Fannie Mae, the quasi-government corporation that is the largest buyer of mortgages in the country, recently announced some new lending policies that at first glance appear to be a mix of wisdom and absolute insanity. I’m still working to make sense of it, but in the mean time, here’s the text of the update memo:

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Announcement 08-16

June 25, 2008

Amends these Guides: Selling

Bankruptcy, Foreclosure, and Conversion of Principal Residence Policy Changes; and Revised Property Value Representation and Warranty Requirements

Introduction

With this Announcement, Fannie Mae is introducing several new and updated policies that pertain to the following topics:

• Bankruptcy and foreclosure policies: updates to manual underwriting requirements for borrowers with prior bankruptcy or foreclosure actions in their credit history, including deeds-in-lieu of foreclosure and preforeclosure sales
• Conversion of principal residence to second home or investment property: new requirements for borrowers who are purchasing a new principal residence, and intend to convert their existing principal residence to a second home or investment property, and
• Representation and warranty requirements: revised property value representation and warranty requirements for mortgage loans that are closed more than 6 months up to 12 months prior to the date the loan is sold to Fannie Mae.

The effective dates for each of the above updates are outlined at the end of this Announcement.

Bankruptcy and Foreclosure Policy Changes

Selling Guide, Part X, Section 302.10, Prior Bankruptcy or Foreclosure; and Section 803.02, Payment History

Announcement 08-08, Mortgage Eligibility and Pricing Updates for Desktop Underwriter® and Manually Underwritten Loans, dated March 31, 2008, outlined changes to the requirements for borrowers with a prior foreclosure in their credit history. With this Announcement 08-16, Fannie Mae is updating the requirements regarding the time period that must elapse before borrowers can demonstrate they have reestablished their credit history after the occurrence of a bankruptcy or foreclosure. The updates pertain to the following policies.

Updating the requirements for bankruptcy actions to apply from the discharge or dismissal date, whichever is applicable, and requiring a longer elapsed time period for Chapter 13 bankruptcies that were dismissed. For all bankruptcy actions, the elapsed time period to reestablish credit will now be measured from the bankruptcy discharge or dismissal date. For all bankruptcy cases, other than Chapter 13 cases, the time period to reestablish credit remains at 4 years. For Chapter 13 cases, a distinction is being made between Chapter 13 bankruptcies that were discharged and those that were dismissed. The updated policy recognizes the fact that borrowers have reestablished credit through the successful completion of a Chapter 13 plan and subsequent discharge by requiring only a 2-year time period to elapse. A borrower who was unable to complete the Chapter 13 plan and received a dismissal, however, will be held to a 4-year time period for reestablishing credit.

Establishing a new policy for borrowers who have more than one bankruptcy filing in the past 7-year time period. A 5-year elapsed time period is now required to reestablish credit from the most recent discharge or dismissal date for borrowers who have more than one bankruptcy filing in the past 7 years. The presence of multiple bankruptcies in the borrower’s credit history is evidence of significant derogatory credit and increases the likelihood of future default. The greater the number of such incidences and the more recently they occurred, the higher the credit risk.

Establishing a new policy for preforeclosure sales. A preforeclosure sale involves the sale of the property by the borrower to a third party for less than the amount owed to satisfy the delinquent mortgage, as agreed to by the lender, investor, and mortgage insurer. Due to the increased incidence of preforeclosure sales, Fannie Mae is establishing a 2-year elapsed time period for reestablishing credit following completion of the action.

The following table outlines Fannie Mae’s current and new policies for manually underwritten loans related to the time period that must elapse before borrowers can demonstrate they have reestablished an acceptable credit history after the occurrence of the bankruptcy or foreclosure. The table also includes new “Additional requirements” that apply to foreclosures.

Action: Bankruptcy (All Except Chapter 13)
Current Requirements: 4-year time period from discharge date
New Requirements: The 4-year time period remains the same but will now be applied from either the discharge or dismissal date of the bankruptcy action.

Action: Chapter 13 Bankruptcy
Current Requirements: 2-year time period from discharge date
New Requirements: The time period for Chapter 13 bankruptcy actions is measured as follows:
• 2 years from the discharge date, or
• 4 years from the dismissal date.

Action: Exceptions for Extenuating Circumstances – All Bankruptcy Actions
Current Requirements: 2-year time period from discharge date. No exception to the 2 year time period for Chapter 13 bankruptcy actions.
New Requirements: The 2-year time period will be measured from the bankruptcy discharge or dismissal date. No exceptions are permitted to the 2-year time period after a Chapter 13 discharge.

Action: Multiple Bankruptcy Filings
Current Requirements: No existing policy
New Requirements: 5-year time period from most recent dismissal or discharge date required for borrowers with more than one bankruptcy filing within the past 7 years.

Action: Exceptions for Extenuating Circumstances – Multiple Bankruptcy Filing
Current Policy: No existing policy
New Requirements: 3-year time period from the most recent discharge or dismissal date. Note: The most recent bankruptcy filing must have been the result of extenuating circumstances.

Action: Foreclosure
Current Requirements: 4-year time period from the date the foreclosure sale was completed (“completion date”)
New Requirements: 5-year time period from completion date
Additional requirements that apply after 5 years up to 7 years following completion date:
• The purchase of a principal residence is permitted with a minimum 10 percent down payment and minimum representative credit score of 680.
• Purchase of a second home or investment property is not permitted.
• Limited cash-out refinances are permitted for all occupancy types pursuant to the eligibility requirements in effect at that time.
• Cash-out refinances are not permitted for any occupancy type.

Action: Exceptions for Extenuating Circumstances – Foreclosure
Current Requirements: 2-year time period from completion date
New Requirements: 3-year time period from completion date. Additional requirements that apply after 3 years up to 7 years following completion date: The same additional requirements apply as above except the minimum credit score of 680 is not required.

Action: Deed-in-Lieu of Foreclosure
Current Requirements: 4-year time period from completion date (date deed-in-lieu executed)
New Requirements: No change
Additional requirements that apply after 4 years up to 7 years following completion date:
• Borrower may purchase a property secured by a principal residence, second home, or investment property with the greater of 10 percent minimum down payment or the minimum down payment required for the transaction.
• Limited-cash-out and cash-out refinance transactions secured by a principal residence, second home, or investment property are permitted pursuant to the eligibility requirements in effect at that time.

Action: Exceptions for Extenuating Circumstances – Deed-in-Lieu of Foreclosure
Current Requirements: 2-year time period from completion date
New Requirements: No change
The same additional requirements noted above for deed-in-lieu apply after 2 years up to 7 years following completion date.

Action: Time Period After Preforeclosure Sale
Current Requirements: No existing policy
New Requirements: 2-year time period from completion date.
Additional Requirements: None
Note: No exceptions are permitted to the 2-year time period due to extenuating circumstances.

Note: The Selling Guide, Part X, Section 803.02 contains several requirements the lender must follow in order to determine that the borrower has successfully reestablished his or her credit history after a bankruptcy or foreclosure action. These requirements continue to be applicable, in addition to the elapsed time periods and any additional requirements noted above. Additionally, Desktop Underwriter (DU®) will be updated in a future release to incorporate some or all of the policy changes noted above.

Conversion of Principal Residence to Second Home or Investment Property

Selling Guide, Part X, Section 402.24 Rental Income, and Section 702.03 All Other Liabilities, D. Payments on real estate mortgages

Borrowers who currently own their home typically have three options when they decide to purchase a new principal residence. They can

• sell the current residence and pay off the outstanding mortgage,
• convert the property to a second home, assuming they can qualify with both the existing and new mortgage payments, or
• convert the property to an investment property and provide documentation that they will rent the property and use the income to offset the mortgage payment

In order to ensure that borrowers have sufficient equity and/or reserves to support both the existing financing and the new mortgage being originated, Fannie Mae is updating the policies for qualifying borrowers purchasing a new principal residence and converting their existing principal residence to a second home or investment property.

Current Requirements:

• Rental income that will be generated from the prior principal residence is based solely on a fully executed lease agreement for that property provided by the borrower (now landlord)
• If the lender uses current lease agreements, the net rental income will be 75 percent of the gross rent from the lease agreement, with the remaining 25 percent being absorbed by vacancy losses and ongoing maintenance expenses.
• Minimum reserves are required for investment properties: 2 months for one-unit properties, and 6 months reserves for two- to four-unit properties. Minimum reserves are not required for second home transactions.

The remainder of the update is here: Fannie Mae Update

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I’ll go over this today and find out what, if anything, is relevant to real estate investors. At the least, the shift in short sale policy seems strange, but some of the other changes seem quite reasonable.