www.hudclips.org
U. S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, D. C. 20410-8000
October 20, 1989
OFFICE OF THE ASSISTANT SECRETARY FOR
HOUSING-FEDERAL HOUSING COMMISSIONER
Mortgagee Letter 89-25
TO: ALL APPROVED MORTGAGEES
SUBJECT: Single Family Loan Production - Use of
Effective Gross Income To Calculate Borrower
Qualifying Ratios and Changes to Underwriting
Investor Applications
A. CHANGE TO USE EFFECTIVE GROSS INCOME
To promote a more accurate analysis of the adequacy
of borrower income, the Department of Housing and Urban
Development (HUD) is changing from using the "net
effective income" approach to using the "effective gross
income" approach to calculate borrower qualifying ratios.
By adopting the "effective gross -income" approach, HUD is
conforming its processing to the general practice within
the industry and, therefore making it easier for
mortgagees to process applications. Direct Endorsement
(DE) lenders may begin to use the effective gross income
qualifying ratios for borrower applications underwritten
(Mortgage Credit Worksheets, Form HUD 92900 WS, signed by
the DE underwriter) on or after October 20, 1989. DE
lenders must use the effective gross income qualifying
ratios for applications involving sales contracts signed
on or after December 1, 1989.
For "prior approval" cases received by HUD involving
sales contracts signed before December 1, l989, we will
continue to process these applications for firm commitment
using net effective income calculations, unless otherwise
requested by the lender. Applications for firm commitment
involving contracts signed on or after December 1, 1989,
will be processed by HUD using the effective gross income
calculations.
The new effective gross income ratios are intended to
be a more meaningful criterion to determine the adequacy
of an applicant's income. Typically, approved
applications should not exceed the new effective gross
income qualifying ratios of 29 and 41 percent. However,
in certain instances, where an underwriter finds there are
significant compensating factors, the ratios may be
exceeded with the pertinent factors used in the analysis
explained in the "Remarks" section of the Mortgage Credit
Worksheet. We expect that the vast majority of borrowers
approved under the old net effective income
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approach, where the ratios were exceeded, will more than
likely be approved under the new effective gross income
approach without the new ratios being exceeded.
HUD will consider it appropriate to permit somewhat
more flexibility in an applicant's initial ratio provided
the second or fixed payment ratio does not exceed the
guideline.
As a preface to the ensuing portion of this letter
the following terms are described as they relate to
effective gross income calculations:
Effective Gross Income: Verifiable, continuing income
from all sources. The Federal tax liability calculation
formerly used with net effective income is no longer
used.
Total Mortgaqe Payment: The sum of the principal,
interest, real estate taxes, hazard insurance (PITI), and
the monthly MIP and/or homeowner association or
condominium fee, when applicable. Maintenance expense and
heat and utilities estimates formerly used with net
effective income will no longer be used in this
calculation. Where there is documented evidence that
utility costs are included in the condominium fee, the fee
should be reduced by the utility costs prior to
calculating the ratios.
Recurring Charges: Any debt that does not mature in
six months or is classed as recurring, i.e., open,
revolving charge account; child support and child care
expense, etc. State and local income taxes and social
security taxes formerly used with net effective income
will no longer be used in this calculation.
Total Fixed Payment: The sum of the total mortgage
payment and the recurring charges.
Mortgage Payment Ratio: Total mortgage payment
divided by effective gross income. The qualifying
guideline is 29 percent.
Fixed Payment Ratio: Fixed payment divided by
effective gross income. The qualifying guideline is 41
percent.
Until a revised Mortgage Credit Worksheet is printed,
use of the current HUD 92900 WS is acceptable with the
following modifications:
1. Block 14: Monthly effective income - Delete
lines f and g. Change line h to read "effective
income."
2. Block 15: Future monthly payments - In line b,
add a third block labeled "Homeowner or Condo
Fee." Delete lines d, h, i, and j. Change the
heading in line k to read "Recurring Charges."
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3. Block 16: Debts and obligations - Delete lines
a and b. Change heading in line f to read
"Total Recurring Charges."
4. Block 17: Borrower rating - To this heading,
add "(A) Acceptable and (R) Reject.
5. Block l8: Ratios, etc. - Change line b to read
"Effective Income," line b1 to read "Total
Mortgage Payment," and delete line c.
A sample of a modified HUD 92900 WS is attached for
your use. Please reproduce this sample as needed.
The "Credit Profile" on the front of each case binder
is to be amended under "E. Income Ratios." For the first
ratio, strike the word "Net" and change 43 percent to 29
percent. For the second ratio, strike the word "Net" and
change 63 percent to 41 percent.
Mortgage Credit Certificate Programs: With the
implementation of the effective gross income approach, HUD
or the DE underwriter will no longer be able to adjust the
Federal tax liability to reflect the effects of a Mortgage
Credit Certificate (MCC). In order to continue to reflect
the benefit to the mortgagor who is participating in the
program, the effective gross income is to be increased by
the amount of the tax credit and the application
underwritten on the adjusted amount.
Energy Efficient Homes: In conjuncton with the
effective gross income approach, HUD will permit
qualifying ratios to be increased by 2 percentage points
from 29 and 41 percent to 31 and 43 percent, respectively,
on newly constructed homes that have been identified as
being "Energy Efficient Homes" (EEH).
Lenders must work with their builders and respective
HUD Field Offices to obtain the 2 percent increase. We
have developed a proposed form for the lender and builder
to complete to provide information necessary to determine
if the home meets the "Energy Efficient Home (EEH)
Guideline." (See proposed Form HUD 91103, attached.) These
guidelines exceed the minimum thermal requirements set
forth in 24 CFR 2OO.926d(e). Builders must meet or exceed
the guidelines in all categories to establish that the
property is eligible as an EEH. On the back of the
proposed form is a listing of cities with the
corresponding heating degree days. For cities not listed,
use the nearest city designation. Column E is to be
filled in by the builder to show the values actually used
for the property and for comparison with the guidelines
shown in Columns A through D.
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Since the Form HUD 91103 is not yet a fully approved
HUD form, its use is optional. The builder may provide
either a complete and certified Form HUD 91103 or a letter
certifying compliance with the minimum guidelines shown on
the form. In the case of a letter, provide the same
information as shown on the top of the form; include the
designation for the heating degree days used, list the
values used for each item on lines I through II and show
the type of heating system (with its energy efficiency
rating as shown on line V of the form). A separate
statement certifying compliance with line IV,
weatherstripping is also required.
If the builder uses the form, he must properly fill
it out and provide the following certification in the
"Remarks" section:
I certify that the above statements in column E
are true and that I meet or exceed the minimum
guidelines in column (select A, B, C, or D)
above.
Date Builder or his Authorized
Representative
Upon receipt of the proposed form, the DE Underwriter
or HUD reviewer should verify that the construction
documents (plans and specifications) comply with the
information shown on Form HUD 91103. If acceptable, sign
and date the form in the Box marked "HUD Authorized
Representative," thereby permitting the 2 percent increase
in qualifying ratios.
A signed copy of the EEH designation should be
provided to the homebuyer by the lender so that at resale,
eligibility for the 2 percent increase can be provided to
subsequent purchaser(s).
The "Credit Profile" area on the front of the case
binder over "HUD Use Only" should be marked "EEH" when
this procedure is used.
B. CHANGE TO UNDERWRITING INVESTOR APPLICATIONS
All investment properties processed using the
effective gross income approach will be subject to
additional criteria when determining the maximum mortgage
amount. The monthly mortgage payment (PITI) may not
exceed the net rental income to be derived from the
property. Net rental income is defined as HUD's estimate
of market rent, as determined by the appraiser, less a
reasonable allowance for vacancies and collections, as
established by each HUD Field Office.
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If you have any questions, please contact your local
HUD Office or Headquarters Mortgage Credit Branch at (202)
755-6700.
Sincerely,
C. Austin Fitts
Assistant Secretary for Housing-
Federal Housing Commissioner
Attachments
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