[Federal Register Volume 75, Number 171 (Friday, September 3, 2010)]
[Rules and Regulations]
[Pages 54020-54023]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-22133]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Ch. II

[Docket No. FR-5404-N-02]


Federal Housing Administration Risk Management Initiatives: New 
Loan-to-Value and Credit Score Requirements

AGENCY: Office of the Assistant Secretary for Housing--Federal Housing 
Commissioner, HUD.

ACTION: Final rule.

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SUMMARY: On July 15, 2010, HUD issued a notice seeking comment on three 
initiatives that HUD proposed would contribute to the restoration of 
the Mutual Mortgage Insurance Fund (MMIF) capital reserve account. This 
document is limited to implementation of HUD's proposal to introduce a 
minimum credit score threshold and reduce the maximum LTV. At the end 
of the public comment period on August 16, 2010, HUD received 902 
comments. The overwhelming majority of these comments focused on HUD's 
proposal to cap seller concessions. HUD is continuing to review and 
consider the issues raised by commenters on capping seller concessions 
as well as those pertaining to HUD's proposal to tighten manual 
underwriting guidelines. HUD's final decision on these two proposals 
will be addressed separately.

DATES: Effective Date: October 4, 2010.

FOR FURTHER INFORMATION CONTACT: Karin Hill, Director, Office of Single 
Family Program Development, Office of Housing, Department of Housing 
and Urban Development, 451 7th Street, SW., Room 9278, Washington, DC 
20410; telephone number 202-708-2121 (this is not a toll-free number). 
Persons with hearing or speech impairments may access this number 
through TTY by calling the toll-free Federal Information Relay Service 
at 800-877-8339.

SUPPLEMENTARY INFORMATION:

I. Background--HUD's July 15, 2010 Notice

    On July 15, 2010, at 75 FR 41217, HUD issued a proposed rule 
seeking comment on three initiatives that HUD proposed would contribute 
to the restoration of the Mutual Mortgage Insurance Fund (MMIF) capital 
reserve account. The proposed changes were developed to preserve both 
the historical role of the Federal Housing Administration (FHA) in 
providing a home financing vehicle during periods of economic 
volatility and HUD's social mission of helping underserved borrowers. 
In the July 15, 2010, notice, HUD proposed the following: To reduce the 
amount of closing costs a seller may pay on behalf of a homebuyer 
purchasing a home with FHA-insured mortgage financing for the purposes 
of calculating the maximum mortgage amount; to introduce a credit score 
threshold as well as reduce the maximum loan-to-value (LTV) for 
borrowers with lower credit scores who represent a higher risk of 
default and mortgage insurance claim; and to tighten underwriting 
standards for mortgage loan transactions that are manually 
underwritten.
    A recently issued independent actuarial study shows that the MMIF 
capital ratio has fallen below its statutorily mandated threshold.\1\ 
Consistent with HUD's responsibility under the National Housing Act to 
ensure that the MMIF remains financially sound, HUD published the July 
15, 2010 document and sought public comment on the three proposals 
described above designed to address features of FHA mortgage insurance 
that have resulted in high mortgage insurance claim rates and present 
an unacceptable risk of loss to FHA.
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    \1\ On November 13, 2009, HUD released an independent actuarial 
study that reported that FHA will likely sustain significant losses 
from mortgage loans made prior to 2009, due to the high 
concentration of seller-financed downpayment assistance mortgage 
loans and declining real estate values nationwide, and that the MMIF 
capital reserve relative to the amount of outstanding insurance in 
force had fallen below the statutorily mandated 2 percent ratio. The 
capital reserve account serves as a back-up fund, where FHA holds 
additional capital to cover unexpected losses. The capital ratio 
generally reflects the reserves available (net of expected claims 
and expenses), as a percentage of the current portfolio, to address 
unexpected losses. The report can be found at: http://www.hud.gov/offices/hsg/fhafy09annualmanagementreport.pdf.
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    Over the past two years, the volume of FHA insurance has increased 
rapidly as private sources of mortgage finance retreated from the 
market. FHA's share of the single-family mortgage market today is 
approximately 30 percent--up from 3 percent in 2007, and the dollar 
volume of insurance written has jumped from the $56 billion issued in 
that year to more than $300 billion in 2009. The growth in the MMIF 
portfolio over such a short period of time coincided with worsening 
economic conditions that have seen high levels of defaults and 
foreclosures, and consequently unacceptable risks of loss to the MMIF. 
Given these conditions and concerns, FHA, in managing the MMIF, must be 
especially vigilant in monitoring the performance of the portfolio, 
enhancing risk controls, and tightening standards to address portions 
of the business that expose homeowners to excessive financial risks. 
FHA's authorizing statute, the National Housing Act (12 U.S.C. 1701 et 
seq.), envisions that FHA will adjust program standards and practices, 
as necessary, to operate the MMIF, with reasonable expectations of 
financial loss. Within the past year, FHA has adjusted several program 
standards and practices so that the MMIF is preserved and FHA is 
operating the MMIF with acceptable risks of financial loss, not 
unacceptable risks.\2\
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    \2\ While the Federal Credit Reform Act of 1990 requires that 
FHA (and all other government credit agencies) estimate and budget 
for the anticipated cost of mortgage loan guarantees, the National 
Housing Act imposes a special requirement that the MMIF hold an 
additional amount of funds in reserve to cover unexpected losses. 
FHA maintains the MMIF capital reserve in a special reserve account. 
The MMIF capital reserve account serves as a back-up fund, where FHA 
holds additional capital to cover unexpected losses.

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[[Page 54021]]

    The July 15, 2010, notice represents another step in HUD's effort 
to preserve the MMIF and preserve FHA as a source of available credit 
for affordable home mortgages. Interested readers are referred to the 
July 15, 2010 notice for details regarding the proposed changes to FHA 
requirements.

II. This Notice--Addressing Solely Minimum Credit Score and New LTV 
Requirements

    As noted in the preceding section, this document is limited to 
implementation of the revised credit score and LTV requirements, and 
takes into consideration the public comments received on HUD's proposal 
to establish a minimum decision credit score and reduce LTV, as set 
forth in the July 15, 2010 notice. The majority of the public comments 
that HUD received in response to the July 15, 2010, focused on the 
other two proposals (the reduction in seller concessions and revised 
manual underwriting requirements). HUD is continuing to review and 
consider the issues raised by the comments on these two proposals, as 
well as alternative proposals raised by commenters. HUD's final 
decision on these two proposals will be addressed separately. Section 
III of this document discusses the significant issues raised by the 
public comments regarding the new credit score and LTV requirements, as 
well as HUD's responses to these issues. The separate document to 
address capping seller concessions and tightening underwriting 
guidelines will address the public comments on these proposals.
    The July 15, 2010 notice more fully addresses the reasons for the 
establishment of a minimum decision credit score and reduction in LTV 
for FHA mortgage insurance, and readers are referred to the notice for 
the more in-depth discussion of this proposal (see 75 FR 41220-41222). 
As discussed in the July 15, 2010, notice, FHA serves very few 
borrowers with credit scores below 500; however, the performance of 
these borrowers is very poor. FHA data indicate that insured mortgages 
with decision credit scores below 580 have significantly worse default 
and claim experience than do loans at or above 580. The revised credit 
score and LTV requirements increase the likelihood that borrowers who 
are offered FHA-insured mortgages are capable of repaying these 
mortgages. Under this document, effectively, a borrower with a decision 
credit score between 500 and 579 will be required to make a greater 
downpayment [at minimum, 10 percent] than a borrower with a higher 
score, for the purchase of a home with the same sales price.\3\ 
Borrowers with credit scores below 500 will not be eligible for FHA-
insured financing. The new LTV and credit score requirements will 
reduce the risk to the MMIF and ensure that home buyers are offered 
mortgage loans that are sustainable. Section IV of this document 
implements the minimum decision credit score and new LTV requirements. 
HUD will also issue additional guidance through Mortgagee Letter to 
assist in implementation of these new requirements.
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    \3\ FHA will continue to allow borrowers to use permissible 
sources of funds, as described in FHA Handbook 4155.1, paragraph 
5.B.1, to meet the minimum cash investment in the form of a 
downpayment. Gifts from family members, charitable organizations, 
employers, and government entities are also permitted, provided that 
none of the parties financially benefit from the sales transaction. 
In addition, governmental entities, including instrumentalities 
thereof, as described in Section 528 of the National Housing Act, 
may offer secondary financing to cover the borrowers' cash 
investment.
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III. Discussion of the Public Comments on the July 15, 2010 Proposal

    At the close of the public comment period on August 16, 2010, HUD 
received 902 public comments on the issue of establishing a minimum 
decision credit score and new LTV requirements. This section discusses 
the most significant issues raised by the commenters on these 
proposals, and HUD's responses to these issues.
    Comment: Support for revised credit score and LTV requirements. 
Several commenters wrote in support of the proposed revised credit 
score and LTV requirements. The commenters agreed that proposed changes 
to FHA requirements would help ensure that borrowers do not assume more 
mortgage debt than they are able to afford.
    HUD Response. HUD appreciates the support expressed by commenters, 
and agrees that the changes will reduce the risk to the MMIF and ensure 
that homebuyers are offered FHA-insured mortgage loans that are 
sustainable.
    Comment: The proposed revisions do not go far enough. Several 
commenters, while supportive of the proposed changes, recommended that 
HUD adopt more stringent credit score and LTV requirements. The 
measures recommended by the commenters varied, with suggested minimum 
decision scores most commonly ranging between 580 and 625. The 
commenters were in agreement that a higher minimum credit score would 
further protect borrowers and the FHA insurance funds.
    HUD Response. HUD has not revised its proposal in response to these 
comments. In establishing the revised credit score requirements, HUD 
has endeavored to balance the need to protect the MMIF capital reserve 
account, while at the same time preserving the historical role of FHA 
in providing home financing vehicles during periods of economic 
volatility. Too high of a minimum score would undermine HUD's mission 
of expanding affordable homeownership opportunity, while too low a 
score would fail to replenish the MMIF capital reserves. As noted 
above, and discussed in more detail in the July 15, 2010, notice, the 
minimum credit score of 500 to determine eligibility for FHA financing 
was selected after a careful analysis of FHA mortgage performance data. 
This data indicates that while FHA serves few borrowers with credit 
scores below 500 their performance is clearly very poor. The data also 
indicates that insured mortgages with decision credit scores below 580 
have significantly worse default and claim experience than do loans at 
or above 580.
    Comment: Opposition to revised credit score requirements. In 
contrast to the preceding comments, several commenters opposed any 
changes to the FHA credit score and LTV requirements. These commenters 
wrote that the changes would only make it more difficult for borrowers 
in difficult economic times to obtain mortgage financing. The 
commenters also expressed concerns that the changes would hurt the 
overall economy by further restricting the availability of mortgage 
financing.
    HUD Response. As noted in the response to the preceding comments, 
FHA takes seriously its mission to help underserved borrowers. As 
discussed above, HUD also has a statutory obligation to protect the 
MMIF capital reserve accounts by ensuring that borrowers who are 
offered FHA-insured mortgages are capable of repaying these mortgages. 
The changes balance the twin goals of protecting the financial health 
of the MMIF, while continuing to meet FHA's historic role of providing 
a vehicle for mortgage lenders to provide affordable mortgages. 
Moreover, as also noted, sustainable homeownership is essential to a 
healthy and well-functioning housing market. These changes will promote 
that goal by helping to ensure that FHA homeowners are able to afford 
their mortgage loans. HUD based the revised credit score

[[Page 54022]]

requirements on a careful analysis of historical data that indicates 
FHA serves few borrowers with a credit score below the new minimum of 
500. Moreover, HUD has taken steps to mitigate the impacts of 
establishing a minimum decision credit score. First, HUD has 
established a threshold score for FHA-insured mortgages that is below 
the cut-off score of 620 used by many private lenders. Second, HUD is 
providing a special, temporary allowance to permit a higher LTV when 
refinancing mortgage loans for certain borrowers with decision credit 
scores between 500 and 579. HUD is providing this special exemption in 
recognition of the fact that even homeowners who have been able to make 
their monthly payments may have had their credit scores negatively 
impacted by the downturn in the economy.
    Comment: A revision to the credit score requirements will have 
minimal effect. Many commenters questioned the need of establishing a 
minimum decision credit score of 500, given that most mortgage lenders 
have adopted a higher minimum credit score. The commenters cited to 
several industry standards, and most commonly to a minimum credit score 
of 620. These commenters wrote that HUD's proposal would have little 
impact since mortgage lenders will not provide mortgage loans to 
borrowers with credit scores below the minimums they have established.
    HUD Response. HUD has not revised its proposal based on these 
comments. Unlike private mortgage lenders, HUD has an important 
historical countercyclical position of supporting the private sector 
when access to capital is constrained, and an equally important social 
mission of helping unserved borrowers. HUD takes these responsibilities 
seriously and, as discussed more fully in the responses to the 
preceding comments, continues to believe that the revised credit score 
requirements strike the appropriate balance between fulfilling HUD's 
historical and social responsibilities, as well as its statutory duty 
to preserve the MMIF capital reserves.
    Comment: Acceptable score ranges for other scoring models. The July 
15, 2010, notice invited comment on the best means for FHA to provide 
guidance on acceptable score ranges for scoring models other than FICO-
based decision scores, to ensure that the scales used for all scoring 
systems are consistent and appropriate for FHA borrowers (see 75 FR 
41220). In response, a few commenters wrote to suggest alternative 
scoring models. For example, one commenter (the developer of a consumer 
credit score model) proposed a calibration analysis of the FHA loan 
portfolio using its credit score model. Another commenter advocated 
that HUD provide further guidance on risk thresholds, decision points 
and pricing tiers, so that developers of risk assessment services can 
initiate new processes. The majority of these commenters, however, 
questioned the usefulness of using any credit score model, writing that 
credit scores are an imperfect indicator of risk and often not 
reflective of a person's ability to pay. The commenters also wrote that 
credit scores sometimes have disparate impact on minorities compared to 
other borrowers.
    HUD Response. HUD has not revised the July 15, 2010, notice in 
response to these comments. With respect to the use of other credit 
scoring models, HUD greatly appreciates the suggestions offered by the 
commenters. However, HUD believes that additional analysis of this 
issue is required given the complexity of the proposed approaches as 
well as the need to provide sufficient notice to the industry of such a 
significant change to current FHA requirements. HUD is not 
unsympathetic to the concerns expressed by the commenters that 
questioned the utility of credit models, and reiterates that it has 
taken several steps to mitigate the impacts of establishing a minimum 
decision credit score. As noted, HUD has established a threshold below 
the threshold score widely used by many private lenders and is 
providing a temporary allowance to permit a higher LTV when refinancing 
mortgage loans for certain borrowers. Further, in response to many of 
the concerns expressed by these commenters, FHA requires the use of 
manual underwriting to address cases where the borrower has very 
limited or nontraditional credit history, a FICO-based credit score may 
not have been issued, or the credit score may be based on references 
that are few in number or do not effectively predict future credit 
worthiness.

IV. Establishment of Minimum Decision Credit Score and New LTV 
Requirements

    Commencing on the effective date:
    1. Minimum Credit Score. Borrowers will be required to have a 
minimum decision credit score of no less than 500 to be eligible for 
FHA financing.
    The decision credit score used by FHA is based on methodologies 
developed by the FICO Corporation. FICO scores, which range from a low 
of 300 to a high of 850, are calculated with input by each of the three 
National Credit Bureaus and are based upon credit-related information 
reported by creditors, specific to each applicant. Lower credit scores 
indicate greater risk of default on any new credit extended to the 
applicant. The decision credit score is based on the middle of three 
National Credit Bureau scores or the lower of two scores when all three 
are not available, for the lowest scoring applicant.
    2. LTV requirements. The LTV for FHA-insured mortgage loans 
(purchase and refinance) will be limited to 90 percent for borrowers 
with a decision score between 500 and 579. Maximum FHA-insured 
financing (typically, 96.5 percent LTV for purchase transactions and 
97.75 percent for rate and term refinance transactions) will continue 
to be available for borrowers with credit scores at or above 580.
    3. Temporary Exemption for Borrowers Seeking to Refinance. As 
indicated in the July 15, 2010 notice, FHA is providing a special, 
temporary allowance to permit higher LTV mortgage loans for borrowers 
with lower decision credit scores, so long as they involve a reduction 
of existing mortgage indebtedness pursuant to FHA program adjustments 
announced in HUD Mortgagee Letter 2010-23.\4\ In accordance with 
Mortgagee Letter 2010-23, the current mortgage lender will need to 
agree to accept a short pay off, accepting less than the full amount 
owed on the original mortgage in order to satisfy the outstanding debt.
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    \4\ The Mortgagee Letter is available at: http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/
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    This temporary exemption recognizes that, given current economic 
conditions, the decision credit scores announced in this notice may be 
counterproductive in helping existing homeowners refinance to obtain 
more affordable mortgages and save their homes. FHA recognizes that 
even homeowners who have been able to make their monthly payments may 
have had their credit scores negatively impacted by the downturn in the 
economy which has so seriously affected the housing market.
    This exemption is applicable only to borrowers with credit scores 
between 500 to 579. Further, the exemption is applicable only to 
refinance transactions originated pursuant to Mortgagee Letter 2010-23 
and closed on or before December 31, 2012.

V. Findings and Certification

Executive Order 12866, Regulatory Planning and Review

    The Office of Management and Budget (OMB) reviewed this document 
under Executive Order 12866 (entitled

[[Page 54023]]

``Regulatory Planning and Review''). The document was determined to be 
a ``significant regulatory action,'' as defined in section 3(f) of the 
Order (although not economically significant, as provided in section 
3(f)(1) of the Order).
    FHA is implementing one change to replenish the MMIF capital 
reserve account. FHA is establishing a two-part credit-score threshold, 
with one lower bound for loans with loan-to-value ratios of 90 percent 
or less, and a higher threshold for those with loan-to-value ratios up 
to the statutory maximums. This is the first time that FHA has ever 
instituted an absolute lower-bound for borrower credit scores. 
Borrowers with low credit scores present higher risk of default and 
mortgage insurance claim. Such transactions that lack the additional 
credit enhancements announced in this document result in higher 
mortgage insurance claim rates and present an unacceptable risk of 
loss. The benefit of the revised credit score and LTV requirements will 
be to reduce the net losses due to high rates of insurance claims on 
affected loans, while the cost will be the value of the homeownership 
opportunity denied to the excluded borrowers. HUD prepared an economic 
analysis assessing costs and benefits in conjunction with development 
of the July 15, 2010, Federal Register notice. As noted above, HUD is 
implementing the proposed credit score and LTV requirements without 
change and, therefore that analysis remains applicable to this 
document. HUD's full analysis can be found at http://www.hud.gov/offices/hsg/sfh/hsgsingle.cfm.
    The docket file is available for public inspection in the 
Regulations Division, Office of General Counsel, Department of Housing 
and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC 
20410-0500. Due to security measures at the HUD Headquarters building, 
please schedule an appointment to review the docket file by calling the 
Regulations Division at 202-402-3055 (this is not a toll-free number). 
Individuals with speech or hearing impairments may access this number 
via TTY by calling the Federal Information Relay Service at 800-877-
8339.

Environmental Impact

    A Finding of No Significant Impact (FONSI) with respect to the 
environment has been made in accordance with HUD regulations at 24 CFR 
part 50, which implement section 102(2)(C) of the National 
Environmental Policy Act of 1969 (42 U.S.C. 4332(2)(C)). The Finding of 
No Significant Impact is available for public inspection between the 
hours of 8 a.m. and 5 p.m. weekdays in the Regulations Division, Office 
of General Counsel, Department of Housing and Urban Development, 451 
7th Street, SW., Room 10276, Washington, DC 20410. Due to security 
measures at the HUD Headquarters building, please schedule an 
appointment to review the FONSI by calling the Regulations Division at 
202-708-3055 (this is not a toll-free number). Individuals with speech 
or hearing impairments may access this number via TTY by calling the 
Federal Information Relay Service at 800-877-8339.

    Dated: August 31, 2010.
David H. Stevens,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 2010-22133 Filed 9-2-10; 8:45 am]
BILLING CODE 4210-67-P