Homeowners whose credit was negatively impacted by the Millennium Boom due to external circumstances may now gain access to FHA-backed financing in as little as one year following a derogatory event. This will funnel a higher volume of FHA-insured funds into the mortgage market, generating more sales volume and broker fees in the process.
Relief from the Millennium Boom fallout
Homebuyers foreclosed upon in the Millennium Boom due to financial circumstances outside their control may now purchase a home earlier than anticipated. Relaxed Federal Housing Administration (FHA) guidelines enable these unintentionally stigmatized homebuyers access to purchase-assist financing. However, they need to meet expanded eligibility standards.
How will the new guidelines impact residential real estate agents? The new FHA guidelines result in the reentry of responsible job-holding homebuyers into the market one to two years ahead of schedule.
FHA-insured financing is a critical artery that funnels money to homebuyers, and by extension, California agents. More homebuyers with access to purchase-assist funds equal more fees for agents in the wake of the housing crisis.
The relaxed rules were released in two FHA mortgagee letters, which:
- lessen the negative impact of collections, disputed accounts and judgments on FHA eligibility; and
- clarify extenuating circumstances for homebuyers who were negatively impacted by the recession, but who now have a job, pay their bills on time and apply for FHA-insured financing.
Credit report woes reexamined
Effective October 15th, 2013, Mortgagee Letter 2013-24 establishes guidelines to navigate the large volume of applicants for low down payment loans negatively affected by:
- disputed accounts; and
The first component of the new guidance covers collections. Collections are delinquent accounts creditors sell to debt collection agencies. Agencies then work to recover the delinquent amounts from debtors.
For example, consider a homebuyer who has $3,000 in outstanding credit card payments. The bank issuing the credit card sells the debt to a collection agency for $1,500 when it no longer expects repayment. The agency then seeks to collect the full $3,000 from the homebuyer. The collection account appears on the homebuyer’s credit report and negatively impacts ability to borrow.
The new rules replace unpopular requirements mandating applicants payoff collections or disputed accounts of $1,000 or greater in order to be eligible for a FHA-backed loan.
The FHA no long requires payoff of collection accounts in order to receive mortgage approval. However, if the total collections amount is $2,000 or greater, the mortgage lender must complete a capacity analysis.
The capacity analysis is used to evaluate whether the homebuyer will be financially capable of making periodic payments to retire the delinquent debt. The capacity analysis also determines if the homebuyer is prepared to pay off the entire collection account prior to closing, making periodic payments unnecessary.
The second component covers derogatory disputed accounts. When an individual claims a derogatory account on their credit report is inaccurate, the account becomes disputed. Credit reporting agencies have 30 days to research the inquiry. At the end of 30 days, the account is either:
- modified; or
- left unaltered, if the account is accurate.
For example, consider a homebuyer with outstanding credit card debt who believes the delinquent amount is $2,000, not $3,000 as it appears on their credit report. The homebuyer reports the error to the credit reporting agency and the account is classified as disputed for the 30 day review period.
Previously, disputed accounts were grouped with collections. Now, manual underwriting by a Direct Endorsement underwriter is required if the total amount of disputed items on a credit report is $1,000 or greater.
Some types of disputed accounts are excluded from the $1,000 limit, such as disputes due to:
- identity theft;
- credit card theft; or
- unauthorized use.
To be excluded, documentation of proof must be submitted to the FHA, such as a letter from the creditor or a police report.
Disputed medical accounts are also excluded but do not require documentation.
The final component of the letter pertains to court ordered judgments. Judgments occur when collection agencies take delinquent accounts to court and a judge orders the debtor to pay.
For example, consider a homebuyer with $3,000 in outstanding credit card debt who fails to pay the collection agency. The agency takes the homebuyer to court and the homebuyer is ordered to pay the $3,000.
Unlike collections and disputed accounts, judgments must be paid as a condition for FHA eligibility. However, the borrower may be eligible if an arrangement has been implemented with the creditor for periodic payments. The borrower must also include the agreement and evidence of at least three on time payments prior to approval.
Credit in context
Lenders are required to evaluate whether outstanding collections and judgments are the result of:
- the borrower’s disregard for financial obligations;
- the borrower’s inability to manage debt; or
- extenuating circumstances.
Mortgagee Letter 2013-26 outlines how lenders are to handle extenuating circumstances, which the FHA refers to as economic events.
An economic event is any negative economic occurrence beyond the homebuyer’s direct control which results in loss of employment and/or loss of income. To be considered an economic event, the loss of employment, loss of income or combination of both must cause a 20% or more reduction in the homebuyer’s household income for a period of at least six months.
In the financial crisis, many homebuyers defaulted on their debt obligations due to the national recession and financial crisis. These homebuyers were unable to make their mortgage payments and lost their homes to foreclosure, pre-foreclosure short sale, or a deed-in-lieu of foreclosure, all of which negatively impacted their credit.
As part of their plan to more accurately evaluate homebuyers who have experienced periods of financial difficulty due to extenuating circumstances, the FHA has expanded consideration for loan approval effective August 15th, 2013 through September 30th, 2016.
Under the previous FHA guidance, a homebuyer was not to be eligible for FHA financing until two years after a bankruptcy, and three years after a foreclosure or short sale. Under the new guidance, the homebuyer may be eligible for an FHA-backed mortgage in as little as one year. [HUD Handbook 4155.1: 4.C.2.g-h]
Evidence of eligibility
To qualify for FHA consideration, homebuyers must provide evidence that:
- their credit downgrade was due to an economic event;
- they have fully recovered from the economic event; and
- they have completed housing counseling.
Recovery from a negative economic event is achieved through satisfactory credit. According to the FHA, a homebuyer has satisfactory credit if they:
- are clear of late payments on installment debt and major derogatory credit issues on revolving accounts;
- are current on mortgage payments and have made timely payments for 12 consecutive months; and
- meet the criteria for FHA consideration listed above.
To document a loss of employment, homebuyers are required to supply their lender with:
- a written verification of employment (VOE) with their termination date [See first tuesday Form 210-1]; or
- if the prior employer went out of business, a written termination notice or publicly available documentation of the business closure and documentation of receipt of unemployment income.
Homebuyers will prove a 20% loss of household income through:
- a written VOE providing the amount of prior income [See first tuesday Form 210 and 210-1]; or
- signed tax returns or W-2s confirming prior income.
Want to tap into this new pool of homebuyers? Offer free credit report analysis to homebuyers plagued by collections, disputed accounts and judgments due to extenuating circumstances. Determine if they are FHA-eligible and, if they are not, explain the steps and documentation necessary to become eligible.
Education buttresses market stability
To fulfill the housing counseling requirement, homebuyers need to participate in Department of Housing and Urban Development (HUD)-approved counseling. Be prepared to recommend an approved counselor to your buyer by compiling a list of local agencies from HUD’s online database.
The counseling is intended to educate homebuyers on:
- the different types of loan products and the obligations under them;
- the need for a budget;
- avoiding scams; and
- preparing in advance for unexpected future financial shocks.
Pre-purchase counseling effectively improves homebuyers’ likelihood of sustainably owning a home and making mortgage payments on time. A 2009 HUD Pre-Purchase Counseling Outcome Study found:
- 35 percent of 573 participants became homeowners within just 18 months after seeking pre-purchase counseling; and
- of those homeowners, only one fell at least 30 days behind on mortgage payments 12-18 months after receiving pre-purchase counseling services.
Homebuyers on the up and up after being down and out have the opportunity to start fresh on a foundation of lending knowledge. Guided by the expertise and practical know how of an agent, buyers make educated decisions and contribute much needed market growth and stability by returning to ownership after a past trauma. Good news for California real estate.