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Dim Prospects For FHA Mortgage Borrowers With Big Debts

New HUD regulations show how people with big debts and weak credit can get FHA financing. Or do they?

HUD says that the “FHA will require lenders to manually underwrite loans for which borrowers have a decision credit score below 620 and a total debt-to-income (DTI) ratio greater than 43 percent. Lenders will be required to document compensating factors that support the underwriting decision to approve loans where these parameters are exceeded, using FHA manual underwriting and compensating factor guidelines.”

Get it? This is not a mortgage standard this is a red flag. It says to lenders if you have a borrower with credit below 620 that you must manually underwrite the loan if the borrower’s debts equal 43 percent or more of their monthly income.

The issue is not so much the credit score — borrowers with a credit score of 500 and 10 percent down can get FHA loans — rather it is the combination of weak credit and big debts that sets off alarms.

Think about it: In the age of computers and instant loan decisions if you were a lender would you really want to manually underwrite a loan? If the loan fails you can’t throw up your hands and say it was automatically approved by the underwriting system. It was approved by YOU and you may well have to buy-back the loan if the borrower is foreclosed.


Wall Street Reform

Oh, and by the way, in presenting this difficult loan be aware that under Wall Street Reform points and fees for a qualified mortgage cannot exceed 3 percent of the loan amount, whether you have a borrower with a credit score of 800 or one with a score of 615. Or whether the loan take 46 seconds to process electronically or 14 hours to review paperwork by hand.

It’s not a subtle message. It says to lenders that the risk is on them if they want to issue marginal FHA loans. Yes, such loans can be made, the rules say they can be made, but what lender wants the hassle and potential liability?

This is also not a case of “layering” — a situation where a lender adds standards not required under FHA guidelines. Instead, in this case the lender is required to make a decision based on its valuation of borrower documents. It could say yes or it could say no — and there is very little incentive to say yes.

The betting here is that there will be few loans for individuals with a debt-to-income ratio anywhere near 43 percent and a credit score at 620 or below. Too much work. Too much liability. Too little profit. Instead lenders — being rational — will market to the borrowers who represent the transactions with the fewest hurdles and the least potential for problems.

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