight 
of lenders.\2\ FHA has terminated and suspended several lenders whose 
default and claim rates were higher than the national default and claim 
rate.
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    \2\ See HUD press release of September 18, 2009, announcing FHA 
credit policy changes to improve risk management functions at http://www.hud.gov/news/release.cfm?content=pr09-177.cfm, and the 
individual Mortgagee Letters implementing these policy changes at 
http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/index.cfm. 
See also HUD's November 30, 2009, rule proposing to increase the net 
worth of FHA-approved lenders at 74 FR 62521.
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    FHA also announced and implemented an increase in the upfront 
mortgage insurance premium. By Mortgagee Letter 2010-02, FHA notified 
the industry that FHA will collect an upfront mortgage insurance 
premium of 2.25 percent for FHA loans for which case numbers are 
assigned on or after April 5, 2010. As the Mortgagee Letter provides, 
the new upfront premium is applicable to mortgages insured under the 
MMIF. The Mortgagee Letter advises that the new upfront premium is not 
applicable to mortgages insured under the following programs: Title I 
of the National Housing Act; Home Equity Conversion Mortgages (HECMs); 
HOPE for Homeowners (H4H); Section 247 (Hawaiian Homelands); Section 
248 (Indian Reservations); Section 223(e) (declining neighborhoods); 
and Section 238(c) (military impact areas in Georgia and New York). The 
Mortgagee Letter also advises that there is no change to the amount of 
annual premiums.

III. Proposed Risk Management Initiatives

    In addition to these measures--which address all four components of 
FHA's enhanced risk management approach--this notice proposes to 
tighten FHA's underwriting guidelines in a manner that balances FHA's 
goals of protecting the MMIF's financial health, while continuing to 
meet FHA's historic mission of providing a vehicle for mortgage lenders 
to provide affordable mortgages. Given the importance of maintaining a 
viable MMIF for existing and future homeowners, it is FHA's intent to 
focus only on particular practices that have been found to result in 
extremely poor mortgage loan performance. TABLE A shows that few 
borrowers are served under the standards that FHA is proposing to 
eliminate, relative to the total FHA portfolio.

                                         Table A--FHA Single-Family Insurance Endorsement Shares in CY 2009 \a\
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                                                                                                Credit score ranges
                                                         -----------------------------------------------------------------------------------------------
                   Loan-to-value range                         None           300-499         500-579         580-619         620-679         680-850
                                                             (percent)       (percent)       (percent)       (percent)       (percent)       (percent)
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Up to 90%...............................................            0.03            0.01            0.12            0.48            2.28            3.51
Above 90%...............................................            0.34            0.02            1.39            7.24           35.80           48.77
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\a\ All fully underwritten loans, excluding streamline refinance loans (and reverse mortgages). Source: U.S. Department of Housing and Urban Development/
  FHA; February 2010.

    Table B clearly indicates, through the performance data provided, 
that these borrowers are at significantly greater risk of losing their 
homes.

                                                          Table B--FHA Single-Family Insurance
                                  [Seriously Delinquent Rates \a\ by LTV and Credit Scores \b\ as of January 31, 2010]
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                                                                                                Credit score ranges
                                                         -----------------------------------------------------------------------------------------------
                        LTV range                              None           300-499         500-579         580-619         620-679         680-850
                                                             (percent)       (percent)       (percent)       (percent)       (percent)       (percent)
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Up to 90%...............................................            13.3            35.4            22.4            15.7             6.1             1.5
Above 90%...............................................            20.9            43.3            30.4            19.6             8.6             2.3
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\a\ Seriously delinquent rates measure the sum of 90\+\-day delinquencies, in-foreclosure, and in-bankruptcy cases, as a percent of all actively insured
  loans on a given date.

[[Page 41220]]

 
\b\ Due to restrictions on the availability of loan-origination credit score data, this table includes only actively insured loans that were endorsed
  for insurance starting in Fiscal Year 2005. This table does not include information on streamline refinance loans.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.

    Given FHA's mission, allowing the continuation of practices that 
result in such a high proportion of families losing their homes 
represents a disservice to American families and communities. It is 
FHA's intent to eliminate this portion of its business, and utilize 
other established methods to reach and support these families, such as 
through HUD's housing counseling program, which helps families prepare 
for and achieve sustainable homeownership. The following presents the 
practices that FHA plans to discontinue.
    First, FHA proposes to reduce the amount of closing costs a seller 
(or other interested party) may pay on behalf of a homebuyer financing 
the purchase of a home with FHA mortgage insurance. Secondly, FHA 
proposes to introduce a minimum credit score for eligibility, as well 
as reduce the maximum LTV for borrowers with lower credit scores. 
Finally, FHA proposes to tighten underwriting standards for mortgage 
loans that are manually underwritten. These initiatives are intended to 
reduce the risk to, and assist in the return of, FHA's MMIF capital 
ratio to its mandated threshold. In addition, the initiatives will help 
to continue FHA's traditional role as a stabilizing force in the 
housing market during troubled economic times and remain a source of 
mortgage credit for low- and moderate-income homebuyers. These new 
guidelines are not applicable to mortgages insured under the following 
programs: Title I of the National Housing Act; Home Equity Conversion 
Mortgages (HECMs); HOPE for Homeowners (H4H); Section 247 (Hawaiian 
Homelands); Section 248 (Indian Reservations); Section 223(e) 
(declining neighborhoods); and Section 238(c) (military impact areas in 
Georgia and New York).

A. Reduction of Seller Concession

    When a home seller pays all or part of the buyer's closing costs, 
such payments are referred to as seller concessions.\3\ HUD's existing 
policy regarding concessions is found in Handbook 4155.1, section 2.A.3 
and Handbook 4155.2, section 4.8, which define seller concessions and 
provide that any concessions exceeding 6 percent must be treated as 
inducements to purchase, resulting in a reduction in the FHA mortgage 
amount. This notice proposes to reduce the 6 percent limitation defined 
in the Handbooks to 3 percent. While HUD previously has allowed seller 
concessions of up to 6 percent of the sales price, conventional 
mortgage lenders have capped seller concessions at 3 percent of the 
sales price on loans with LTV ratios similar to FHA. Loans guaranteed 
by the Department of Veterans Affairs cap seller concessions at 4 
percent of the sales price.
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    \3\ Seller concessions include any payment toward the borrower's 
closing costs by any third party with an interest in the 
transaction, to include the seller, builder, developer, mortgage 
broker, lender, or settlement company.
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    FHA proposes to cap the seller concessions in FHA-insured single-
family mortgage transactions at 3 percent of the lesser of the sales 
price or appraised value, for the purpose of calculating the maximum 
mortgage amount. Table C shows that borrowers who received more than 3 
percent in seller concessions had a significantly higher risk of losing 
their homes. While seller concessions above 3 percent would not be 
prohibited under this proposal, concessions that exceed FHA's 3 percent 
cap would be required to result in a dollar-for-dollar reduction in the 
sales price for the purpose of calculating the maximum FHA loan amount. 
This proposed cap will not only align FHA's single-family mortgage 
insurance programs to industry practice, but will help ensure that 
borrowers who rely on FHA-insured financing have sufficient investment 
in their home purchases and are less likely to default.

                                                          Table C--FHA Single-Family Insurance
                       [To-Date Claim Rates by Seller Concession Level--Percentage of Home Purchase Price as of January 31, 2010]
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                                                                        Concession rates                                Comparative ratios
                Endorsement fiscal year                -------------------------------------------------------------------------------------------------
                                                             Zero        Low: up to 3%   High: above 3%      Low/Zero        High/Zero       High/Low
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2003..................................................            6.5%            6.2%             10.0%            0.96            1.55            1.61
2004..................................................            6.3%            7.0%             11.0%            1.11            1.76            1.59
2005..................................................            6.9%            7.9%             10.9%            1.14            1.58            1.38
2006..................................................            6.3%            7.5%              9.5%            1.19            1.51            1.27
2007..................................................            4.5%            5.3%              6.5%            1.19            1.46            1.23
2008..................................................            1.0%            1.2%              1.7%            1.18            1.67            1.41
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Low = greater than zero and up to 3% of the sales price; High = greater than 3% of the sales price and up to 6%. Source: U.S. Department of HUD/FHA;
  Home Purchase loans excluding HECM, February 2010.

B. New LTV Ratio and Credit Score Requirements

    FHA is proposing to introduce a minimum decision credit score of no 
less than 500 to determine eligibility for FHA financing and reduce the 
maximum LTV for all borrowers with decision credit scores of less than 
or equal to 579. Maximum FHA-insured financing (96.5 percent LTV for 
purchase transactions and 97.75 percent LTV for rate and term refinance 
transactions) would be available only to borrowers with credit scores 
at or above 580. All borrowers with decision credit scores between 500 
and 579 would be limited to 90 percent LTV.
    The decision credit score used by FHA in this analysis is based on 
methodologies developed by the FICO Corporation. FICO scores, which 
range from a low of 300 to a high of 850, are calculated by each of the 
three National Credit Bureaus and are based upon credit-related 
information reported by creditors, specific to each applicant. Lower 
credit scores indicate greater risk of default on any new credit 
extended to the applicant. The decision credit score is based on the 
middle of three National Credit Bureau scores or the lower of two 
scores when all three are not available, for the lowest scoring 
applicant. While FHA's historical data and analysis is derived from the 
``FICO-

[[Page 41221]]

based'' decision credit score, it is not FHA's intent to prohibit the 
use of other credit scoring models to assess an FHA borrower's credit 
profile. In this notice, FHA seeks comment on the best means for FHA to 
provide guidance to the industry on acceptable score ranges for other 
scoring models, to ensure that the scales used for all scoring systems 
are consistent and appropriate for an FHA borrower.
    While FHA is serving very few borrowers with credit scores below 
500, as shown in TABLE A, the performance of these borrowers is clearly 
very poor, as reflected in TABLES B and D. TABLE D shows the serious 
delinquency rates for borrowers with credit scores below 500, 
demonstrating that these borrowers struggle to meet their mortgage 
obligations. TABLE E demonstrates that the percentage of borrowers who 
ultimately lose their homes is twice as high for borrowers with lower 
credit scores. Similarly, FHA data demonstrates that borrowers with 
decision credit scores below 580, who invest only a minimal amount of 
funds into the transaction, struggle to make their mortgage payments 
and ultimately lose their homes at a rate that is unacceptable to FHA. 
Table D shows that borrowers affected by this notice have seriously 
delinquent rates four to five times higher than those who remain 
eligible.

                  Table D--FHA Single Family Insurance
  [Seriously Delinquent Rates by Proposed Credit Score Floor\a\ January
                                31, 2010]
------------------------------------------------------------------------
                    Below 500 Floor    Below 580 Floor
   Above Floor       (LTV up to 90)    (LTV above 90)       All Loans
------------------------------------------------------------------------
          7.63%             35.38%             29.80%             9.29%
------------------------------------------------------------------------
\a\ On active insured cases meeting today's underwriting criteria, which
  require 10% down for borrowers with credit scores below 500, excluding
  streamline refinance loans, endorsements Fiscal Years 2005-2009.
  Source: U.S. Department of Housing and Urban Development, Federal
  Housing Administration; February 2010.

    FHA data indicate that insured mortgages with decision credit 
scores below 580 have significantly worse default and claim experience 
than do loans at or above 580. As seen in Table D, the seriously 
delinquent rate on actively insured mortgage loans in January 2010 was 
more than three times as high for loans below the proposed floor versus 
those above the floor. Higher delinquencies do translate into higher 
insurance claims over time. Table E shows the to-date claim rate of 
insured loans above and below the proposed floor, for Fiscal Years 
(FYs) 2005--FY 2008 books of business. The claim rate of mortgage loans 
below the floor is more than twice as high as those mortgage loans with 
credit characteristics above the floor.

                                      Table E--FHA Single Family Insurance
 [To-Date Claim Rates on Fully Underwritten Loans\a\ by Proposed FICO Floor Restrictions (Above or Below)\b\ as
                                              of January 31, 2010]
----------------------------------------------------------------------------------------------------------------
                                           Decision Credit Score Floor
    Endorsement FY    ---------------------------------------------------------------------   Ratio Below/Above
                               Above                  Below                   All
----------------------------------------------------------------------------------------------------------------
                                                  All Borrowers
----------------------------------------------------------------------------------------------------------------
              2005                  5.76%                 14.44%                  7.28%                  2.51
              2006                  5.42%                 12.79%                  6.59%                  2.36
              2007                  3.74%                  8.39%                  4.65%                  2.24
              2008                  0.97%                  2.88%                  1.20%                  2.96
----------------------------------------------------------------------------------------------------------------
The proposed restrictions are a minimum 500 FICO score for borrowers with loan-to-value ratios less than or
  equal to 90%, and a minimum of 580 for borrowers with ratios above 90%.
Source: U.S. Department of Housing and Urban Development; February 2010.

    FHA also must take measures that increase the likelihood that 
borrowers who are offered FHA-insured mortgages are capable of repaying 
these mortgages. The proposed changes announced in this notice address 
these concerns.
    Under this proposal, effectively, a borrower with a decision credit 
score between 500 and 579 would be required to make a greater 
downpayment [at minimum, 10 percent] than a borrower with a higher 
score, for the purchase of a home with the same sales price.\4\ 
Borrowers with credit scores below 500 would not be eligible for FHA-
insured financing. The proposed new LTV and credit score requirements 
will reduce the risk to the MMIF and ensure that home buyers are 
offered mortgage loans that are sustainable.
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    \4\ FHA will continue to allow borrowers to use permissible 
sources of funds, as described in FHA Handbook 4155.1, paragraph 
5.B.1, to meet the minimum cash investment in the form of a 
downpayment. Gifts from family members, charitable organizations, 
employers, and government entities are also permitted, provided that 
none of the parties financially benefit from the sales transaction. 
In addition, governmental entities, including instrumentalities 
thereof, as described in Section 528 of the National Housing Act, 
may offer secondary financing to cover the borrowers' cash 
investment.
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    Proposed Exemption for Borrowers Seeking to Refinance. While FHA 
proposes to introduce a minimum decision credit score of no less than 
500 to determine eligibility for FHA financing and to reduce the 
maximum LTV for all borrowers with decision credit scores between 500 
and 579, FHA is also considering a special, temporary allowance to 
permit higher LTV mortgage loans for borrowers with lower decision 
credit scores, so long as they involve a reduction of existing mortgage 
indebtedness pursuant to FHA program adjustments announced on March 26, 
2010. The program adjustments will be proposed under separate notice. 
The current mortgage lender will need to agree to accept a short pay 
off, accepting less than the full amount owed on the original mortgage 
in order to satisfy the outstanding debt. This exemption will be 
applicable only to borrowers with credit scores between 500 to 579. 
Given the current economic conditions and the

[[Page 41222]]

need (and encouragement by federal and other governmental programs) to 
refinance mortgages in order to obtain a more affordable mortgage 
through lower monthly payments, the decision credit scores proposed by 
this notice may be counterproductive in helping existing homeowners 
save their homes. Existing homeowners have an established payment 
history that can be taken into consideration in the underwriting 
process, but FHA recognizes that even homeowners who have been able to 
make their monthly payments may have had their credit scores negatively 
impacted by the downturn in the economy which has so seriously affected 
the housing market. FHA's consideration of different credit score 
requirements for refinance transactions would only be temporary, and 
would be applicable only to refinanced mortgages involving a short pay 
off. FHA is not proposing this distinct criteria permanently for 
refinance transactions, but rather only for such period as would help 
existing homeowners maintain their homes during this current economic 
downturn. FHA is proposing only different credit scores for refinance 
transactions to continue through, but not beyond, December 31, 2012. 
HUD specifically seeks comment on FHA's proposal.

C. Manual Underwriting

    The purpose of mortgage underwriting is to determine a borrower's 
ability and willingness to repay the debt and to limit the probability 
of default. An underwriter must consider a borrower's credit history, 
evaluate their capacity to repay the loan based on income and current 
debt, determine if the cash to be used for closing is sufficient and 
from an acceptable source, and determine if the value of the collateral 
supports the amount of money being borrowed.
    In cases where the borrower has very limited or nontraditional 
credit history, a FICO credit score may not have been issued by the 
credit bureaus, or the credit score may be based on references that are 
few in number or do not effectively predict future credit worthiness.

                                     Table F--Manual Underwriting Standards
----------------------------------------------------------------------------------------------------------------
             LTV                     Credit score                 Ratios                      Reserves
----------------------------------------------------------------------------------------------------------------
90.00%.......................  >= 500 to <= 579........  31/43%--Cannot Exceed...  1 month PITI
96.50%*......................  >= 580 to 619...........  31/43%--Cannot Exceed...  1 month PITI
                               Nontraditional Credit...
96.50%*......................  >= 620 and above........  31/43%--May Exceed......  1 month PITI
----------------------------------------------------------------------------------------------------------------
* Cash-out refinance LTV limit is 85% and conventional-to-FHA refinance LTV limit is 97.75%.

Mortgage loans for borrowers in this category will need to be manually 
underwritten as are all ``Refer'' risk classifications provided by 
FHA's TOTAL Mortgage Score Card. Naturally, these categories of 
borrowers present a higher level of risk and, as a result, manual 
underwriting guidelines are generally more stringent to address that 
higher risk level.
    FHA has determined that factors concerning borrower housing and 
debt-to-income ratios, along with cash reserves, are good predictive 
indicators as to the sustainability of the mortgage. FHA is proposing 
to implement additional requirements that will consider these factors 
for manually underwritten mortgage loans, as seen in TABLE F.
    These additional requirements will consider the borrower's credit 
history, LTV percentage, housing/debt ratios, and reserves. On all 
manually underwritten mortgage loans, borrowers will be required to 
have minimum cash reserves equal to one monthly mortgage payment, which 
includes principal, interest, taxes, and insurance(s). Maximum housing 
and debt-to-income ratios will be set at 31 percent and 43 percent, 
respectively. Borrowers with credit scores of 620 or higher may exceed 
the qualifying ratios of 31/43 percent, not to exceed 35/45 percent 
provided that they are able to meet at least one of the compensating 
factors listed below. To exceed the qualifying ratios of 35/45 percent, 
not to exceed 37/47 percent, borrowers must meet at least two 
compensating factors listed below. Any other compensating factors are 
not acceptable. Mortgage lenders cannot use compensating factors to 
address unacceptable credit. While this notice does not address the 
interplay of the housing and debt-to-income ratios, FHA is seeking 
comment on how to serve borrowers with housing ratios above the 
threshold and debt-to-income ratios below the threshold, i.e., 36/36 
percent.
    Acceptable compensating factors are:
     The borrower will have a documented significant decrease 
or a documented minimal change in housing expense AND a documented 12-
month housing payment history with no more than 1X30 late payments, 
e.g., no more than one month late on all rental or mortgage payments 
made within the month due.
     Documented significant additional income that is not 
considered effective income, e.g., part-time income that does not meet 
the requirements in Handbook 4155.1, paragraph 4.D.2.d., and is not 
reasonably expected to continue for the next 2 years.
    Documented cash reserves in the amount of 3 total monthly mortgage 
payments (principle, interest, taxes, insurance). The reserves, 
consisting of the borrower's own funds, must be liquid or readily 
accessible, and may not consist of gift funds.
     Energy Efficient Mortgages, as well as those homes that 
were built to the 2000 International Energy Conservation Code, formerly 
known as the Model Energy Code, or are being retrofitted to that 
standard, have ``stretch ratios'' up to 33/45 percent.
    TABLE G shows that borrowers who met the proposed ratio and reserve 
requirements performed considerably better than those borrowers who did 
not meet the same guidelines. These proposed new requirements for 
manual underwriting will reduce the risk to the FHA MMIF, by helping to 
ensure that home buyers are financially capable of repaying the 
mortgage loan to be insured by FHA.

[[Page 41223]]



                                                          Table G--FHA Single-Family Insurance
                       [Credit Risk Comparisons for Proposed Limits on Manual Underwriting Approvals Data as of January 31, 2010]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Seriously                       Seriously
                                                           To-date claim    delinquent     To-date claim    delinquent      Claim rate       Seriously
                 Endorsement fiscal year                  rate (percent)     rate \a\     rate (percent)     rate \a\          ratio        delinquent
                                                                             (percent)                       (percent)                      rate ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                            LTV up to 90, meeting ratio
                                                                and reserve limits
                                                                LTV up to 90, not meeting ratio and reserve limits
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004....................................................             4.3            21.2             6.3            26.7            1.48            1.26
2005....................................................             4.0            21.2             5.6            27.1            1.41            1.28
2006....................................................             4.4            26.3             5.2            35.4            1.18            1.35
2007....................................................             2.9            25.1             3.3            36.1            1.13            1.44
2008....................................................             0.6            20.2             1.3            30.4            2.23            1.51
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Above 90 LTV, 580-619 FICO (or
                                                          nontraditional credit) meeting
                                                          ratio and reserve requirements
                                                            Above 90 LTV, 580-619 FICO (or nontraditional credit), not
                                                                      meeting ratio and reserve requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004....................................................             5.0            15.9             5.8            20.2            1.18            1.27
2005....................................................             5.0            18.4             7.2            24.5            1.43            1.33
2006....................................................             5.3            21.8             7.3            30.8            1.38            1.42
2007....................................................             2.9            23.5             4.4            33.7            1.51            1.43
2008....................................................             0.9            19.4             1.2            27.4            1.35            1.41
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             Above 90 LTV, FICO > 620
                                                              meeting reserve limits
                                                            Above 90 LTV, FICO > 620, not meeting reserve requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
2004....................................................             3.2            10.8             4.7            13.6            1.48            1.26
2005....................................................             3.9            12.6             5.0            17.0            1.29            1.35
2006....................................................             3.5            20.4             5.6            22.1            1.59            1.08
2007....................................................             2.7            21.8             4.2            27.3            1.59            1.25
2008....................................................             0.9            17.7             1.0            21.6            1.19            1.22
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ The seriously delinquent rate is the sum of all loans 3 or more months delinquent, plus all in-foreclosure and in-bankruptcy cases, as a ratio of
  all active insurance in-force.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.

    Table H shows that borrowers with credit scores below 620 who did 
not meet the proposed ratio and reserve requirements performed 
significantly worse than borrowers meeting those requirements.

                                      Table H--FHA Single-Family Insurance
   [Comparison of Seriously Delinquent Rates \a\--by Proposed Manual Underwriting Standards All Active Loans]
----------------------------------------------------------------------------------------------------------------
                                                             Loans that meet
                                                             proposed ratio     Loans that do   Ratio: not meet/
           LTV ratio                 Credit score range        and reserve        not meet            meet
                                                               limits \b\      proposed limits
----------------------------------------------------------------------------------------------------------------
Up to 90.......................  500-579..................             22.02             30.06              1.37
Above 90.......................  580-619 or nontraditional             18.33             26.15              1.43
                                  credit.
Above 90.......................  620 or above.............             12.01             17.05              1.42
----------------------------------------------------------------------------------------------------------------
\a\ The seriously delinquent rate is the sum of all loans 3 or more months delinquent, plus all in-foreclosure
  and in-bankruptcy cases, as a ratio of all active insurance in force.
\b\ See Chart below for Proposed Ratio and Reserve Limits.
Source: U.S. Department of Housing and Urban Development/FHA; February 2010.

    All borrowers with credit scores must be classified by FHA's TOTAL 
Mortgage Scorecard to determine if manual underwriting is required. In 
cases where TOTAL Scorecard refers the case for manual underwriting, or 
in cases where the borrower(s) has no credit score, FHA is proposing 
the additional requirements for manual underwriting as illustrated in 
TABLE F. This table is applicable for purchase transactions, FHA cash-
out refinance transactions, and all conventional to FHA refinance 
transactions. TABLE F is not applicable for FHA-to-FHA rate and term 
refinance (no cash-out), FHA streamline refinance (including credit 
qualifying), and HECM transactions.
    The proposed changes announced in this notice will preserve both 
the historical role of the FHA in providing liquidity to the housing 
and mortgage markets during periods of economic volatility, as well as 
HUD's social mission of helping underserved borrowers access capital 
when the private sector needs additional credit enhancement to do so.

IV. Solicitation of Public Comments

    FHA welcomes comments on the proposed risk management initiatives 
for a period of 30 calendar days. All comments will be considered in 
the development of the final Federal Register notice announcing the 
risk management initiatives and providing their effective date.

[[Page 41224]]

V. Findings and Certification

Executive Order 12866, Regulatory Planning and Review

    The Office of Management and Budget (OMB) reviewed this notice 
under Executive Order 12866 (entitled ``Regulatory Planning and 
Review''). The notice was determined to be a ``significant regulatory 
action,'' as defined in section 3(f) of the Order (although not 
economically significant, as provided in section 3(f)(1) of the Order).
    In this notice, FHA proposes three policy changes that FHA can 
implement to replenish the MMIF capital reserve account. First, FHA 
proposes to reduce the amount of financing costs a property seller or 
other interested party may pay on behalf of a homebuyer using an FHA-
insured mortgage. This proposed cap on ``seller concessions'' will more 
closely align FHA's single family mortgage insurance programs with 
standard industry practice and minimize FHA exposure to the risk of 
adverse selection. Secondly, FHA proposes to introduce a two-part 
credit-score threshold, with one lower bound for loans with loan-to-
value ratios of 90 percent or less, and a higher threshold for those 
with loan-to-value ratios up to the statutory maximums. This will be 
the first time that FHA has ever instituted an absolute lower-bound for 
borrower credit scores. Borrowers with low credit scores present higher 
risk of default and mortgage insurance claim. Third, FHA will tighten 
underwriting standards for mortgage loan transactions that are manually 
underwritten. Such transactions that lack the additional credit 
enhancements proposed under this Notice result in higher mortgage 
insurance claim rates and present an unacceptable risk of loss. The 
benefit of these set of actions will be to reduce the net losses due to 
high rates of insurance claims on affected loans, while the cost will 
be the value of the homeownership opportunity denied to the excluded 
borrowers. The total saving to the FHA would be $96 million in reduced 
claim losses and the net cost to society of excluding reduced 
homeownership rates could be as high as $82 million.
    With respect to expected benefits of this policy change, as noted 
earlier, the direct purpose of the policy change is to achieve the 
statutorily mandated minimum capital reserve ratio of 2 percent. The 
broader purpose of the policy change, however, and of the capital 
reserve ratio requirement itself, is to ensure the financial soundness 
of the FHA throughout a wide range of economic conditions. The current 
financial crisis has led to a credit crunch in which FHA has become the 
only source of mortgage credit for households who lack significant 
funds for downpayments and who do not have pristine credit histories. 
FHA's share of the single family mortgage market today is approximately 
30 percent--up from a low point of just 3 percent in 2007. The dollar 
volume of insurance written jumped from just $56 billion in 2007 to 
over $300 billion in 2009. Facilitating the provision of credit during 
a liquidity crisis is a welfare-enhancing activity and the FHA provides 
such a public benefit. Quantifying the benefit involves measuring the 
extent to which this Notice increases the abilities of the FHA to meet 
its mission requirements without having to substantially increase 
insurance premiums, and then estimating the value of the net economic 
benefits provided to households by the housing options afforded them 
through FHA insurance.
    With respect to possible costs of this policy change, FHA 
recognizes that tightening its underwriting guidelines will cause 
excluded households to either delay transition to homeownership status 
or else never make that transition. For refinance loans, the proposed 
restrictions will cause higher housing costs until such time as the 
excluded households can improve their credit histories and/or gain more 
home equity through general market-level house price appreciation. 
Individuals may face other costs from being excluded from an FHA-
insured loan, one of which is a search cost for an alternative. 
However, an individual lender or broker will offer a wide variety of 
products to a potential customer. An FHA loan is only one of many 
products offered by the typical lender so that the typical potential 
borrower is not likely to go to another lender. The lender would inform 
the applicant that FHA guidelines have changed and that given their 
credit score, there are no loans for that individual. Some consumers 
may wish for a second opinion, however, in which case they would expend 
additional resources and time. If for example, a consumer spent two 
hours valued at $40 per hour and another $20 for an additional credit 
report, then the search cost would be $100 for a fraction of the 
excluded borrowers.
    The foregoing provides only a brief overview of the analysis that 
HUD undertook in assessing costs and benefits. HUD's full analysis can 
be found at http://www.hud.gov/offices/hsg/sfh/hsgsingle.cfm.
    The docket file is available for public inspection in the 
Regulations Division, Office of General Counsel, Department of Housing 
and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC 
20410-0500. Due to security measures at the HUD Headquarters building, 
please schedule an appointment to review the docket file by calling the 
Regulations Division at 202-402-3055 (this is not a toll-free number). 
Individuals with speech or hearing impairments may access this number 
via TTY by calling the Federal Information Relay Service at 800-877-
8339.

Executive Order 13132, Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any policy document that has federalism implications if 
the document either imposes substantial direct compliance costs on 
state and local governments and is not required by statute, or the 
document preempts state law, unless the agency meets the consultation 
and funding requirements of section 6 of the Executive Order. This 
notice does not have federalism implications and would not impose 
substantial direct compliance costs on state and local governments or 
preempt state law within the meaning of the Executive Order.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (2 U.S.C. 
1531-1538) (UMRA) establishes requirements for federal agencies to 
assess the effects of their regulatory actions on state, local, and 
tribal governments, and on the private sector. This notice would not 
impose any federal mandates on any state, local, or tribal governments, 
or on the private sector, within the meaning of UMRA.

Environmental Impact

    A Finding of No Significant Impact (FONSI) with respect to the 
environment has been made in accordance with HUD regulations at 24 CFR 
part 50, which implement section 102(2)(C) of the National 
Environmental Policy Act of 1969 (42 U.S.C. 4332(2)(C)). The Finding of 
No Significant Impact is available for public inspection between the 
hours of 8 a.m. and 5 p.m. weekdays in the Regulations Division, Office 
of General Counsel, Department of Housing and Urban Development, 451 
7th Street, SW., Room 10276, Washington, DC 20410. Due to security 
measures at the HUD Headquarters building, please schedule an 
appointment to review the FONSI by calling the Regulations Division at 
202-708-3055 (this is not a toll-free number). Individuals with speech 
or hearing impairments may access this number via TTY by calling the 
Federal

[[Page 41225]]

Information Relay Service at 800-877-8339.

    Dated: July 9, 2010.
David H. Stevens,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 2010-17326 Filed 7-14-10; 8:45 am]
BILLING CODE 4210-67-P