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 _____________________________________________________________________ 2 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." _____________________________________________________________________ 3 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. _____________________________________________________________________ 4 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. _____________________________________________________________________ 5 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 _____________________________________________________________________