C. Borrower Credit Analysis

Past credit performance is the most useful guide to use when

• determining a borrower's attitude toward credit obligations, and
• predicting a borrower's future actions.

Borrowers who have made payments on previous and current obligations in a timely manner represent a reduced risk. Conversely, if a borrower's credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, significant compensating factors will be necessary to approve the loan.

When analyzing a borrower's credit history, examine the overall pattern of credit behavior, not just isolated occurrences of unsatisfactory or slow payments.

A period of past financial difficulty does not necessarily make the risk unacceptable, if the borrower has maintained a good payment record for a considerable time period since the financial difficulty.

The lender must document the analysis of delinquent accounts, including whether late payments were based on

• a disregard for financial obligations
• an inability to manage debt, or
• factors beyond the borrower's control, such as
• delayed mail delivery, or
• disputes with creditors.

Minor derogatory information occurring two or more years in the past does not require an explanation. Major indications of derogatory credit, such as judgments, collections, and other recent credit problems, require sufficient written explanation from the borrower. The explanation must make sense, and be consistent with other credit information in the file.

TOTAL Scorecard Accept/Refer Recommendation

The TOTAL Scorecard Accept recommendation does not require an explanation for adverse credit, or other derogatory information; however, there must be evidence of payoff for any outstanding judgments shown on the credit report.

The TOTAL Scorecard Refer recommendation requires an explanation for major indications of derogatory credit, such as

• judgments and collections, and
• any minor indications within the past two years.

Reference: For more information on the TOTAL Scorecard recommendations, see Pages 18 & 19 of the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

The lack of a credit history, or the borrower's decision to not use credit, may not be used as the basis for rejecting the loan application.

Some prospective borrowers may not have an established credit history. For these borrowers, including those who do not use traditional credit, the lender must obtain a non traditional merged credit report (NTMCR) from a credit reporting company or develop a credit history from

• utility payment records
• rental payments
• automobile insurance payments, and
• other means of direct access from the credit provider.

TOTAL Scorecard Accept Recommendation

If TOTAL Scorecard has issued an Accept recommendation, additional development of credit history is not required.

Reference: For more information on the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

Only if a NTMCR does not exist or such a service is unavailable may a lender choose to obtain independent verification of credit references. Lenders must document that the providers of non traditional credit do exist, and verify the credit information. Documents confirming the existence of a non traditional credit provider may include

• public records from the state, county, or city, or
• other documents providing a similar level of objective information.

To verify credit information, lenders must use a published address or telephone number for the credit provider and not rely solely on information provided by the applicant.

Rental references from management companies with payment history for the most recent 12 months may be used in lieu of 12 months cancelled checks. Credit references may also be developed via independent verification directly to the creditor. If a method other than NTMCR is used to verify credit information or rental references, all references obtained from individuals should be backed up with the most recent 12 months cancelled checks

Lenders may use a non traditional mortgage credit report developed by a credit reporting agency as an alternative method for developing a credit history. Use of this type of report requires that the credit reporting agency has verified

• the existence of the credit providers
• that the non-traditional credit was actually extended to the borrower, and
• the creditor has a published address or telephone number.

Reference: For more information on non traditional credit reports, see HUD 4155.1 1.7.

The basic hierarchy for evaluating credit involves reviewing how payments were made on the following:

• previous housing expenses, including utilities, then
• payment history on installment debts, then
• payment history on revolving accounts.

Generally, a borrower is considered to have an acceptable credit history if he/she does not have late housing or installment debt payments, unless there is major derogatory credit on his/her revolving accounts.

The borrower's housing obligation payment history holds significant importance when evaluating credit. The lender must determine the borrower's housing obligation payment history through the

• credit report
• verification of rent directly from the landlord (for landlords with no identity-of-interest with the borrower)
• verification of the mortgage directly from the mortgage servicer, or
• the review of canceled checks that cover the most recent 12-month period.
• 
  

Note: The lender must verify/document the previous 12 months housing history even if the borrower states he/she is living rent free.

TOTAL Scorecard Accept Recommendation

Waive the housing/rental history requirement.

Reference: For more information on the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

Lenders must determine the purpose of any recent debts as the indebtedness may have been incurred to obtain the required cash investment.

A borrower must provide a satisfactory explanation for any significant debt that is shown on the credit report, but not listed on the loan application. Written explanation is required for all inquiries shown on the credit report for the last 90 days.

TOTAL Scorecard Accept Recommendation

• Verify the actual monthly payment amount.
• Include the monthly payment amount and resubmit the loan if the liability is greater than $100 per month.
• Determine that any funds borrowed were not/will not be used for the homebuyer's cash investment in the transaction.

Note: Explanation is not required for inquiries.

Reference: For more information on the TOTAL Scorecard recommendations, see Page 17 of the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

Collections and judgments indicate a borrower's regard for credit obligations, and must be considered in the creditworthiness analysis.

The lender must document reasons for approving a mortgage when the borrower has collection accounts or judgments. The borrower must explain, in writing, all collections and judgments.

Note: Compliance with the requirements specified in HUD 4155.1 4.C.2.e is applicable to judgments.

TOTAL Scorecard Accept Recommendation

Collection accounts trigger neither an explanation requirement nor a hypothetical monthly payment to be used in qualifying borrowers. The presence of collection accounts in the borrower's credit history already result in lowering the credit bureau scores used in TOTAL and, thus, no further information need be provided by the borrower.

References: For information on

• paying off collections and judgments, see HUD 4155.1 4.C.2.e and
• the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

FHA does not require that collection accounts be paid off as a condition of mortgage approval. However, court-ordered judgments must be paid off before the mortgage loan is eligible for FHA insurance endorsement.

Exception: An exception on a court-ordered judgment may be made if the borrower

• has an agreement with the creditor to make regular and timely payments, and
• has provided documentation indicating that payments have been made according to the agreement.

TOTAL Scorecard Accept/Refer Recommendation

TOTAL Scorecard Accept and Refer recommendations require that the lender obtain evidence of payoff for any outstanding judgments shown on the credit report.

Reference: For more information on the TOTAL Scorecard recommendations, see Page 18 of the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

A borrower is generally not eligible for a new FHA-insured mortgage when, during the previous three years

• his/her previous principal residence or other real property was foreclosed, or
• he/she has given a deed-in-lieu of foreclosure.

Exception: The lender may grant an exception to the three-year requirement if the foreclosure was the result of documented extenuating circumstances that were beyond the control of the borrower, such as a serious illness or death of a wage earner, and the borrower has re-established good credit since the foreclosure. Divorce is not considered an extenuating circumstance. However, the situation in which a borrower whose loan was current at the time of a divorce in which the ex-spouse received the property and the loan was later foreclosed qualifies as an exception.

Note: The inability to sell the property due to a job transfer or relocation to another area does not qualify as an extenuating circumstance.

A Chapter 7 bankruptcy (liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage, if at least two years have elapsed since the date of the discharge of the bankruptcy. During this time, the borrower must

• have reestablished good credit, or
• chosen not to incur new credit obligations.

An elapsed period of less than two years, but not less than 12 months may be acceptable for an FHA-insured mortgage, if the borrower

• can show that the bankruptcy was caused by extenuating circumstances beyond his/her control, and
• has since exhibited a documented ability to manage his/her financial affairs in a responsible manner.

Note: The lender must document that the borrower's current situation indicates that the events that led to the bankruptcy are not likely to recur.

A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA-insured mortgage, provided that the lender documents that

• one year of the payout period under the bankruptcy has elapsed, and
• the borrower's payment performance has been satisfactory and all required payments have been made on time.

The borrower must receive written permission from the court to enter into the mortgage transaction.

TOTAL Scorecard Accept Recommendation

Lender documentation must show two years from the discharge date of a Chapter 13 bankruptcy.

If the Chapter 13 bankruptcy has not been discharged for a minimum period of 2 years, the loan must be downgraded to a Refer and be evaluated by a Direct Endorsement (DE) underwriter.

Reference: For more information on the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

Participating in a consumer credit counseling program does not disqualify a borrower from obtaining an FHA mortgage, provided the lender documents that

• one year of the pay-out period has elapsed under the plan, and
• the borrower's payment performance has been satisfactory and all required payments have been made on time.

The borrower must receive written permission from the counseling agency to enter into the mortgage transaction.

TOTAL Scorecard Accept Recommendation

The borrower's decision to participate in consumer credit counseling does not trigger a requirement for additional documentation since the credit scores already reflect the degradation in credit history. The borrower's credit history, not voluntary participation in consumer credit counseling, is the important variable in scoring the mortgage and, thus, no explanation or other documentation is needed.

Reference: For more information on the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

In an effort to reduce the risk of identity theft and other forms of financial fraud, some providers of consumer credit reports have begun using a truncated version of an individual's Social Security Number (SSN) on the credit report product that is offered.

A truncated SSN, that contains as few as the last four digits of a borrower's full number, is acceptable for FHA mortgage insurance purposes provided that

• the loan application captures the full 9-digit SSN, and
• the borrower's name, SSN and date of birth are validated through the FHA Connection or its functional equivalent.

For guidelines for evaluating borrowers with non traditional or insufficient credit histories, see HUD 4155.1 4.C.3.

A borrower is not eligible for a new FHA-insured mortgage if s/he pursued a short sale agreement on his or her principal residence simply to

• take advantage of declining market conditions, and
• purchase at a reduced price a similar or superior property within a reasonable commuting distance.

Borrowers Current at the time of Short Sale

A borrower is considered eligible for a new FHA-insured mortgage if, from the date of loan application for the new mortgage

• all mortgage payments due on the prior mortgage were made within the month due for the 12 month period preceding the short sale, and
• all installment debt payments for the same time period were also made within the month due.

Borrowers in Default at the time of Short Sale

A borrower in default on his or her mortgage at the time of the short sale (or pre-foreclosure sale) is not eligible for a new FHA-insured mortgage for three years from the date of the pre-foreclosure sale.

Note: A borrower who sold his or her property under FHA's pre-foreclosure sale program is not eligible for a new FHA-insured mortgage from the date that FHA paid the claim associated with the pre-foreclosure sale.

References: For detailed information on converting existing principal residences into rental properties, see HUD 4155.1 4.E.4.g.

When evaluating borrowers with non traditional credit histories, a satisfactory credit history, at least 12 months in duration, must include:

• no history of delinquency on rental housing payments
• no more than one 30-day delinquency on payments due to other creditors, and
• no collection accounts/court records reporting (other than medical) filed within the past 12 months.

When evaluating borrowers with no credit references, or otherwise having only Group II references as outlined in HUD 4155.1 1.7.f, a satisfactory credit history, at least 12 months in duration, must include:

• no more than one 30-day delinquency on payments due to any Group II reference, and
• no collection accounts/court records reporting (other than medical) filed within the past 12 months.

In order to enhance the likelihood of homeownership sustainability for borrowers with insufficient credit histories, the underwriting guidance below is provided.

• Qualifying ratios are to be computed only on those occupying the property and obligated on the loan, and may not exceed 31 percent for the payment-to-income ratio and 43 percent for the total debt-to-income ratio. Compensating factors are not applicable for borrowers with insufficient credit references.
• Borrowers should have two months of cash reserves following mortgage loan settlement from their own funds (no cash gifts from any source should be counted in the cash reserves for borrowers in this category).

Reference: For more information on the restriction on the addition of non occupant co borrowers for credit underwriting, see HUD 4155.1 3.B.2.c.

Recurring obligations include

• all installment loans
• revolving charge accounts
• real estate loans
• alimony
• child support, and
• other continuing obligations.

The lender must include the following when computing the debt to income ratios for recurring obligations:

• monthly housing expense, and
• additional recurring charges extending ten months or more, such as
• payments on installment accounts
• child support or separate maintenance payments
• revolving accounts, and
• alimony.

Debts lasting less than ten months must be included if the amount of the debt affects the borrower's ability to pay the mortgage during the months immediately after loan closing, especially if the borrower will have limited or no cash assets after loan closing.

Note: Monthly payments on revolving or open-ended accounts, regardless of the balance, are counted as a liability for qualifying purposes even if the account appears likely to be paid off within 10 months or less.

If the credit report shows any revolving accounts with an outstanding balance but no specific minimum monthly payment, the payment must be calculated as the greater of

• 5 percent of the balance, or
• $10.

Note: If the actual monthly payment is documented from the creditor or the lender obtains a copy of the current statement reflecting the monthly payment, that amount may be used for qualifying purposes.

Since there are tax consequences of alimony payments, the lender may choose to treat the monthly alimony obligation as a reduction from the borrower's gross income when calculating qualifying ratios, rather than treating it as a monthly obligation.

A contingent liability exists when an individual is held responsible for payment of a debt if another party, jointly or severally obligated, defaults on the payment.

The contingent liability policies described in this topic apply unless the borrower can provide conclusive evidence from the debt holder that there is no possibility that the debt holder will pursue debt collection against him/her should the other party default.

Contingent liability must be considered when the borrower remains obligated on an outstanding FHA-insured, VA-guaranteed, or conventional mortgage secured by property that

• has been sold or traded within the last 12 months without a release of liability, or
• is to be sold on assumption without a release of liability being obtained.

When a mortgage is assumed, contingent liabilities need not be considered if

• the originating lender of the mortgage being underwritten obtains, from the servicer of the assumed loan, a payment history showing that the mortgage has been current during the previous 12 months, or
• the value of the property, as established by an appraisal or the sales price on the HUD-1 Settlement Statement from the sale of the property, minus the Up-Front Mortgage Insurance Premium (UFMIP) results in an LTV of 75% or less.

TOTAL Scorecard Accept Recommendation

Obtain either

• a copy of the divorce decree ordering the spouse to make payments, or
• the assumption agreement and deed showing transfer of title out of the borrower's name. (Note: A 12-month history is not required.)

Reference: For more information on the TOTAL Scorecard recommendations, see the TOTAL Mortgage Scorecard User Guide at http://www.hud.gov/offices/hsg....

Contingent liability applies, and the debt must be included in the underwriting analysis, if an individual applying for an FHA-insured mortgage is a cosigner/co-obligor on a

• car loan
• student loan
• mortgage, or
• any other obligation.

If the lender obtains documented proof that the primary obligor has been making regular payments during the previous 12 months, and does not have a history of delinquent payments on the loan during that time, the payment does not have to be included in the borrower's monthly obligations.

Debt payments, such as a student loan or balloon note scheduled to begin or come due within 12 months of the mortgage loan closing, must be included by the lender as anticipated monthly obligations during the underwriting analysis.

Debt payments do not have to be classified as projected obligations if the borrower provides written evidence that the debt will be deferred to a period outside the 12-month timeframe.

Balloon notes that come due within one year of loan closing must be considered in the underwriting analysis.

Obligations not considered debt, and therefore not subtracted from gross income, include

• Federal, state, and local taxes
• Federal Insurance Contributions Act (FICA) or other retirement contributions, such as 401(k) accounts (including repayment of debt secured by these funds)
• commuting costs
• union dues
• open accounts with zero balances
• automatic deductions to savings accounts
• child care, and
• voluntary deductions.