The Federal Housing Administration (“FHA”) is updating its Technology Open to Approved Lenders (“TOTAL”) Mortgage Scorecard in an effort to address excessive risk layering where, for example, FHA mortgage loan applicants have low credit scores and high debt-to-income (“DTI”) ratios. The FHA announced on March 14th that the TOTAL Mortgage Scorecard updates will apply for all mortgages with FHA case numbers assigned on or after March 18, 2019. As a result, the Department of Housing and Urban Development (“HUD”) indicated that lenders should expect to receive an increase in the number of referrals from TOTAL for manual underwriting. While HUD appears to be focused on loans with low credit scores and high DTI ratios, it did not identify the specific changes it will make or the precise combinations of factors that may result in referrals for manual underwriting.

HUD created the FHA TOTAL Mortgage Scorecard as a statistical algorithm to evaluate loan applications and consumer credit using a scoring system that remains constant for all applicants. FHA lenders access TOTAL through an automated underwriting system. Lenders are required to score potential FHA mortgage transactions through TOTAL, except for streamline refinances, home equity conversion mortgages, Title I mortgages, and loans involving borrowers without credit scores. TOTAL uses application and credit variables to determine loan eligibility for FHA insurance and recommends a decision of “Accept” or “Refer” for each application. An “Accept” decision means that FHA will insure the loan without manual underwriting (subject to certain exceptions delineated in FHA guidelines). A “Refer” decision means that a Direct Endorsement (“DE”) underwriter must manually underwrite and approve the loan for it to receive FHA endorsement.

In 2013, HUD updated the TOTAL Mortgage Scorecard to include manual underwriting requirements for FHA mortgage loan applicants with credit scores under 620 and DTI ratios exceeding 43%. At that time, through Mortgagee Letter 2013-05, HUD directed lenders to manually downgrade such loans to a Refer scoring recommendation even if they received an Accept recommendation from TOTAL Mortgage Scorecard. Lenders were required to manually underwrite the loans in accordance with all FHA manual underwriting requirements; alternative documentation options available for TOTAL Scorecard Accept/Approve decisions were not available. The new requirement was effective for all FHA loans with case numbers assigned on or after April 1, 2013. HUD then withdrew the requirement three years later when it revised the TOTAL Scorecard User Guide, effective August 22, 2016.

HUD has indicated that, since that time, FHA has insured an increasing number of loans with high-risk credit characteristics. HUD believes that termination of the manual underwriting requirement for loans with credit scores below 620 and DTI ratios above 43% has contributed to the increase in high-risk loans. According to FHA’s most recent Annual Report to Congress, in Fiscal Year 2018: (1) there was a 60% increase in cash-out refinances; (2) approximately 25% of the forward mortgage purchase transactions were comprised of borrowers with DTI ratios above 50%’ (3) borrowers’ credit scores were at their lowest since 2008 and are continuing to decline; and (4) borrowers with both credit scores below 640 and DTI ratios over 50% increased. In response to such trends, FHA Commissioner Brian Montgomery announced that FHA’s goals for Fiscal Year 2019 include upholding FHA’s “core mission” to  promote sustainable mortgage credit, strengthening FHA’s work by maintaining the integrity of its endorsements and attracting quality lenders to FHA programs, and managing risks.

HUD’s announcement last week regarding updates to TOTAL Mortgage Scorecard appears to be a direct response to the increase in high-risk FHA loans and the Commissioner’s stated goals. HUD stated that, to support sustainable homeownership and manage risk to protect the FHA insurance fund, FHA must make “prudent and necessary changes to recalibrate and adjust its policies as warranted.” However, while indicating that change is imminent, HUD did not specify what changes or adjustments to expect, only that (as mentioned above) TOTAL may provide feedback results that certain mortgages must be manually underwritten. Given HUD’s focus on loans with credit scores below 640 and DTI ratios above 50%, it is probably safe to assume that this combination of factors will require manual underwriting. However, the question remains as to what other factors or combinations of factors will trigger a manual underwriting referral.

Starting next week, FHA lenders should not be surprised to see changes in TOTAL Mortgage Scorecard or to receive Refer recommendations to manually underwrite loans with higher-risk characteristics, especially when multiple risk factors are present. DE underwriters should remember to document their underwriting decisions for such loans in accordance with existing FHA requirements for manually underwritten mortgages. Given HUD’s focus on managing risk and lack of specificity regarding the impending changes to TOTAL Mortgage Scorecard, lenders should be vigilant in demanding underwriter compliance with applicable requirements and prepared to defend their underwriting decisions.

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