Every single day I receive numerous emails and phone calls from loan originators and potential borrowers asking whether FHA guidelines have changed and asking me why a particular loan scenario can no longer be approved as an FHA loan. Consumers, in particular often get confused when I explain that FHA guidelines are not the issue. The problem is with the lender they or their mortgage broker have chosen.
In just the last few months I have seen ridiculous scenarios such as borrowers being asked for full documentation of their income on FHA streamline refinances! Or borrowers’ credit scores becoming an issue on streamline refinances.
Some time ago we began to see many lenders start enforcing a 580 minimum credit score in order to qualify for an FHA loan. At the end of January, Wells Fargo raised the minimum credit score for loans submitted by mortgage brokers to 620. To put that into perspective, a couple of years ago 620 was the score we looked for to qualify for a conventional Fannie Mae or Freddie Mac loan. At about the same time, everyone received a memo from Taylor, Bean and Whitaker - for a very long time one of the last bastions of wholesale lenders who followed FHA guidelines and still my personal favorite lender - indicating that TBW would no longer accept FHA loans with credit scores under 600.
I know that, to people with good credit, and to mortgage originators who specialize in loans for clients with excellent credit, griping about having to adhere to credit scores that low seems ridiculous. But to those loan originators who have made a specialty of helping good people who’ve been thrown a few unexpected curveballs in life yet still recovered, this goes against everything the FHA program represents.
I want to make one thing clear. I’m not talking about those people the subprime industry pushed into home loans without caring about anything except whether their credit profile fit into a box in a qualifying matrix. The people who had a history of borrowing too much every time they got access to credit again and then letting everything go when the payments added up. I’m talking about people who may have been laid off, or the primary wage earner in their family had health problems but who fought tooth and nail trying to keep their head above water and only used their credit cards to keep food on the table until they had to choose between their power bill or their credit card payment. But who did everything they could to re-establish a good payment history once their emergency was over. The kind of people who have downright terrible credit scores but are really a good bet when it comes to whether or not they will make their house payment.
Over 24 years in the real estate/mortgage industry has shown me that there are a lot of people in both of those groups. Over the last few years there has even been another group. Those with 690 to 750 credit scores who would gladly take a $10,000 payment from a house flipper to stand in as a straw buyer to help consummate a fraudulent real estate transaction.
Now, in the midst of this huge crisis the mortgage industry is in, those good folks are being thrown under the bus because the mortgage industry has become too reliant on automated underwriting and credit scores instead of traditional guidelines and common sense. The system has become disconnected from the people and it gets worse every day.
I can’t count the number of times I’ve looked a 750 credit score borrower in the eyes and spoken with them and just known that I couldn’t rely on them to pay back $20 in gas money much less a home loan. Yet they have credit that causes the automated systems to allow them to be approved with 58% debt to income ratios. The kind of people who have good credit scores, but you can easily see would run those credit cards up to their high limits with no qualms whatsoever. Who you know in your gut from your conversation would walk away from their home loan if the mortgage balance was even slightly under water. And I’ve known of many of this group who did just that.
And I’ve seen an equal number of 550 credit score borrowers (or worse) who fought their way out of bankruptcy after a horrendous unexpected catastrophe. Who don’t even have any high credit limits to run up to if they wanted. But who would fight tooth and nail to keep their home paid for even if it was worth 80% of what they paid for it. Just because it is their “home” and not just a house. The kind of people who have always been helped by the traditional FHA loan, but who have already been fighting an uphill battle against automated underwriting for years.
Underwriters today (and in the underwriters’ defense, lenders as well) want to see those automated approvals that cause them not to have to look at the patterns of the borrowers’ credit and find out why those people had problems and what they’ve done to stop them from happening again.
Why is all this happening? It’s almost as if common sense has been divorced from the mortgage industry for so long that no one can imagine how we did it back when underwriters really tried to analyze people and not just “files”. Before complicated software started (supposedly) analyzing things underwriters couldn’t possibly even understand. Like what the chances of default were just because you had a department store card compared to not having one. Or how many and what type of lines of credit the group of people likely to make their payments possessed. The funny thing is that defaults have gone up by unbelievable order of magnitude since the mortgage industry started using these more advanced and supposedly accurate methods of underwriting.
I know lenders have all sorts of reasons they feel we need these higher credit scores. They’ve analyzed all the pools and tranches and macro trends and determined that groups of loans with these characteristics will be more likely to perform as investments. But the sad thing is that no one is comparing today’s loans to the days when real people took their time and followed the debt ratio guidelines and asked people why they were late on their payments. When it took a month or more and stacks and stacks of paper to check and double check and make sure a good decision was being made. Before the whole goal became to close as many loans as you can as fast as you can so you can collect your fees and turn the loan over to the next company to collect the payments.
Maybe, just maybe, this is one process that hasn’t improved with time. Maybe it’s time to give very serious thought about whether automated underwriting has been a positive influence in the mortgage industry as a whole and in FHA lending in particular. I’d love to hear your thoughts.
Update: In a comical turn of events as we face FHA loans with minimum credit scores of 620 in some instances, here is a quote from a Fannie Mae guideline update published just after I wrote the above post:
"Starting April 4, 2009…
In order to provide lenders with increased efficiencies for the origination and underwriting of limited cash-out refinance transactions, and allow more borrowers to take advantage of today’s historically low interest rates…
Expanded Eligibility Criteria
The following expanded eligibility guidelines will be applied to limited cash-out refinance loan casefiles meeting the DU Refi Plus eligibility criteria noted above (including the successful identification of the existing Fannie Mae mortgage loan):
- Loan casefiles with an LTV less than or equal to 80 percent will not be subject to the minimum “representative” credit score requirement of 580.
- High-balance mortgage ARM loan casefiles with an LTV less than or equal to 80 percent will not be subject to the minimum “representative” credit score requirement of 680.
Reduced Employment Documentation Requirements
DU will offer the following reduced employment documentation requirements on all DU Refi Plus eligible loan casefiles:
- Salary/Bonus/Overtime: one current paystub and a verbal verification of employment
- Commission/Self-Employment: one year’s federal income tax return"
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