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FHA brings back more manual underwriting for high-risk loans

Increased borrower risks over the past several years has led the Federal Housing Administration (FHA) to update the evaluation process for single-family mortgages that involve borrowers with low credit scores and high debt-to-income (DTI) ratios.

FHALoanAccording to a letter released this month by the FHA, the agency will update its Technology Open to Approved Lenders (TOTAL) Mortgage Scorecard system to refer more high-risk applications for manual underwriting. The change applies to loans with case numbers assigned on or after March 18, 2019.

The FHA cited an increase of mortgage applications with high DTIs and lower credit scores as an impetus for the change. Almost 25 percent of all FHA-insured purchase transactions in fiscal-year 2018, for example, involved a borrower with a DTI greater than 50 percent — the highest percentage since 2000. Likewise, the past fiscal year saw an average borrower credit score of 670, the lowest figure since 2008.

DTIs and credit scores have become increasingly risky so far this year. More than 28 percent of FHA endorsements in January had a DTI above 50 percent, while more than 13 percent of FHA endorsements in first-quarter 2019 include credit scores of less than 620. Additionally, the FHA said that it is seeing an “increasing concentration” of loan applications with sub-640 credit scores combined with DTI ratios greater than 50 percent.

The letter did not specify a concrete combination of risk factors that would lead the TOTAL scorecard to flag an application for manual underwriting. Still, lenders should anticipate an increase in the number of loans referred to a Direct Endorsement underwriter.

The change is a partial return to regulations of a few years ago. TOTAL was updated in 2013 to include manual-underwriting requirements for borrowers with credit scores below 620 and DTIs above 43 percent. Back then, the Department of Housing and Urban Development (HUD) specifically instructed lenders to flag such mortgages for manual underwriting, even if TOTAL did not.

That requirement, however, was abolished when HUD revised the TOTAL user guide in August 2016 — a move that FHA now claims has contributed to the increase in high-risk loan endorsements.

“Federal Housing Commissioner [Brian] Montgomery has publicly stated numerous times in recent months that FHA must seek the right balance between managing risk and fulfilling its mission of supporting sustainable homeownership,” the FHA’s letter stated. “To be successful long term, FHA must maintain the integrity of its insurance endorsements.”

Lenders and mortgage originators can likely expect additional changes moving forward that are designed to mitigate risk in the FHA portfolio. The agency “will carefully monitor the impact of this change and is preparing to implement additional changes to maintain a better balance of managing risk and fulfilling its mission," the letter stated.



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