FHA Closes Loophole for Student Debt in Revamped Lender Handbook

The sweeping overhaul of the Federal Housing Administration's single-family handbook offers lenders long-sought clarity on acceptable underwriting practices. But that added certainty comes at the expense of flexibility to get loans qualified, including a popular workaround for borrowers with deferred student loan debt.

"It tightens certain underwriting guidelines that were on the 'why people love FHA' list," said Alice Alvey, senior vice president at technology and outsourcing vendor Indecomm Global Services.

Among the changes to the Single Family Housing Policy Handbook that took effect Sept. 14 is a requirement for lenders to consider deferred loan payments when calculating a borrower's debt-to-income ratio. Previously, deferred debt, such as student loans not yet in repayment, could be excluded with proper documentation.

"Given the rise in student loan debt in the population, that will shut out many young professionals," said Daniel Jacobs, president of Pro Mortgage Branching Solutions. "There are a wide variety of circumstances where the deferral is automatically granted, and it's pretty much a given that you can get a deferral when you first start working."

While it may hurt loan sales, it also improves risk management.

"Will that borrower actually be able to afford their loan and the student loan payment? It's a legitimate issue to consider," Jacobs said.

"Deferred student debt is debt all the same and really must be considered when determining a borrower's ability to sustain both student debt payments and a mortgage long term," said HUD spokesperson Brian Sullivan. "Our primary interest is to make certain that a first-time homebuyer is put on a path of sustainable homeownership rather than being placed into a financial situation they can no longer tolerate once their student debt deferment expires."

The FHA's handbook addresses lender complaints that the indemnification risk stemming from loan defects has been unmanageable. Underwriters appreciate its clarity.

"The guidelines have been clarified to eliminate many of the gray areas, helping eliminate the need for subjective interpretation of a guideline, which also promotes consistent underwriting decisions," said Eric Webb, underwriting manager at Churchill Mortgage.

Guidelines like the deferred debt policy can help underwriters better forecast if borrowers can pay their loans over the long term and help lenders return a quicker decision to applicants, he said.

"The FHA's underwriting changes consolidated all FHA guides into one, which reduced the time it takes an underwriter to research a guideline," said Webb. "FHA also separated the guidelines for TOTAL [Scorecard, its automated underwriting system] versus manual underwriting review, which provides further time savings by clearly delineating the separate underwriting requirements for these."

The revamped guidelines give underwriters more certainty around the nuances of the FHA's lending policies, but there has also been confusion about changes made to its property valuation policies.

An FHA announcement published in April suggested that appraisers would be required to analyze three years' worth of transaction history for comparable sale properties, up from the industry standard of one year. But a Nov. 5 information bulletin later clarified that only one year is required.

"It's less burdensome," Gerry Glavey, senior vice president and chief credit officer at technology vendor LoanLogics, said of the one-year requirement. But Glavey added the FHA could have done more to communicate its clarified position on this point.

Another uncertainty for appraisers has been whether the FHA wants them to do work they feel is outside their bailiwick, such as utility reviews typically handled by home inspectors.

The FHA took pains not to use the word "inspect" in its handbook due to this concern. Nevertheless, some of the guidelines for appraiser responsibilities verge on being inspector-type tasks, said William Fall, chief executive of property valuations provider the William Fall Group.

"We've seen some appraisers rebelling on that because they are afraid they're going to be held liable if the back burner on the stove isn't working," he said.

Fall, whose company operates an appraisal firm and an appraisal management company, said believes best practices that evolve over time and potential clarification by HUD will address the concern. It won't stop business, but some appraisers could shy away from FHA assignments in the short-term.

Not all of the guidelines codified in the new handbook for collateral and credit reviews are tighter. There also are other changes that create some new leeway for lenders.

For example, consumers with pending tax lien payments previously couldn't get an FHA loan, but new rules allow borrowers with a payment plan and three months of on-time payments to qualify.

"A pretty good number of people were shut out of the home-buying process because of these judgments," Jacobs said.

The handbook changes follow the FHA's move last year to cut its mortgage insurance premiums, a move cited for helping boost home sales. But while the handbook does offer more underwriting latitude in some areas, lenders find more changes in the handbook tighten credit than loosen it, he said.

"I think the general sense is there are more restrictions," said Jacobs.

"How large a population will be adversely affected is really yet to be determined," he added. "I don't think it's much ado about nothing, I just don't know how big it will be yet."