A Shrinking FHA Footprint In 2019?
An update to the TOTAL Mortgage Scorecard may foreshadow additional Federal Housing Administration (FHA) restrictions over the coming years.
The Federal Housing Administration (FHA) announced on March 14 that it’s updating its TOTAL Mortgage Scorecard to redefine which loans need to be manually underwritten. While the impact of this change will be felt most by borrowers with low credit scores and high debt-to-income (DTI) ratios, it also may foreshadow more FHA restrictions over the coming year as the agency strives to mitigate risks in its single-family portfolio.
The TOTAL Mortgage Scorecard
The TOTAL (Technology Open To Approved Lenders) Mortgage Score-card is an algorithm accessed through an automated underwriting system that evaluates borrower credit history and application information. Lenders are required to score potential FHA loans through TOTAL, except for streamline refinances, Home Equity Conversion Mortgages, Title I mortgages, and loans involving borrowers without credit scores.
TOTAL recommends a decision of “Accept” or “Refer” for each application. “Accept” means the FHA will insure the borrower’s loan with reduced documentation and without a manual underwriting review, and “Refer” means the loan must be underwritten by a Direct Endorsement (DE) underwriter using FHA guidelines.
What the New FHA Guidelines Do
FHA now advises that, for loans with case numbers assigned on or after March 28, 2019, borrowers with credit scores of under 620 and DTIs of over 43 percent may receive results from TOTAL indicating that the loan must be manually underwritten. This is a reversal of its 2016 decision to remove similar requirements it had imposed in 2013.
Since the FHA did not identify precise loan characteristics other than low credit scores and high DTI ratios that may trigger manual underwriting, questions remain as to what other factors or combinations of factors will create a manual underwriting referral.
The Potential Impact
Overall, the percentage of loans flagged for manual underwriting is expected to be relatively small. An FHA official reportedly told The Wall Street Journal that approximately 40,000 to 50,000 loans a year likely will be affected by the manual underwriting trigger, which amounts to 4 to 5 percent of all the mortgages the FHA insures on an annual basis.
But mortgage industry observers say it’s likely that many of the loans targeted for manual underwriting will end up being disqualified, since DE underwriters may be cautious about approving marginal loans that could affect their endorsement authority—even if there are compensating factors that could improve a borrower’s chance of qualifying.
The Reasons Why
The FHA took this step because it has insured an increasing number of loans in recent years with high-risk credit characteristics that it believes could lead to higher default rates and more insurance claims. This could eventually drain the Mutual Mortgage Insurance Fund.
The agency highlighted the following risk factors in its Annual Report to Congress released in November 2018:
- Increased Cash-Out Refinances: FHA cash-out refinances increased by about 60 percent in 2018, compared to total refinances.
- Higher Debt-to-Income (DTI) Ratios: During the fiscal year 2018, 25 percent of all FHA forward mortgage purchase transactions had DTI ratios above 50 percent, the highest percentage since 2000. The average borrower DTI ratio continued to increase for the sixth straight year and was 43.09 percent for the fiscal year 2018.
- Lower Credit Scores: Borrower credit scores dropped to an average of 670 in 2018, the lowest average since 2008. First Quarter 2019 statistics show that they are continuing to decline, with 28 percent of all FHA loans having credit scores under 640 and 13 percent having credit scores under 620.
Is There More to Come?
The FHA has cautioned that this TOTAL Mortgage Scorecard modification is just the first step it will be taking to address the higher risk factors in its loan pool.
President Trump’s Housing Policy Reform Plan announced on March 27, identifies two FHA programs involving higher credit risks that will be assessed in 2019. The Plan instructs the FHA to “address the financial viability of it’s Home Equity Conversion Mortgage (HECM) program,” which had a negative economic net worth of over $13 billion in the last fiscal year. It also directs the FHA to assess “the risks and benefits associated with providing assistance to first-time homebuyers, including down payment assistance.” The share of FHA mortgages with some form of down payment assistance increased to 38.79 percent in the fiscal year 2018 and exhibit higher delinquency and default rates, according to FHA’s 2018 Annual Report.
The bottom line is that buyers, sellers, and real estate professionals could find that loans involving borrowers with lower credit scores and higher DTIs that once made it through the TOTAL system now may be delayed or rejected. There may be more FHA announcements in 2019 that could further shrink the FHA footprint.
Sue Johnson is the former executive director of RESPRO, the Real Estate Services Providers Council Inc. She retired in 2015 and is now a strategic alliance consultant.