For more information on documenting a non-permanent resident alien's employment and income stability, credit history, and liquid assets, see Announcement 94-19 (dated 12/09/94).

Refinance Transactions Involving "Buy-out" of Domestic Partner's or Affianced's Interest

Announcement 94-19 clarified that a lender should treat a refinancing that results from a divorce settlement in which one of the spouses is required to "buy-out" the other spouse's interest in a property as a "limited cash-out" refinance transaction if the borrower who acquired sole ownership of the property receives no cash out of the refinance proceeds.  We have received a number of inquiries about how to treat similar "buy-outs" by domestic partners, fiancées, or fiancés.

Lenders may consider a person's "buy-out" of the interests of his or her domestic partner, fiancée, or fiancé to be a "limited cash-out" refinance transaction as long as the following conditions are satisfied:

• The mortgage property must have been jointly owned by both parties for at least the 12 months preceding the date of the mortgage application.
• Both parties must be able to demonstrate that they occupied the mortgage property as their principal residence, by providing an acceptable source of verification (such as a driver's license or a bank statement, credit card bill, utility bill, etc. that was mailed to the individual at the address of the mortgaged property).
• Both parties must sign a written agreement that states the terms of the property transfer and the proposed disposition of the proceeds from the refinancing transaction.  (The borrower who acquires sold ownership of the property must receive no cash out of the proceeds of the refinancing.)
• The party who is "buying out" the other party's interest must be able to qualify for the mortgage under our standard underwriting guidelines.

Lenders should also note that, if we have an ownership interest in the mortgage that is being refinance, we permit that mortgage to be assumed by the borrower who is gaining full ownership of the property (rather than requiring that it be refinanced) -- as long as that borrower will continue to occupy the property and the transfer takes place at least 12 months after the mortgage was closed.  Since this type of transaction is an "exempt" transaction, under our due-on-sale enforcement policy, the borrower who is gaining full ownership of the property does not generally have to re-qualify for the mortgage.  However, if the borrower whose interest is "bought out" requests a release of liability, then the remaining borrower must be able to qualify for the mortgage under our standard underwriting guidelines.  (See Part III, Section 408.02, of the Servicing Guide for more information.)

Previous Bankruptcy, Mortgage Foreclosure, or Deed-in-Lieu

One of the most important indicators in determining how a mortgage will perform is the quality of the applicant's credit history.  The presence of significant derogatory credit dramatically increases the likelihood of a future mortgage default.  Part VI, Section 205, of the Selling Guide currently requires lenders to look at an applicant's credit history over the past seven years to determine whether there are any major instances of derogatory credit (such as judgments, bankruptcies, foreclosures, voluntary conveyances by a deed in lieu of foreclosure, etc.).  If the applicant filed for bankruptcy during that time period, the bankruptcy must have since been discharged and the applicant must have re-established an acceptable credit record and demonstrated an ability to manage his or her financial affairs.  This is also true if the borrower's previous mortgage was foreclosed (or otherwise liquidated by a deed in lieu of foreclosure) during that time period.  We have generally considered two years to be sufficient time for re-establishing credit; however, when the bankruptcy or foreclosure-related action was caused by extraordinary circumstances, we have permitted lenders to rely on just the latest 12 months.

Our recent research into mortgage performance indicates that an individual who has a previous bankruptcy filing will have a higher likelihood of mortgage default than an individual who has no history of bankruptcy  (even if both individuals have be same credit score).  Therefore, we are modifying our underwriting guidelines for applicants who have a previous bankruptcy in their credit history (and are making similar changes with respect to borrowers who have a previous mortgage foreclosure or deed-in-lieu) -- effective with mortgage applications taken on or after November 1, 1998.  Under these revised guidelines, we expect lenders to consider any instances of bankruptcy filing or foreclosure-related actions disclosed in the borrower's mortgage application or revealed in the borrower's credit history.  Key points in this revised policy are summarized below (and discussed in more detail in the following materials):

• We will require an elapse time of four years for an applicant to re-establish a credit record.  Elapsed time is measured by comparing the date of an application for a new mortgage loan to (1) the date a Chapter 7, 11, or 12 bankruptcy was discharged, (2) the date a Chapter 13 repayment plan was successfully completed and the bankruptcy discharged, (3) the date of a foreclosure sale, or (4) the date of a deed-in-lieu was executed.  We make the following exceptions to this policy:
• We will consider a shorter elapsed time of two years to be an acceptable interval for re-establishing a credit record when the previous action was a Chapter 13 bankruptcy, regardless of the reasons that contributed to the previous bankruptcy.
• We will consider a shorter elapse time of two years as an acceptable interval for re-establishing a credit record if the previous action related to a foreclosure, deed-in-lieu, or Chapter 7, 11, or 12 bankruptcy -- as long as the applicant can satisfactorily document that the bankruptcy of foreclosure-related action resulted from extenuating circumstances.  If the applicant cannot provide satisfactory documentation of the extenuating circumstances, four full years must have elapsed.
• We have redefined the "extenuating circumstances" that may lead to bankruptcy or foreclosure-related action.  Extenuating circumstances are created by nonrecurring events that are beyond the applicant's control, which result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.  However, extenuating circumstances cannot be solely defined by the event; they must take into consideration the interrelationship between the event, the severity of the resulting hardship, and the extent of the applicant's efforts to resolve the situation.
• We have established new requirements for determining an "acceptable" payment record under an applicant's re-established credit.

When an applicant's credit report or information provided in the applicant's mortgage application or other documents in the individual mortgage file reveals a previous bankruptcy or foreclosure-related action, the lender should request the applicant to provide a copy of the applicable bankruptcy documents or a copy of appropriate documentation that will establish the date of the previous foreclosure or deed-in-lieu.  If the foreclosure or deed-in-lieu was completed or a Chapter 7, 11, or 12 bankruptcy was discharged within the last four years, the lender should also ask the applicant to submit a written statement to explain the circumstances that contributed to the bankruptcy or foreclosure-related action and, if applicable, to provide documentation to support his or her claim of extenuating circumstances.  Documentation provided to support claims of extenuating circumstances should confirm the nature of the event that led to the bankruptcy or foreclosure-related action and illustrate that the applicant had no reasonable options other than to default on his or her financial obligations.  Examples of documentation that can be used to support extenuating circumstances included the following:

• A copy of a divorce decree, medical reports or bills, notice of job layoff, job severance papers, etc. can be used to confirm the event.
• A copy of insurance papers or claim statements, property listing agreements, lease agreements, tax returns (covering the periods prior to, during and after a loss of employment), etc. can be used to illustrate factors that contributed to the applicant's inability to work his or her way through the problems that resulted from the event.

The lender should review the information provided by the applicant (1) to confirm the amount of time that has elapsed since the date of the bankruptcy discharge, deed-in-lieu, or foreclosure sale; (2) to determine, if applicable, that the applicant's explanations for the previous bankruptcy or foreclosure-related action agree with the documentation that was provided to support an extenuating circumstances claim; and (3) to make sure that the information is consistent with the applicant's credit report.

When an applicant provides documentation to support a claim of extenuating circumstances, the documentation should clearly reflect that the financial hardship was brought about by factors beyond the applicant's control and illustrate that the extent of the hardship was such that it reasonably could be considered insurmountable given the applicant's resources and available options at the time the hardship occurred.  In evaluating the extenuating circumstances, the lender should focus on the interrelationship between the event, the severity of the hardship, and the applicant's efforts to resolve the situation.  For example, a job layoff (the event) in itself should not automatically be considered an extenuating circumstance (even if it is supported by documentation from a third party).  If, however, the unemployment that results from a job layoff was prolonged and the loss of income was significant in relation to the applicant's obligations and available assets at the time of the layoff, then the layoff can be considered as an extenuating circumstance.  Similarly, a divorce (the event) should not be considered an extenuating circumstance unless, as the result of the divorce, the applicant had no reasonable options other than to default on his or her obligations and to file for bankruptcy protection or offer a voluntary conveyance in lieu of foreclosure.

Regardless of the reason for the bankruptcy or foreclosure-related action or, the elapsed time since the completion of that action, the lender must determine that the applicant has an acceptable payment record under the re-established credit history.  The applicant's re-established credit history must reveal a payment record that illustrates that the borrower now has the willingness and ability to manage his or her finances over time an, if applicable, under different economic conditions.

Generally, the presence of a previous bankruptcy or foreclosure-related action in an applicant's credit history suggests that the applicant was not able to successfully manage credit from traditional sources.  Some individuals may attempt to avoid a recurrence of their credit problems by not re-establishing the types of credit accounts that led to their previous difficulties.  However, before approving mortgage financing, a lender needs to determine that the applicant has acquired successful credit management skills.  An applicant's complete avoidance of traditional credit sources is not the best way of demonstrating the presence of those skills.  Since there are multiple sources for obtaining traditional credit, an applicant can avoid the type of credit accounts that led to the previous financial difficulties (such as revolving accounts), while re-establishing credit through the use of other types of traditional credit (such as fixed-payment installment accounts).  Because of the need to evaluate the applicant's ability to manage traditional credit, we require that at least one of the accounts under the re-established credit be from a traditional source of credit.  In no instance may credit from a nontraditional source be used to offset a delinquency for a traditional credit account.

When the applicant's previous credit history included a bankruptcy filing or foreclosure-related action, all the accounts in the applicant's credit report must be current as of the date of the mortgage application.  In addition, the applicant's credit record under the re-established credit history must include

1. a minimum of four credit references, with at least one of the references being a traditional credit reference and one of the references being a housing-related.  (Housing-related references should cover the period following the bankruptcy discharge, foreclosure, or deed-in-lieu and can be in the form of mortgage payments or rental payments.  If rental payments were not reported to the credit repositories, the applicant must provide copies of bank statements, money orders, or cancelled checks for the most recent 12-month period as a supplement of the rent verification.)  Three of the four credit references (including any rental housing reference) must have been active in the 24 months proceeding the date of the mortgage applications;
2. no more than two installment or revolving debt payments that were 30 days past due in the last 24 months;
3. no installment or revolving debt payments 60 or more days past due since the discharge or completion of the bankruptcy or the completion of the foreclosure-related action;
4. no housing debt payments past due since the discharge or completion of the bankruptcy or the completion of the foreclosure-related action; and
5. no new public records for bankruptcies, foreclosures, deeds-in-lieu, pre-foreclosure sales, unpaid judgments or collections, garnishments, liens, etc. since the discharge or completion of the bankruptcy or the completion of the foreclosure-related action.

In completing the evaluation of the applicant's payment record under the re-established credit history, the lender should also confirm that the applicant's latest credit standing indicates the demonstrated ability to successfully manage his or her credit usage.  Credit scores can be a useful tool in making this assessment.  We recommend that lenders use a FICO bureau score of 660 or higher as an indicator of successful credit management.  Our policy on the use of credit scores has always been that a credit score should be used as part of a careful, comprehensive analysis of the characteristics of each mortgage application and should never be used in isolation or as the sole factor in the underwriting decision.  This is especially true for applicants who have a previous bankruptcy, mortgage, mortgage foreclosure, or deed-in-lieu in their credit history.  Although our research indicates that applicants who have a previous bankruptcy have a higher default rate than applicants with the same credit score who have no history of bankruptcy, credit scores can still be used to provide an objective measurement of the applicant's credit standing, as long as the applicant has sufficiently re-established his or her credit and provides an acceptable explanation of the circumstances leading to the bankruptcy, foreclosure, or deed-in-lieu.

The applicant does not have to have a FICO bureau score of 660 or above in order for the lender to determine that the applicant has an acceptable payment record, rather the lender should use this score as a benchmark (which means that the lender can approve an applicant who has a lower score as long as there is no additional layering of risk and sufficient compensating factors that justify the approval decision -- such as a lower loan-to-value ratio or a co-borrower who has a high credit score -- can be documented).  It is also important that the lender not automatically approve an applicant who has a FICO bureau score of 660 or higher, unless the applicant's credit record also has the minimum four accounts (with the required seasoning) we specify as necessary to re-establish acceptable credit.

"Trailing" Secondary Wage Earner's Income

It is not unusual for a household that consists of two wage earners to relocate to another area because one of the wage earners is transferred by his or her employer or finds a different job in a new location.  Often these individuals will find a home in the new location that they want to purchase before the other wage earner finds a new job.  This means that the wage earner who has the job (the primary wage earner) generally must be able to qualify for a mortgage based solely on his or her income, although the fact that the other wage earner (the secondary wage earner) has worked in the past and plans to do so in the future may serve as a compensating factor to justify the use of higher qualifying ratios.  Different lenders may not be applying the same weight to this compensating factor.

We have decided to establish specific criteria that set forth the conditions under which a portion of a secondary wage earner's income before the relocation can be considered as "anticipated" income for the job he or she will eventually obtain in the new area.  This treatment of a "trailing" secondary wage earner's income may be used only for relocations that take place in connection with a documented corporate relocation program offered by the primary wage earner's employer, and then should be considered only all of the following conditions are satisfied:

• The mortgage is a fixed-rate purchase money first mortgage that is secured by a one-family owner-occupied principal residence, and is not subject to a temporary interest rate buy down plan or any type of subordinate financing.
• The loan-to-value ratio for the mortgage does not exceed 80%.
• The secondary wage earner is a relative, domestic partner, fiancée, or fiancé of the primary wage earner. A relative is the primary wage earner's spouse, child, or other dependent or any other individual who is related to the primary wage earner by blood, marriage, adoption, or legal guardianship.  A domestic partner is an unrelated individual who shares a committed relationship with the primary wage earner, and intends to reside with the primary wage earner at the new location.  (The primary wage earner's fiancée or fiancé does not have to currently reside in the same household with the primary wage earner.)
• The secondary wage earner was employed as a salaried employee or as an hourly wage or commissioned employee in the same statement indicating his or her intention to obtain employment in the new location.  As long as the lender is able to document a reasonable employment market for positions that are the same as (or similar to) the secondary wage earner's previous position(s), the lender may consider 50% of the secondary wage earner's documented income from his or her previous employment as "anticipated" income for the future employment.  (The lender may use a salaried or hourly was earner's latest salary; however, if the secondary wage earner was a commissioned employee, the lender should use the average of the wage earner's income for the last two years.)
• The combined incomes (actual income for the primary wage earner and "anticipated" income for the secondary wage earner) and expense of the two wage earners result in a monthly housing expense-to-income ratio of 28% or less and a total obligations-to-income ratio of 36% or less.  However, higher qualifying ratios may be used when strong compensating factors exist.
• The borrowers have cash reserves (or other liquid assets that are easily converted to cash) at closing equal to at least six months of payments for the mortgage and all other recurring debt obligations.

For borrowers who are unable to satisfy the above criteria, lenders may continue using the "trailing" secondary wage earner's intent to obtain employment at the new location as a compensating factor to justify the use of higher qualifying ratios.

Gifts as a Source of Funds

The Selling Guide currently states that a borrower can use a gift form a relative as the source of funds for the down payment or closing costs.  We have not in the past specifically indicated whether the proposed occupancy status of the property has any bearing on the acceptability of gifts for this purpose.  Since our decision to accept gifts as a source of the down payment or closing costs was based on the desire to help as many borrowers as possible achieve homeownership, we are modifying out policy on gifts to permit their use only in connection with the purchase of principal residence properties -- effective with mortgage applications taken on or after November 1, 1998.

We also have received a number of inquires regarding the individuals who can be considered relatives and whether gifts from a domestic partner, fiancée, or fiancé are acceptable.  The term "relative" is defined in the Selling Guide as "the borrower's spouse, child, or dependent, or any other individual related to the borrower by blood, marriage, adoption, or legal guardianship."  Therefore, a gift can come from the borrower's spouse, parents, siblings, children, grandchildren, aunts, uncles, cousins, step-parents or step-children, regardless of whether the relationship is by blood, adoption, marriage, or legal guardianship.  The gift may also come from the borrower's domestic partner, fiancée, or fiancé.

If a domestic partner, fiancée, or fiancé has lived with the borrower for the last 12 months and will continue to do so, his or her gift may be pooled with the borrower's funds to satisfy our minimum 5% cash down payment requirement (in accordance with the provisions of Part VI, Section 203.03C, of the Selling Guide).

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Lenders should contact their Customer Account Manager in their lead Fannie Mae regional office if they have any questions about these policy changes or clarifications.