Last fall the Department of Housing and Urban Development (“HUD”) issued the first section of its new Single Family Housing Policy Handbook (“Single Family Handbook” or “Handbook”).[1] The Single Family Handbook is designed to achieve a consolidated, authoritative source of single-family housing policy.  In addition to consolidating all policy into a single document, the Handbook makes numerous substantive changes to Federal Housing Administration (“FHA”) requirements. The Handbook will be effective for FHA-insured loans with case numbers assigned on and after June 15, 2015. This client alert analyzes key changes introduced by the Handbook.

I. Background
Since the FHA’s creation 81 years ago, the agency has insured over 40 million single-family home loans.[2] The FHA insures mortgage lenders against losses from default generally by providing 100 percent insurance policies on a home loan’s unpaid balance. With this 100 percent insurance comes demand for strict compliance with numerous FHA requirements. As mentioned, the new Single Family Handbook is an attempt to streamline and consolidate all FHA requirements which are currently spread throughout various handbooks, mortgagee letters, and other documents, into one handbook, allowing lenders to more easily locate relevant requirements.

The first section of the Single Family Handbook titled “Origination through Post-Closing/Endorsement” is over 300 pages long. This section governs the origination, underwriting, closing, post-closing, and endorsement of FHA-insured loans. It is divided into eight subsections: (1) Origination/Processing; (2) Allowable Mortgage Parameters; (3) Underwriting the Property; (4) Underwriting the Borrower Using the TOTAL Mortgage Scorecard; (5) Manual Underwriting of the Borrower; (6) Closing; (7) Post-Closing and Endorsement; and (8) Programs and Products.

Other sections including Servicing, Quality Control, and Doing Business with the FHA, have been released for review and comment but are still in draft form. Additional sections, such as Home Equity Conversion Mortgages and Title I loans, have not yet been released. The FHA plans to release these additional sections in the spring of 2015 and intends all sections to become effective on June 15, 2015.[3]

Current HUD policies and requirements will remain in effect until June 15, 2015. Once the Handbook is effective, HUD plans to continue issuing mortgagee letters to announce changes in policy and update the Handbook to incorporate new issuances.[4]

As noted earlier, in addition to consolidating all existing mortgagee requirements into one source, the Handbook alters requirements in many instances. Although HUD plans to release a list of each source that is replaced by the Handbook, HUD stated that it will not provide a document summarizing each policy changed by the Handbook.[5] As a result, mortgagees will need to review the new guidelines closely.

Below we discuss several of the most significant changes to origination, underwriting, model forms, and post-closing requirements. The impending changes are complex and significant. This alert attempts to highlight the most substantial changes contained in the new Handbook but is not intended to be comprehensive.  Instead, we analyze key changes and direct readers to the full Handbook for complete information.

II. Origination
While many of the origination requirements consolidated into the new Single Family Handbook have not changed, numerous differences in wording alter substantive requirements. Below we discuss some of the most significant changes, including changes related to electronic signatures, verification information, eligibility requirements, and refinance.

A. Electronic Signatures
The Single Family Handbook introduces new requirements for electronic signatures. While current guidelines contain requirements related to electronic signatures on third-party documents, the new guidelines contain requirements related to electronic signatures on all documents where a signature is required. Specifically, the Handbook states that mortgagees choosing to use electronic signatures must fully comply with the performance standards that govern FHA acceptance of electronic signatures. These standards include complying with the Electronic Signatures in Global and National Commerce Act (“E-Sign Act”). The E-Sign Act contains guidelines relating to disclosures, consent, signature, presentation, delivery, and retention. 

In addition, the Single Family Handbook requires mortgagees to: (1) have methods in place to establish intent to sign; (2) confirm the identity of the signer by authenticating data provided by the signer with information maintained by an independent source; and (3) maintain evidence sufficient to establish that the electronic signature may be attributed to the individual purported to have signed the document.

B. Verification Information
The Single Family Handbook changes slightly the wording of the current rules related to verification information. Under the current guidelines, a lender may obtain a borrower’s authorization to verify information needed to process a loan application. The Handbook requires lenders to obtain the borrower’s authorization to verify the information needed to process the application in all instances.  Note that a blanket authorization satisfies this requirement.

C. Eligibility Requirements
The Single Family Handbook also alters requirements related to determining borrower ineligibility based on delinquent federal debt.  Mortgagees are still required to check all borrowers against the Credit Alert Verification Reporting System (“CAIVRS”) to identify delinquent federal debt, and delinquent federal debt still renders a borrower ineligible for FHA loans. However, the new guidelines introduce a verification requirement. If delinquent federal debt is reflected in a public record or CAIVRS, the lender must verify the validity and delinquency status of the debt by contacting the creditor agency to whom the debt is owed. Lenders are prohibited from denying a loan solely on the basis of information obtained from CAIVRS if it has not been verified by the lender.

D. Program-Specific Requirements: Refinance
The Single Family Handbook also contains origination requirements specific to certain programs, such as refinances, energy efficient mortgages, adjustable rate mortgages, weatherization, and mortgage insurance for disaster victims.  Several changes to origination requirements in the refinancing context are discussed below.

1. No Skipped Payment Requirement Eliminated
First, the Single Family Handbook eliminates the “no skipped payment” requirement for all types of refinances. Current guidelines require borrowers to be current on the loan that is being refinanced for the month due prior to the month in which the borrower closes the refinancing, and for the month in which he or she closes. For example, under the current requirements, a borrower who refinances on June 7 is required to make his or her mortgage payment for the month of May as well as for the month of June.

In contrast, the Handbook states that payments for all mortgages secured by the subject property must be paid within the month due for the month prior to mortgage disbursement. Under these guidelines, the borrower in the previous example would be required to make the May, but not the June, mortgage payment.  

2. New Net Tangible Benefit Standard
Next, the Single Family Handbook introduces a new net tangible benefit standard for streamline refinances. Under current guidelines, net tangible benefit is defined as a reduction in the mortgage payment or a change in interest rate when switching from an adjustable-rate mortgage (“ARM”) to a fixed-rate mortgage. In contrast, the new guidelines define net tangible benefit as “a reduced Combined Rate, a reduced term, and/or a change from an ARM to a fixed-rate mortgage that results in a financial benefit to the Borrower.” Combined rate refers to the interest rate on the mortgage plus the mortgage insurance premium rate.

The Handbook identifies the required net tangible benefit for the following streamline refinance transactions:

• Fixed rate to fixed rate, 1-year ARM, or hybrid ARM
• Any ARM with less than 15 months to next payment change date to fixed rate, 1-year ARM, or hybrid ARM
• Any ARM with greater than or equal to 15 months to next payment change date to fixed rate, 1-year ARM, or hybrid ARM

In addition, a reduction in term alone constitutes net tangible benefit if the new interest rate does not exceed the current interest rate and the payment does not increase by more than $50.

3. Required Document Standards
The Single Family Handbook also introduces new documentation requirements for cash-out refinances, no cash-out refinances, simple refinances, and streamline refinances. Specifically, the new guidelines require specific documentation to evidence occupancy requirements, payment history requirements, and maximum mortgage amount. First, mortgagees must review the borrower’s employment documentation or obtain utility bills to evidence that the borrower meets the specific occupancy requirements, which vary by the type of the refinance. Next, if the mortgage on the subject property is not reported in the borrower’s credit report or is not in the name of the borrower, the mortgagee must obtain verification of the mortgage to evidence payment history for the previous 12 months. Finally, mortgagees must obtain the payoff statement for all existing mortgages to satisfy the documentation requirements relating to the maximum mortgage amount.

III. Underwriting
Many changes to underwriting requirements provide additional clarity and remove mortgagee discretion. Other changes add entirely new mortgagee requirements. Specifically, the Single Family Handbook makes changes to age of documentation requirements, credit analysis, the treatment of liabilities and projected obligations, employment and income documentation, and earnest money and cash to close requirements.

A. Age of Documentation
Under the current rules, at loan closing, documents for new construction must be no more than 180 days old, while documents for existing construction must be no more than 120 days old. Under the Handbook, new construction documents no longer enjoy a longer limit.  Instead, documents used in the origination and underwriting of a mortgage may not be more than 120 days old at the disbursement date.[6] The clock starts to run on the day after the effective or issue date of the document, whichever is later.

B. Credit Analysis
Among other changes to credit analysis, the Single Family Handbook defines “major derogatory credit” and alters when a non-traditional mortgage credit report (“NTMCR”) is required. 

1. Major Derogatory Credit
While the current guidelines offer no definition of “major derogatory credit” except to state that indications of major derogatory credit include judgments, collections, and other recent credit problems, the Handbook defines the phrase. Under the new rules “major derogatory credit” means “payments made more than 90 days after the due date or three or more payments made more than 60 days after the due date.”

2. Non-Traditional Mortgage Credit Report
Under the current rule, a lender must obtain an NTMCR whenever it uses alternative credit to qualify a borrower, unless an NTMCR is unavailable. In contrast, the Single Family Handbook does not require an NTMCR before developing alternative credit. Instead, for borrowers without a credit score, a lender must either obtain an NTMCR or develop a credit history using alternative references subject to documentation and verification guidelines. Alternative references may include (1) a review of public records to verify the provider’s existence; (2) verification of credit information using published addresses and telephone numbers; and (3) copies of the most recent 12 months of canceled checks or equivalent proof of payment.

C. Treatment of Liabilities and Projected Obligations
In addition, the Single Family Handbook alters the treatment of recurring debt, deferred debt, medical debt, alimony, child support, and revolving accounts. Changes to the treatment of recurring debt and deferred debt are discussed in more detail below.

1. Recurring Debt
Under the current rule, installment debt with fewer than 10 months remaining may be excluded from ratio calculations. If the loan is manually underwritten, the lender must determine that the debt will not negatively affect the borrower’s ability to make mortgage payments during the early months after closing, especially if the borrower will have limited or no cash assets after closing.

The Single Family Handbook provides lenders with less discretion. Installment debt with 10 or fewer payments remaining may be excluded from ratio calculations only if the debt has cumulative payments of less than or equal to 5 percent of the borrower’s gross monthly income. The borrower may not pay the debts down to achieve this percentage.   

2. Deferred Debt
To determine if deferred debt payments must be included in ratio calculations, the current rules look to when the payments will commence. Debt payments scheduled within 12 months of loan closing must be included as anticipated monthly obligations. Debt payments deferred to a period outside the 12-month time frame may be excluded if the lender receives written evidence of the deferral. 

In contrast, the Single Family Handbook requires all deferred obligations, regardless of when they will commence, to be included in the qualifying ratios. In addition, the new guidelines provide specific calculation requirements. Mortgagees must use the actual monthly payment or, if the actual payment is unknown, the terms of the debt or 5 percent of the outstanding balance. However, if the actual payment is unknown and the debt is a student loan, then mortgagees must use 2 percent of the outstanding balance. In addition, mortgagees must obtain evidence of the debt’s deferral, the outstanding balance, the terms of the liability, and the anticipated monthly payments.

D. Employment and Income Documentation
The Single Family Handbook also makes numerous changes to employment and income documentation including the treatment of gaps in employment; frequent job changes; part-time employment; declining income of self-employed borrowers; salary and hourly income; bonus, overtime, and commission income; alimony and child support; rental income; nontaxable income; Social Security income; and pensions and 401(k)s. Some of the most significant changes with respect to the treatment of gaps in employment, the calculation of nontaxable income, and the calculation of salary and hourly income are discussed below.

1. Gaps in Employment
The current rule states that borrowers must explain any gaps in employment of one month or more. The Single Family Handbook is more lenient and only requires borrowers to explain any gaps in employment of six months or more.

2. Calculating Nontaxable Income
The Single Family Handbook changes the default tax rate for nontaxable income from 25 percent under the current rule to 15 percent.  Under the current rule, lenders must use the same tax rate the borrower used to calculate his or her income tax the prior year. If the borrower did not file a federal tax return the prior year, the lender may use a tax rate of 25 percent. Under the Handbook, lenders must use the greater of 15 percent or the tax rate the borrower used in the prior year.  If the borrower did not file a federal tax return the prior year, the lender must use a tax rate of 15 percent.

3. Calculating Salary and Hourly Income
In general, when it comes to calculating salary and hourly income, the current rule leaves the method of calculation to the underwriter. As a result, two different underwriters with identical borrower information may report different results.  The Single Family Handbook removes underwriter discretion and standardizes salary and hourly income calculation. Under the new guidelines, for salaried employees, underwriters must use the current salary if consistently earned. For hourly employees, the calculation depends on whether the hours vary. If the hours do not vary, underwriters must use the hourly rate. If the hours vary, underwriters must use a two-year average. If the hours vary and there is a documented increase in pay rate, underwriters must use a 12-month average of hours at the current pay rate.

E. Earnest Money and Cash to Close
The Single Family Handbook also alters earnest money and cash to close requirements in the areas of earnest money deposits, tax service fees, origination fees, prepaid items, reserves, checking and savings accounts, retirement accounts, stocks and bonds, gifts, and premium pricing. Earnest money deposits, reserves, and checking and savings accounts are discussed below. 

1. Earnest Money Deposits
The Single Family Handbook provides more stringent earnest money documentation requirements. Under the current rule, underwriters must document the source of funds if an earnest money deposit exceeds 2 percent of the sales price or appears excessive based on the borrower’s savings history. Under the new guidelines, underwriters must document the source of funds if an earnest money deposit exceeds 1 percent of the sales price or appears excessive based on the borrower’s savings history.

2. Reserves
Under the current rule, reserves may include gift funds, including surplus gift funds that remain in the borrower’s account after closing if properly documented. Under the Single Family Handbook, reserves do not include gift funds.  Instead, the Handbook defines reserves as the sum of the borrower’s verified and documented liquid assets minus the total funds the borrower is required to pay at closing.

3. Checking and Savings Accounts
The Single Family Handbook defines what constitutes a large deposit and provides greater clarity to the treatment of checking and savings accounts. Under the current rules, if there is a large increase in the account or the account was opened recently, the underwriter must obtain a credible explanation and document the source of funds. Under the Handbook, if the account was recently opened or there is a deposit greater than 1 percent of adjusted value, the underwriter must obtain documentation of deposits and verification that no debts were incurred to obtain part or all of the minimum required investment.[7] In addition, if the account is jointly owned, the underwriter must obtain a written statement from the other parties that the borrower has full access to and use of the funds. 

IV. New Model Note and Mortgage Forms
Next, the Single Family Handbook requires that mortgagees develop or obtain separate mortgage and note documents that generally conform to the Freddie Mac and Fannie Mae forms in both form and content but that also include the specific modifications required by the FHA. HUD has provided model documents that meet these requirements.[8] The new model note forms have been updated to conform with HUD’s regulatory amendments, including the elimination of post-payment interest charges and ARM notification requirements. The model mortgage document has also been updated to conform more closely to the Fannie Mae and Freddie Mac forms.

Unlike in the past, HUD will not require the use of the model forms, but their use is recommended as the forms contain the necessary amendments to satisfy the new Handbook requirements.

V. Closing and Post-Closing Requirements
In addition, the Single Family Handbook consolidates the closing and post-closing requirements for Lender Insurance (“LI”) mortgagees and non-LI mortgagees. It contains sections regarding pre-insurance review of case binder documents and case binder compilation that appear to apply to both LI and non-LI mortgagees. In addition, it contains separate sections for LI and non-LI mortgagees with instructions on endorsement and case binder submission.

A. Pre-Insurance Review
The Single Family Handbook requires mortgagees to conduct a pre-insurance review to ensure that all applicable documents as described in the Uniform Case Binder Stacking Order are included in the endorsement submission. The pre-insurance review must be conducted by staff members who are not involved in the origination, processing, or underwriting of the mortgage. 

When conducting the pre-insurance review, mortgagees must review and verify numerous items.  For example, mortgagees must ensure that the FHA Loan Underwriting and Transmittal Summary is completed and signed and dated by the underwriter. In addition, mortgagees must confirm that the note is the authoritative copy, the borrower name on the note is correct, the required language from the model note is present, and the note has been executed, among other requirements. The Handbook requires mortgagees to verify and review many other documents, including the settlement statement, final Uniform Residential Loan Application, borrower credit report, and CAIVRS report, among other documents.

In addition, the Handbook includes specific instructions on inspection and repair escrow requirements for loans pending closing or endorsement in Presidentially-Declared Major Disaster Areas.

B. Case Binder Submission
Finally, the Single Family Handbook requires mortgagees to compile uniform case binders. As with prior guidance, the Handbook includes a list of documents that must be included in the case binder. However, the list has been altered so it is important for mortgagees to review the new requirements carefully. Much like current requirements, the Handbook contains separate sections governing case binder submission for LI and non-LI mortgagees. Non-LI mortgagees’ case binders must be received by the Homeownership Center no later than 60 days after the disbursement date. LI mortgagees must only submit case binders involving a severe case warning or if requested to do so by HUD.

VI. Conclusion
While the Single Family Handbook consolidates and streamlines previous HUD policy into one source, making it easier for mortgagees to locate relevant origination, underwriting, and closing requirements, many of these requirements will change significantly from the current FHA guidelines. With less than six months until these new requirements become effective, it is imperative that mortgagees familiarize their staff with the new lending guidelines to ensure they will be ready to implement the changes on June 15, 2015.

Notes:
[1] Dep’t of Housing & Urb. Dev., Handbook 4000.1, Single Family Housing Policy Handbook (available at: http://portal.hud.gov/hudportal/documents/huddoc?id=40001HSGH.pdf). 

[2] Dep’t of Housing & Urb. Dev., Ann. Rep., 2014 (available at: http://portal.hud.gov/hudportal/documents/huddoc?id=fhafy14annualmgmntrpt.pdf).

[3] Dep’t of Housing & Urb. Dev., Single Family Housing Policy Handbook: Origination through Post-Closing/Endorsement for Title II Forward Mortgages Frequently Asked Questions, December 9, 2014 (available at: http://portal.hud.gov/hudportal/documents/huddoc?id=SFH_HB_4000-1_FAQS.PDF). 

[4] Id.

[5] Id.

[6] The disbursement date is the date on which the mortgage proceeds are made available to the borrower. 

[7] For purchase transactions, the Handbook defines “adjusted value” as the lesser of the purchase price less any inducements to purchase or the property value. 

[8] Model documents can be found here: http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/model_documents.