Loan Guaranty: Credit Standards

DEPARTMENT OF VETERANS AFFAIRS

38 CFR Part 36

RIN 2900-AI16

Loan Guaranty: Credit Standards

AGENCY: Department of Veterans Affairs.

ACTION: Proposed rule.

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SUMMARY: This document proposes to amend VA's loan guaranty regulations

regarding credit standards used by lenders to evaluate the

creditworthiness of veteran-borrowers for home loans. VA is committed

to regular review and revision of the standards used to determine the

creditworthiness of veteran-applicants as issues arise and as the

mortgage industry changes. These proposed changes are designed to keep

VA in step with the rest of the home mortgage industry, at least to an

extent appropriate for a Government benefit-related mortgage program.

This document also requests Paperwork Reduction Act comments concerning

the collection of information contained in this document.

DATES: Comments must be received on or before July 7, 1997.

ADDRESSES: Mail or hand deliver written comments to: Director, Office

of Regulations Management (02D), Department of Veterans Affairs, 810

Vermont Avenue, NW, Room 1154, Washington, DC 20420. Comments should

indicate that they are submitted in response to ``RIN 2900-AI16.'' All

written comments received will be available for public inspection at

the above address in the Office of Regulations Management, Room 1158,

between the hours of 8:00 a.m. and 4:30 p.m., Monday through Friday

(except holidays).

FOR FURTHER INFORMATION CONTACT: Ms. Judith Caden, Assistant Director

for Loan Policy (264), Loan Guaranty Service, Veterans Benefits

Administration, Department of Veterans Affairs, 810 Vermont Avenue, NW,

Washington, DC 20420, (202) 273-7368.

SUPPLEMENTARY INFORMATION: VA is proposing to amend its loan guaranty

regulations regarding credit standards used by lenders to evaluate the

creditworthiness of veteran-borrowers for home loans. The regulations

proposed to be amended are set forth at 38 CFR 36.4337.

Statutory credit criteria applicable to the VA Loan Guaranty

Program are set forth at 38 U.S.C. 3710. Under the VA Loan Guaranty

Program, a loan may not be guaranteed unless the veteran is a

satisfactory credit risk, and the

[[Page 24875]]

contemplated terms of payment required in a mortgage to be given in

part payment of the purchase price or the construction cost bear a

proper relation to the veteran's present and anticipated income and

expenses. When making a credit determination for a VA-guaranteed loan,

the lender must consider that a veteran's benefit is involved. The law

intends that the veteran have this benefit provided the requirements of

the law are met. However, it serves no purpose to approve or make a

loan to a veteran who will be unable to meet the repayment terms or is

not a satisfactory credit risk. Such an approval would be, in fact, a

disservice since it could well result in the veteran losing the home, a

debt being owed by the veteran to the U.S. Government, and an adverse

effect on the veteran's credit standing.

VA is committed to regular review and revision of the standards

used to determine the creditworthiness of veteran-applicants as issues

arise and as the mortgage industry changes. VA recognizes that it is

important to keep in step with the rest of the home mortgage industry,

at least to an extent appropriate for a Government benefit-related

mortgage program.

Accordingly, we are proposing to amend Sec. 36.4337 for the reasons

discussed below.

Tax-Exempt Income (Paragraphs (d) and (f))

It is proposed to amend paragraph (d) and to add a new paragraph

(f)(4) concerning tax-free income when underwriting a loan. Previously,

VA regulations recognized the impact of tax-free income on the debt-to-

income ratio (generally higher) through noting it as a compensating

factor. However, the mortgage industry has come to require direct

recognition through what is generally called ``grossing up.'' This is

the adjusting of the tax-exempt income upward to a pre-tax or gross

income amount which, after deducting State and Federal income taxes,

would equal the tax-exempt income. This enables the calculation of the

debt-to-income ratio as if the borrower's income were all taxable and

results in the same ratio as a borrower with after-tax income equal to

the borrower's tax-exempt income. In recognition of the industry

practice, and for consistency, this proposed change to VA regulations

would allow ``grossing up'' for the purpose of calculating the debt-to-

income ratio. The actual tax-exempt income would be required to be used

in calculating the residual income.

Compensating Factors for Underwriting a Loan (Paragraph (c))

It is proposed to add two additional factors to the list of

compensating factors lenders are to consider in the course of

underwriting a loan. Upon review, it appears to be appropriate to

expand this list to include tax credits for child care and tax benefits

of home ownership as additional compensating factors.

Increase in Residual Income Required for Family Support (Paragraph

(e))

It is proposed to provide for an increase in the amount of residual

income required for family support. The computation of the Residual

Income tables set forth in this paragraph is based upon cost-of-living

and expenditure data compiled by the U.S. Bureau of Labor Statistics.

Based upon VA's review of that data, a 4-percent increase in those

guideline amounts appears to be an appropriate reflection of that data.

Inclusion of Household Members in Residual Income Determinations

(Paragraph (e))

It is proposed to clarify that the use of residual income

guidelines is to be based on consideration of all members of the

veteran's household. This reflects that all members of a household

(without regard to the nature of the relationship) are relevant to

determinations regarding residual income.

Residual Income Tiers (Paragraph (e))

It is proposed to adjust the breakpoint in the two residual income

tiers from $70,000 to $80,000. When the tiers were originally

established in December 1987, the median VA loan was approximately

$70,000. The median loan amount has risen steadily to its current level

of approximately $87,000, and it appears that an adjustment would be in

order. However, since this revision would constitute a slight loosening

of the credit standards, limiting the increase in the breakpoint in the

two tiers to $80,000 would be consistent with prudent underwriting

policy.

Age of Credit Documentation (Paragraphs (f), (g), and (h))

VA is proposing to change the maximum allowable age of credit

documentation to 120 days (or 180, in the case of new construction)

from the date the note is signed. This is proposed in order to

establish a standard consistent with industry standards and to clarify

the baseline for determining the maximum allowable age of credit

documents. Previously, the maximum age was 90 days, and, for automatic

loans, the baseline was the date of application. The use of the date of

application as the baseline sometimes resulted in cases in which the

documents were very old by the time they were used to underwrite the

borrowers' qualifications. This change would establish a standard more

closely tied to the time of the underwriting decision, which is usually

made at a time close to loan closing.

Reserves or National Guard (Paragraph (f))

VA is proposing a change to include members of the Reserves or

National Guard in the requirements that pertain to active duty

applicants within 12 months of release from active duty. Since income

received by a member of the Reserves or National Guard can be important

to a borrower's ability to qualify for a loan and since Reserves and

National Guard are subject to the same downsizing as the active

military, those applicants who are within 12 months of completion of

their current terms of service would be subject to the same

documentation requirements as members of the active military within 12

months of release from active duty.

Verification of Employment (Paragraph (f))

It is proposed to clarify that if an employer puts N/A or otherwise

declines to complete the block for ``probability of continued

employment'' on the Verification of Employment (VOE), no further action

would be required of the lender. Although written verification of

employment forms contain space for the employer to indicate the

borrower's probability of continued employment, many employers have

adopted the policy of not giving any indication as to such probability.

In order to assure that the lender will not be considered to have been

deficient in underwriting the loan without the probability of continued

employment having been given by the employer, if the space is shown as

``NA'' or has an indication that the company policy precludes giving

such information, no further development of probability of continued

employment would be required. The lender would be expected to have made

an assessment based on the borrower's overall work history and tenure

in his/her current position.

Income Such As Workers' Compensation and Foster Care (Paragraph

(f))

It is proposed to clarify when income such as workers' compensation

and

[[Page 24876]]

foster care income can be used as income. In the past VA has addressed

some types of unusual income, but workers' compensation and foster care

income have not been addressed. This proposed regulatory change would

set forth that such income can be considered when it can be determined

to be stable and reliable.

Automobile Allowance or Other Expense Account Type of Income

(Paragraph (f))

It is proposed to address income derived from an automobile

allowance or other expense account type of income. VA credit standards

have not previously addressed ``income'' derived from automobile or

similar allowances, which are often a part of the borrower's overall

income. Therefore, VA proposes to add information for determining when

an automobile allowance or other expense allowance constitutes income

for loan qualification purposes.

Profit and Loss Statements Prepared by Accountants (Paragraph (f))

It is proposed to delete the requirement that profit and loss

statements be prepared by an accountant. Inasmuch as full tax returns

are required in connection with every self-employed applicant and the

cost of an accountant-prepared financial statement can be an excessive

burden for very small businesses (e.g., hairdressers or independent

house painters), the requirement to submit an accountant-prepared

profit and loss statement in every instance would be deleted. Instead,

it is proposed that the financial statement must be sufficient for a

loan underwriter to determine the necessary information for loan

approval and that an independent audit by a Certified Public Accountant

would be required if necessary for such determination.

Temporary Income (Paragraph (f))

It is proposed to change the length of time temporary income such

as that from public assistance programs must be expected to continue

before it can be counted for loan qualification purposes, from ``a

substantial fraction of the term of the loan, i.e., one-third or more''

to 3 years or more. This proposed change is consistent with current

industry standards.

Rental Income From a Multi-Unit Residence (Paragraph (f))

It is also proposed to simplify the treatment of rental income in

the credit underwriting standards. Existing instructions for

consideration of rental income from a multi-unit residence require

analysis of the seller's records. Since such records are seldom

actually available for review, the regulations are proposed to be

changed to provide for use of 75 percent of expected gross rental

income, unless documentation supports use of a greater amount. This

percentage would be consistent with current industry standards.

Consumer Credit Counseling Plan (Paragraph (g))

It is proposed to state that veterans in a Consumer Credit

Counseling (CCC) plan would be treated in the same manner as

individuals in a plan under Chapter 13 of the Bankruptcy Code, since

CCC plans and Chapter 13 plans are similar programs for those having

credit difficulties. This change would incorporate that policy for

borrowers with bad credit who entered a counseling program. We also

note that the proposed policy would address participation in a CCC plan

by a veteran who entered such a program before reaching the point of

having bad credit and would not treat the participation as a negative

credit item, since we believe this would be unfair.

Chapter 13 Bankruptcy (Paragraph (g))

It is proposed that the provisions be changed regarding when a

borrower should be considered a satisfactory credit risk after having

filed for relief under Chapter 13 of the Bankruptcy Code. The prior

criteria of requiring a Chapter 13 plan be 75 percent completed before

a borrower can be found to be a satisfactory credit risk is more

stringent when the plan calls for payout over a 5-year period than the

requirement for someone who took straight bankruptcy under Chapter 7.

This proposed change to accept satisfactory payment over 12 months

would remove that inequity and make VA's guideline consistent with

other criteria in the industry. Court approval for new credit would

still be required.

Chapter 7 Bankruptcy (Paragraph (g))

It is proposed to provide that a Chapter 7 bankruptcy would not

cause a person to be considered a bad credit risk if 2 years have

elapsed from the date of discharge in bankruptcy and to clarify

treatment of more recent bankruptcies. This would eliminate imprecise

language concerning longer periods and would bring VA's provisions in

line with criteria used in the rest of the industry, including the

Department of Housing and Urban Development (HUD), the Federal National

Mortgage Association (FNMA), and the Federal Home Loan Mortgage

Corporation (Freddie Mac).

Re-establishment of Satisfactory Credit (Paragraph (g))

It is proposed to state when satisfactory credit is considered to

be reestablished. One of the frequently asked questions for which VA's

credit standards have not previously provided an answer is when to

consider that satisfactory credit has been reestablished after a period

of bad credit not involving bankruptcy. To be consistent with other

criteria involving Consumer Credit Counseling and Chapter 13 plans, 12

months since the date of the last derogatory credit item would be

sufficient to consider that satisfactory credit has been reestablished.

Minimum Payment of Monthly Debts (Paragraph (g))

It is proposed to delete the requirement to include in an analysis

of monthly debts a minimum payment even if a revolving account has a

zero balance. Previously, a requirement to include a minimum payment

for a revolving charge that has a zero balance at the time of loan

application was intended to offset those who temporarily pay off such

an account for the sole purpose of appearing to have a stronger

financial status than is usual. However, it is very difficult to

distinguish between those with an open account but no balance at the

moment, those who seldom use the account and pay it off every month,

and those who have not used the account in many months. Since assuming

that a borrower will be using the account is potentially unfair, the

requirement that a minimum payment amount must be included would be

deleted as part of this proposal.

Long-Term and Short-Term Debts (Paragraph (g))

The definition of relatively long-term obligation which must be

included in a loan analysis is proposed to be changed from one with

remaining payments of at least 6 months to one with remaining payments

of at least 10 months. This change would be consistent with current

industry standards and with HUD requirements. It is also proposed to

remove unnecessary language.

Allotments Shown on Pay Stubs (Paragraph (g))

It is proposed to add a requirement that lenders investigate the

reasons for allotments shown on pay stubs or leave and earning

statements in order to assure that all debts are properly considered.

As pay stubs and leave statements have become a common method of

verifying a borrower's

[[Page 24877]]

income, it has become common to see allotments on those documents which

are not adequately identified as to whether they exist to repay a debt

which is not otherwise disclosed by the borrower. This proposed

regulatory change would require lenders to investigate to determine if

an allotment is related to a debt.

Debts Assigned by Divorce Decree (Paragraph (g))

It is proposed to add a clarification regarding debts assigned to

an ex-spouse by a divorce decree. Often the responsibility for a debt

that had been jointly established by a veteran and former spouse has

been assigned to the former spouse by divorce decree. However, since

the debt remains a part of the veteran's credit history, it may appear

as an open account on the veteran's credit report. It appears that it

would be unfair to consider such debts as the veteran's obligation and,

therefore, VA proposes to establish that such debts would not be

considered the veteran's obligation.

Collection Accounts (Paragraph (g))

It is proposed to clarify that collection accounts do not

necessarily have to be paid off as a condition for loan approval. Only

account balances reduced to judgment by a court would be required to be

paid in full.

Merged Credit Reports (Paragraph (g))

It is proposed to permit the use of a 3-file merged credit report

(MCR) as an alternative to the Residential Mortgage Credit Report

(RMCR) currently in use. The use of merged in-file credit reports is

growing within the mortgage industry, in light of industry analysis

which shows no extra risk associated with using such reports in

underwriting mortgages. Therefore, VA proposes to change the credit

report requirement to allow the use of MCRs as an alternative to RCMRs.

VA already allows the use of the MCR as an alternative to RCMRs for

quality control purposes.

Nonsubstantive Changes

In addition to the proposed changes discussed under the specific

headings above, nonsubstantive changes would be made for purposes of

clarity and to correct typographical errors.

Paperwork Reduction Act of 1995

Under the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520), a

collection of information is set forth in the provisions of the

proposed Sec. 36.4337. This section prescribes the information to be

submitted for approval of a VA loan guaranty and contains material

which further explains the quality of the information needed for

approval. To facilitate access to the collection of information

provisions, all of Sec. 36.4337 is included in the text portion of this

document. Also, as required under section 3507(d) of the Act, VA has

submitted a copy of this proposed rulemaking action to the Office of

Management and Budget (OMB) for its review of the collection of

information.

OMB assigns control numbers to collections of information it

approves. VA may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a

currently valid OMB control number.

Comments on the collections of information should be submitted to

the Office of Management and Budget, Attention: Desk Officer for the

Department of Veterans Affairs, Office of Information and Regulatory

Affairs, Washington, DC 20503, with copies to the Director, Office of

Regulations Management (02D), Department of Veterans Affairs, 810

Vermont Avenue, NW, Washington, DC 20420. Comments should indicate that

they are submitted in response to ``RIN 2900-AI16.''

Title: Credit Standards.

Summary of collection of information: Pursuant to 38 U.S.C. 3710, a

loan may not be guaranteed unless the veteran is a satisfactory credit

risk. The statute also requires that VA set forth in regulatory form

standards to be used by lenders in underwriting VA-guaranteed loans and

obtaining credit information. Lenders must collect certain specific

information concerning the veteran and the veteran's credit history

(and spouse or other co-borrower, as applicable), in order to properly

underwrite the veteran's loan. Collection of this information is normal

business practice for mortgage lenders. The proposed Sec. 36.4337 would

require that the lender provide VA with a certification and other

limited information in addition to that which would be required for a

non-Government-guaranteed mortgage loan.

Description of need for information and proposed use of

information: VA requires the lender to provide the Department with the

credit information to assure itself that applications for VA-guaranteed

loans are underwritten in a reasonable and prudent manner.

Description of likely respondents: Mortgage lenders who make VA-

guaranteed home loans.

Estimated number of respondents: 300,000 in FY 1997; 280,000 in FY

1998.

Estimated frequency of responses: This is a ``one-time'' request

for each application for a VA-guaranteed loan.

Estimated average burden per collection: 10 minutes. VA estimates

that an average of 80 minutes would be needed for the portion of the

information that would already be collected as normal business practice

for mortgage lenders. VA estimates that 10 minutes constitutes the

average additional time needed due to the provisions of this

information collection.

Estimated total annual reporting and recordkeeping burden: 5000

hours in FY 1997 and 4667 hours in FY 1998 for the information that

would not otherwise be collected and retained in the ordinary course of

business.

The Department considers comments by the public on proposed

collections of information in--

Evaluating whether the proposed collections of information

are necessary for the proper performance of the functions of the

Department, including whether the information will have practical

utility;

Evaluating the accuracy of the Department's estimate of

the burden of the proposed collections of information, including the

validity of the methodology and assumptions used;

Enhancing the quality, usefulness, and clarity of the

information to be collected; and

Minimizing the burden of the collections of information on

those who are to respond, including through the use of appropriate

automated, electronic, mechanical, or other technological collection

techniques or other forms of information technology, e.g., permitting

electronic submission of responses.

OMB is required to make a decision concerning the proposed

collection of information contained in this proposed rule between 30

and 60 days after publication of this document in the Federal Register.

Therefore, a comment to OMB is best assured of having its full effect

if OMB receives it within 30 days of publication. This does not affect

the deadline for the public to comment on the proposed regulations.

Regulatory Flexibility Act

The Secretary hereby certifies that these proposed regulatory

amendments will not, if promulgated, have a significant economic impact

on a substantial number of small entities as they are defined in the

Regulatory Flexibility Act, 5 U.S.C. 601-612. Industry norms for other

lending programs already require lenders to comply with most of the

proposed

[[Page 24878]]

standards set forth in this regulatory package. Further, activities

concerning loans subject to the VA Loan Guaranty Program do not

constitute a significant portion of activities of small businesses.

(The Catalog of Federal Domestic Assistance Program numbers are

64.106, 64.114, 64.118 and 64.119.)

List of Subjects in 38 CFR Part 36

Condominiums, Handicapped, Housing Loan programs--housing and

community development, Reporting and recordkeeping requirements,

Veterans.

Approved: February 21, 1997.

Jesse Brown,

Secretary of Veterans Affairs.

For the reasons set out in the preamble, 38 CFR part 36 is proposed

to be amended as set forth below.

PART 36--LOAN GUARANTY

1. The authority citation for part 36 Secs. 36.4300 through 36.4375

continues to read as follows:

Authority: Sections 36.4300 through 36.4375 issued under 38

U.S.C. 101, 501, 3701-3704, 3710, 3712-3714, 3720, 3729, 3732,

unless otherwise noted.

2. Section 36.4337 is revised to read as follows:

Sec. 36.4337 Underwriting standards, processing procedures, lender

responsibility, and lender certification.

(a) Use of standards. Except for refinancing loans guaranteed

pursuant to 38 U.S.C. 3710(a)(8), the standards contained in paragraphs

(c) through (j) of this section will be used to determine that the

veteran's present and anticipated income and expenses, and credit

history, are satisfactory.

(b) Waiver of standards. Use of the standards in paragraphs (c)

through (j) of this section for underwriting home loans will be waived

only in extraordinary circumstances when the Secretary determines,

considering the totality of circumstances, that the veteran is a

satisfactory credit risk.

(c) Methods. The two primary underwriting tools that will be used

in determining the adequacy of the veteran's present and anticipated

income are debt-to-income ratio and residual income analysis. They are

described in paragraphs (d) through (f) of this section. Ordinarily, to

qualify for a loan, the veteran must meet both standards. Failure to

meet one standard, however, will not automatically disqualify a

veteran. The following shall apply to cases where a veteran does not

meet both standards:

(1) If the debt-to-income ratio is 41 percent or less, and the

veteran does not meet the residual income standard, the loan may be

approved with justification, by the underwriter's supervisor, as set

out in paragraph (c)(4) of this section.

(2) If the debt-to-income ratio is greater than 41 percent (unless

it is larger due solely to the existence of tax-free income which

should be noted in the loan file), the loan may be approved with

justification, by the underwriter's supervisor, as set out in paragraph

(c)(4) of this section.

(3) If the ratio is greater than 41 percent and the residual income

exceeds the guidelines by at least 20 percent, the second level review

and statement of justification are not required.

(4) In any case described by paragraphs (c)(1) and (c)(2) of this

section, the lender must fully justify the decision to approve the loan

or submit the loan to the Secretary for prior approval in writing. The

lender's statement must not be perfunctory, but should address the

specific compensating factors, as set forth in paragraph (c)(5) of this

section, justifying the approval of the loan. The statement must be

signed by the underwriter's supervisor. It must be stressed that the

statute requires not only consideration of a veteran's present and

anticipated income and expenses, but also that the veteran be a

satisfactory credit risk. Therefore, meeting both the debt-to-income

ratio and residual income standards does not mean that the loan is

automatically approved. It is the lender's responsibility to base the

loan approval or disapproval on all the factors present for any

individual veteran. The veteran's credit must be evaluated based on the

criteria set forth in paragraph (g) of this section as well as a

variety of compensating factors that should be evaluated.

(5) The following are examples of acceptable compensating factors

to be considered in the course of underwriting a loan:

(i) Excellent long-term credit;

(ii) Conservative use of consumer credit;

(iii) Minimal consumer debt;

(iv) Long-term employment;

(v) Significant liquid assets;

(vi) Downpayment or the existence of equity in refinancing loans;

(vii) Little or no increase in shelter expense;

(viii) Military benefits;

(ix) Satisfactory homeownership experience;

(x) High residual income;

(xi) Low debt-to-income ratio;

(xii) Tax credits for child care; and

(xiii) Tax benefits of home ownership.

(6) The list in paragraph (c)(5) of this section is not exhaustive

and the items are not in any priority order. Valid compensating factors

should represent unusual strengths rather than mere satisfaction of

basic program requirements. Compensating factors must be relevant to

the marginality or weakness.

(d) Debt-to-income ratio. A debt-to-income ratio that compares the

veteran's anticipated monthly housing expense and total monthly

obligations to his or her stable monthly income will be computed to

assist in the assessment of the potential risk of the loan. The ratio

will be determined by taking the sum of the monthly Principal,

Interest, Taxes and Insurance (PITI) of the loan being applied for,

homeowners and other assessments such as special assessments,

condominium fees, homeowners association fees, etc., and any long-term

obligations divided by the total of gross salary or earnings and other

compensation or income. The ratio should be rounded to the nearest two

digits; e.g., 35.6 percent would be rounded to 36 percent. The standard

is 41 percent or less. If the ratio is greater than 41 percent, the

steps cited in paragraphs (c)(1) through (c)(6) of this section apply.

(e) Residual income guidelines. The guidelines provided in this

paragraph for residual income will be used to determine whether the

veteran's monthly residual income will be adequate to meet living

expenses after estimated monthly shelter expenses have been paid and

other monthly obligations have been met. All members of the household

must be included in determining if the residual income is sufficient.

They must be counted even if the veteran's spouse is not joining in

title or on the note, or if there are any other individuals depending

on the veteran for support, such as children from a spouse's prior

marriage who are not the veteran's legal dependents. It is appropriate,

however, to reduce the number of members of a household to be counted

for residual income purposes if there is sufficient verified income not

otherwise included in the loan analysis, such as child support being

regularly received as discussed in paragraph (e)(4) of this section. In

the case of a spouse not to be obligated on the note, verification that

he/she has stable and reliable employment as discussed in paragraph

(f)(3) of this section would allow not counting the spouse in

determining the sufficiency of the residual income. The guidelines for

residual income are based on data supplied in the Consumer Expenditure

Survey (CES) published by the Department of Labor's Bureau of Labor

Statistics. Regional minimum incomes

[[Page 24879]]

have been developed for loan amounts up to $79,999 and for loan amounts

of $80,000 and above. It is recognized that the purchase price of the

property may affect family expenditure levels in individual cases. This

factor may be given consideration in the final determination in

individual loan analyses. For example, a family purchasing in a higher-

priced neighborhood may feel a need to incur higher-than-average

expenses to support a lifestyle comparable to that in their

environment, whereas a substantially lower-priced home purchase may not

compel such expenditures. It should also be clearly understood from

this information that no single factor is a final determinant in any

applicant's qualification for a VA-guaranteed loan. Once the residual

income has been established, other important factors must be examined.

One such consideration is the amount being paid currently for rental or

housing expenses. If the proposed shelter expense is materially in

excess of what is currently being paid, the case may require closer

scrutiny. In such cases, consideration should be given to the ability

of the borrower and spouse to accumulate liquid assets, such as cash

and bonds, and to the amount of debts incurred while paying a lesser

amount for shelter. For example, if an application indicates little or

no capital reserves and excessive obligations, it may not be reasonable

to conclude that a substantial increase in shelter expenses can be

absorbed. Another factor of prime importance is the applicant's manner

of meeting obligations. A poor credit history alone is a basis for

disapproving a loan, as is an obviously inadequate income. When one or

the other is marginal, however, the remaining aspect must be closely

examined to assure that the loan applied for will not exceed the

applicant's ability or capacity to repay. Therefore, it is important to

remember that the figures provided below for residual income are to be

used as a guide and should be used in conjunction with the steps

outlined in paragraphs (c) through (j) of this section. The residual

income guidelines are as follows:

(1) Table of residual incomes by region (for loan amounts of

$79,999 and below):

Table of Residual Incomes by Region

[For loan amounts of $79,999 and below]

------------------------------------------------------------------------

Family size

\1\ Northeast Midwest South West

------------------------------------------------------------------------

1............ 390 382 382 425

2............ 654 641 641 713

3............ 788 772 772 859

4............ 888 868 868 967

5............ 921 902 902 1,004

------------------------------------------------------------------------

\1\ For families with more than five members, add $75 for each

additional member up to a family of seven. ``Family'' includes all

members of the household.

(2) Table of residual incomes by region (for loan amounts of

$80,000 and above):

Table of Residual Incomes by Region

[For loan amounts of $80,000 and above]

------------------------------------------------------------------------

Family size

\1\ Northeast Midwest South West

------------------------------------------------------------------------

1............ 450 441 441 491

2............ 755 738 738 823

3............ 909 889 889 990

4............ 1,025 1,003 1,003 1,117

5............ 1,062 1,039 1,039 1,158

------------------------------------------------------------------------

\1\ For families with more than five members, add $80 for each

additional member up to a family of seven. ``Family'' includes all

members of the household.

(3) Geographic regions for residual income guidelines: Northeast--

Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York,

Pennsylvania, Rhode Island and Vermont; Midwest--Illinois, Indiana,

Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota,

Ohio, South Dakota and Wisconsin; South--Alabama, Arkansas, Delaware,

District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland,

Mississippi, North Carolina, Oklahoma, Puerto Rico, South Carolina,

Tennessee, Texas, Virginia, West Virginia; West--Alaska, Arizona,

California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico,

Oregon, Utah, Washington and Wyoming.

(4) Military adjustments. For loan applications involving an

active-duty serviceperson or military retiree, the residual income

figures will be reduced by a minimum of 5 percent if there is a clear

indication that the borrower or spouse will continue to receive the

benefits resulting from the use of facilities on a nearby military

base. (This reduction applies to tables in paragraph (e) of this

section.)

(f) Stability and reliability of income. Only stable and reliable

income of the veteran and spouse can be considered in determining

ability to meet mortgage payments. Income can be considered stable and

reliable if it can be concluded that it will continue during the

foreseeable future.

(1) Verification. Income of the borrower and spouse which is

derived from employment and which is considered in determining the

family's ability to meet the mortgage payments, payments on debts and

other obligations, and other expenses must be verified. If the spouse

is employed and will be contractually obligated on the loan, the

combined income of both the veteran and spouse is considered when the

income of the veteran alone is not sufficient to qualify for the amount

of the loan sought. In other than community property states, if the

[[Page 24880]]

spouse will not be contractually obligated on the loan, Regulation B,

promulgated by the Federal Reserve Board pursuant to the Equal Credit

Opportunity Act, prohibits any request for, or consideration of,

information concerning the spouse (including income, employment,

assets, or liabilities), except that if the applicant is relying on

alimony, child support, or maintenance payments from a spouse or former

spouse as a basis for repayment of the loan, information concerning

such spouse or former spouse may be requested and considered (see

paragraph (f)(4) of this section). In community property states,

information concerning a spouse may be requested and considered in the

same manner as that for the applicant. The standards applied to income

of the veteran are also applicable to that of the spouse. There can be

no discounting of income on account of sex, marital status, or any

other basis prohibited by the Equal Credit Opportunity Act. Income

claimed by an applicant that is not or cannot be verified cannot be

considered when analyzing the loan. If the veteran or spouse has been

employed by a present employer for less than 2 years, a 2-year history

covering prior employment, schooling, or other training must be

secured. Any periods of unemployment must be explained. Employment

verifications and pay stubs must be no more than 120 days (180 days for

new construction) old to be considered valid. For loans closed

automatically, this requirement will be considered satisfied if the

date of the employment verification is within 120 days (180 days for

new construction) of the date the note is signed. For prior approval

loans, this requirement will be considered satisfied if the

verification of employment is dated within 120 days of the date the

application is received by VA.

(2) Active-duty applicants. (i) In the case of an active-duty

applicant, a military Leave & Earnings Statement is required and will

be used instead of an employment verification. The statement must be no

more than 120 days old (180 days for new construction) and must be the

original or a lender-certified copy of the original. For loans closed

automatically, this requirement is satisfied if the date of the Leave &

Earnings Statement is within 120 days (180 days for new construction)

of the date the note is signed. For prior approval loans, this

requirement will be considered satisfied if the verification of

employment is dated within 120 days of the date the application is

received by VA.

(ii) For servicemembers within 12 months of release from active

duty, including members of the Reserves or National Guard, one of the

following is also required:

(A) Documentation that the servicemember has in fact already

reenlisted or extended his/her period of active duty to a date beyond

the 12-month period following the projected closing of the loan.

(B) Verification of a valid offer of local civilian employment

following release from active duty. All data pertinent to sound

underwriting procedures (date employment will begin, earnings, etc.)

must be included.

(C) A statement from the servicemember that he/she intends to

reenlist or extend his/her period of active duty to a date beyond the

12 month period following the projected loan closing date, and a

statement from the service member's commanding officer confirming that

the service member is eligible to reenlist or extend his/her active

duty as indicated and that the commanding officer has no reason to

believe that such reenlistment or extension of active duty will not be

granted.

(D) Other unusually strong positive underwriting factors, such as a

downpayment of at least 10 percent, significant cash reserves, or clear

evidence of strong ties to the community coupled with a nonmilitary

spouse's income so high that only minimal income from the active duty

servicemember is needed to qualify.

(iii) Each active-duty member who applies for a loan must be

counseled through the use of VA Form 26-0592, Counseling Checklist for

Military Homebuyers. Lenders must submit a signed and dated VA Form 26-

0592 with each prior approval loan application or automatic loan report

involving a borrower on active duty.

(3) Income reliability. Income received by the borrower and spouse

is to be used only if it can be concluded that the income will continue

during the foreseeable future and, thus, should be properly considered

in determining ability to meet the mortgage payments. If an employer

puts N/A or otherwise declines to complete a verification of employment

statement regarding the probability of continued employment, no further

action is required of the lender. Reliability will be determined based

on the duration of the borrower's current employment together with his

or her overall documented employment history. There can be no

discounting of income solely because it is derived from an annuity,

pension or other retirement benefit, or from part-time employment.

However, unless income from overtime work and part-time or second jobs

can be accorded a reasonable likelihood that it is continuous and will

continue in the foreseeable future, such income should not be used.

Generally, the reliability of such income cannot be demonstrated unless

the income has continued for 2 years. The hours of duty and other work

conditions of the applicant's primary job, and the period of time in

which the applicant was employed under such arrangement, must be such

as to permit a clear conclusion as to a good probability that overtime

or part-time or secondary employment can and will continue. Income from

overtime work and part-time jobs not eligible for inclusion as primary

income may, if properly verified for at least 12 months, be used to

offset the payments due on debts and obligations of an intermediate

term, i.e., 6 to 24 months. Such income must be described in the loan

file. The amount of any pension or compensation and other income, such

as dividends from stocks, interest from bonds, savings accounts, or

other deposits, rents, royalties, etc., will be used as primary income

if it is reasonable to conclude that such income will continue in the

foreseeable future. Otherwise, it may be used only to offset

intermediate-term debts, as above. Also, the likely duration of certain

military allowances cannot be determined and, therefore, will be used

only to offset intermediate-term debts, as above. Such allowances are:

Pro-pay, flight or hazard pay, and overseas or combat pay, all of which

are subject to periodic review and/or testing of the recipient to

ascertain whether eligibility for such pay will continue. Only if it

can be shown that such pay has continued for a prolonged period and can

be expected to continue because of the nature of the recipient's

assigned duties, will such income be considered as primary income. For

instance, flight pay verified for a pilot can be regarded as probably

continuous and, thus, should be added to the base pay. Income derived

from service in the Reserves or National Guard may be used if the

applicant has served in such capacity for a period of time sufficient

to evidence good probability that such income will continue beyond 12

months. The total period of active and reserve service may be helpful

in this regard. Otherwise, such income may be used to offset

intermediate-term debts. There are a number of additional income

sources whose contingent nature precludes their being considered as

available for repayment of a long-term mortgage obligation. Temporary

income items

[[Page 24881]]

such as VA educational allowances and unemployment compensation do not

represent stable and reliable income and will not be taken into

consideration in determining the ability of the veteran to meet the

income requirement of the governing law. As required by the Equal

Opportunity Act Amendments of 1976, Public Law 94-239, income from

public assistance programs is used to qualify for a loan if it can be

determined that the income will probably continue for 3 years or more.

(4) Tax-exempt income. Special consideration can be given to

verified nontaxable income once it has been established that such

income is likely to continue (and remain untaxed) into the foreseeable

future. Such income includes certain military allowances, child support

payments, workers' compensation benefits, disability retirement

payments and certain types of public assistance payments. In such

cases, current income tax withholding tables may be used to determine

an amount which can be prudently employed to adjust the borrower's

actual income. This adjusted or ``grossed up'' income may be used to

calculate the monthly debt-to-income ratio, provided the analysis is

documented. Only the borrower's actual income may be used to calculate

the residual income. Care should be exercised to ensure that the income

is in fact tax-exempt.

(5) Alimony, child support, maintenance, workers' compensation,

foster care payments. (i) If an applicant chooses to reveal income from

alimony, child support or maintenance payments (after first having been

informed that any such disclosure is voluntary pursuant to the Federal

Reserve Board's Regulation B), such payments are considered as income

to the extent that the payments are likely to be consistently made.

Factors to be considered in determining the likelihood of consistent

payments include, but are not limited to: Whether the payments are

received pursuant to a written agreement or court decree; the length of

time the payments have been received; the regularity of receipt; the

availability of procedures to compel payment; and the creditworthiness

of the payor, including the credit history of the payor when available

under the Fair Credit Reporting Act or other applicable laws. However,

the Fair Credit Reporting Act (15 U.S.C. 1681(b)) limits the

permissible purposes for which credit reports may be ordered, in the

absence of written instructions of the consumer to whom the report

relates, to business transactions involving the subject of the credit

report or extensions of credit to the subject of the credit report.

(ii) If the applicant chooses to reveal income related to workers'

compensation, it will be considered as income to the extent it can be

determined such income will continue.

(iii) Income received specifically for the care of any foster

child(ren) may be counted as income if documented. Generally, however,

such foster care income is to be used only to balance the expenses of

caring for the foster child(ren) against any increased residual income

requirements.

(6) Military quarters allowance. With respect to off-base housing

(quarters) allowances for service personnel on active duty, it is the

policy of the Department of Defense to utilize available on-base

housing when possible. In order for a quarters allowance to be

considered as continuing income, it is necessary that the applicant

furnish written authorization from his or her commanding officer for

off-base housing. This authorization should verify that quarters will

not be made available and that the individual should make permanent

arrangements for nonmilitary housing. A Department of Defense form, DD

Form 1747, Status of Housing Availability, is used by the Family

Housing Office to advise personnel regarding family housing. The

applicant's quarters allowance cannot be considered unless item b

(Permanent) or d is completed on DD Form 1747, dated October 1990. Of

course, if the applicant's income less quarters allowance is

sufficient, there is no need for assurance that the applicant has

permission to occupy nonmilitary housing provided that a determination

can be made that the occupancy requirements of the law will be met.

Also, authorization to obtain off-base housing will not be required

when certain duty assignments would clearly qualify service personnel

with families for quarters allowance. For instance, off-base housing

authorizations need not be obtained for service personnel stationed

overseas who are not accompanied by their families, recruiters on

detached duty, or military personnel stationed in areas where no on-

base housing exists. In any case in which no off-base housing

authorization is obtained, an explanation of the circumstances

justifying its omission must be included with the loan application

except when it has been established by the VA facility of jurisdiction

that the waiting lists for on-base housing are so long that it is

improbable that individuals desiring to purchase off-base housing would

be precluded from doing so in the foreseeable future. If stations make

such a determination, a release shall be issued to inform lenders.

(7) Automobile (or similar) allowance. Generally, automobile

allowances are paid to cover specific expenses related to an

applicant's employment, and it is appropriate to use such income to

offset a corresponding car payment. However, in some instances, such an

allowance may exceed the car payment. With proper documentation, income

from a car allowance which exceeds the car payment can be counted as

effective income. Likewise, any other similar type of allowance which

exceeds the specific expense involved may be added to gross income to

the extent it is documented to exceed the actual expense.

(8) Commissions. When all or a major portion of the veteran's

income is derived from commissions, it will be necessary to establish

the stability of such income if it is to be considered in the loan

analysis for the repayment of the mortgage debt and/or short-term

obligations. In order to assess the value of such income, lenders

should obtain written verification of the actual amount of commissions

paid to date, the basis for the payment of such commissions and when

commissions are paid; i.e., monthly, quarterly, semiannually, or

annually. Lenders should also obtain signed and dated individual income

tax returns, plus applicable schedules, for the previous 2 years, or

for whatever additional period is deemed necessary to properly

demonstrate a satisfactory earnings record. The length of the veteran's

employment in the type of occupation for which commissions are paid is

also an important factor in the assessment of the stability of the

income. If the veteran has been employed for a relatively short time,

the income should not normally be considered stable unless the product

or service was the same or closely related to the product or service

sold in an immediate prior position. Generally, income from commissions

is considered stable when the applicant has been receiving such income

for at least 2 years. Less than 2 years of income from commissions

cannot usually be considered stable. When an applicant has received

income from commissions for less than 1 year, it will rarely be

possible to demonstrate that the income is stable for qualifying

purposes; such cases would require in-depth development.

(9) Self-employment. Generally, income from self-employment is

considered stable when the applicant has been in business for at least

2 years. Less than 2 years of income from self-

[[Page 24882]]

employment cannot usually be considered stable unless the applicant

has had previous related employment and/or extensive specialized

training. When an applicant has been self-employed less than 1 year, it

will rarely be possible to demonstrate that the income is stable for

qualifying purposes; such cases would require in-depth development. The

following documentation is required for all self-employed borrowers:

(i) A profit-and-loss statement for the prior fiscal year (12-month

accounting cycle), plus the period year to date since the end of the

last fiscal year (or for whatever shorter period records may be

available), and balance sheet based on the financial records. The

financial statement must be sufficient for a loan underwriter to

determine the necessary information for loan approval and an

independent audit (on the veteran and/or the business) by a Certified

Public Accountant will be required if necessary for such determination;

and

(ii) Copies of signed individual income tax returns, plus all

applicable schedules for the previous 2 years, or for whatever

additional period is deemed necessary to properly demonstrate a

satisfactory earnings record, must be obtained. If the business is a

corporation or partnership, copies of signed Federal business income

tax returns for the previous two years plus all applicable schedules

for the corporation or partnership must be obtained; and

(iii) If the business is a corporation or partnership, a list of

all stockholders or partners showing the interest each holds in the

business will be required. Some cases may justify a written credit

report on the business as well as the applicant. When the business is

of an unusual type and it is difficult to determine the probability of

its continued operation, explanation as to the function and purpose of

the business may be needed from the applicant and/or any other

qualified party with the acknowledged expertise to express a valid

opinion.

(10) Recently discharged veterans. Loan applications received from

recently discharged veterans who have little or no employment

experience other than their military occupation and from veterans

seeking VA-guaranteed loans who have retired after 20 years of active

military duty require special attention. The retirement income of the

latter veterans in many cases may not be sufficient to meet the

statutory income requirements for the loan amount sought. Many have

obtained full-time employment and have been employed in their new jobs

for a very short time.

(i) It is essential in determining whether veterans in these

categories qualify from the income standpoint for the amount of the

loan sought, that the facts in respect to their present employment and

retirement income be fully developed, and that each case be considered

on its individual merits.

(ii) In most cases the veteran's current income or current income

plus his or her retirement income is sufficient. The problem lies in

determining whether it can be properly concluded that such income level

will continue for the foreseeable future. If the veteran's employment

status is that of a trainee or an apprentice, this will, of course, be

a factor. In cases of the self-employed, the question to be resolved is

whether there are reasonable prospects that the business enterprise

will be successful and produce the required income. Unless a favorable

conclusion can be made, the income from such source should not be

considered in the loan analysis.

(iii) If a recently discharged veteran has no prior employment

history and the veteran's verification of employment shows he or she

has not been on the job a sufficient time in which to become

established, consideration should be given to the duties the veteran

performed in the military service. When it can be determined that the

duties a veteran performed in the service are similar or are in direct

relation to the duties of the applicant's present position, such duties

may be construed as adding weight to his or her present employment

experience and the income from the veteran's present employment thus

may be considered available for qualifying the loan, notwithstanding

the fact that the applicant has been on the present job only a short

time. This same principle may be applied to veterans recently retired

from the service. In addition, when the veteran's income from

retirement, in relation to the total of the estimated shelter expense,

long-term debts and amount available for family support, is such that

only minimal income from employment is necessary to qualify from the

income standpoint, it would be proper to resolve the doubt in favor of

the veteran. It would be erroneous, however, to give consideration to a

veteran's income from employment for a short duration in a job

requiring skills for which the applicant has had no training or

experience.

(iv) To illustrate the provisions of this paragraph (f), it would

be proper to use short-term employment income in qualifying a veteran

who had experience as an airplane mechanic in the military service and

the individual's employment after discharge or retirement from the

service is in the same or allied fields; e.g., auto mechanic or

machinist. This presumes, however, that the verification of employment

included a statement that the veteran was performing the duties of the

job satisfactorily, the possibility of continued employment was

favorable and that the loan application is eligible in all other

respects. An example of nonqualifying experience is that of a veteran

who was an Air Force pilot and has been employed in insurance sales on

commission for a short time. Most cases, of course, fall somewhere

between those extremes. It is for this reason that the facts of each

case must be fully developed prior to closing the loan automatically or

submitting the case to VA for prior approval.

(11) Employment of short duration. The provisions of paragraph

(f)(7) of this section are similarly applicable to applicants whose

employment is of short duration. Such cases will entail careful

consideration of the employer's confirmation of employment, probability

of permanency, past employment record, the applicant's qualifications

for the position, and previous training, including that received in the

military service. In the event that such considerations do not enable a

determination that the income from the veteran's current position has a

reasonable likelihood of continuance, such income should not be

considered in the analysis. Applications received from persons employed

in the building trades, or in other occupations affected by climatic

conditions, should be supported by documentation evidencing the

applicant's total earnings to date and covering a period of not less

than 1 year as well as signed and dated copies of complete income tax

returns, including all schedules for the past 2 years or for whatever

additional period is deemed necessary to properly demonstrate a

satisfactory earnings record. If the applicant works out of a union,

evidence of the previous year's earnings should be obtained together

with a verification of employment from the current employer.

(12) Rental income.--(i) Multi-unit subject property. When the loan

pertains to a structure with more than a one-family dwelling unit, the

prospective rental income will not be considered unless the veteran can

demonstrate a reasonable likelihood of success as a landlord, and

sufficient cash reserves are verified to enable the veteran to carry

the mortgage loan payments (principal, interest, taxes, and insurance)

without assistance from the rental income for a period of at least 6

months. The determination of the veteran's likelihood of success as a

[[Page 24883]]

landlord will be based on documentation of any prior experience in

managing rental units or other collection activities. The amount of

rental income to be used in the loan analysis will be based on 75

percent of the amount indicated on the lease or rental agreement,

unless a greater percentage can be documented.

(ii) Rental of existing home. Proposed rental of a veteran's

existing property may be used to offset the mortgage payment on that

property, provided there is no indication that the property will be

difficult to rent. If available, a copy of the rental agreement should

be obtained. It is the responsibility of the loan underwriter to be

aware of the condition of the local rental market. For instance, in

areas where the rental market is very strong the absence of a lease

should not automatically prohibit the offset of the mortgage by the

proposed rental income.

(iii) Other rental property. If income from rental property will be

used to qualify for the new loan, the documentation required of a self-

employed applicant should be obtained together with evidence of cash

reserves equaling 3 months PITI on the rental property. As for any

self-employed earnings (see paragraph (f)(7) of this section),

depreciation claimed may be added back in as income. In the case of a

veteran who has no experience as a landlord, it is unlikely that the

income from a rental property may be used to qualify for the new loan.

(13) Taxes and other deductions. Deductions to be applied for

Federal income taxes and Social Security may be obtained from the

Employer's Tax Guide (Circular E) issued by the Internal Revenue

Service (IRS). (For veterans receiving a mortgage credit certificate

(MCC), see paragraph (f)(14) of this section.) Any State or local taxes

should be estimated or obtained from charts similar to those provided

by IRS which may be available in those states with withholding taxes. A

determination of the amount paid or withheld for retirement purposes

should be made and used when calculating deductions from gross income.

In determining whether a veteran-applicant meets the income criteria

for a loan, some consideration may be given to the potential tax

benefits the veteran will realize if the loan is approved. This can be

done by using the instructions and worksheet portion of IRS Form W-4,

Employee's Withholding Allowance Certificate, to compute the total

number of permissible withholding allowances. That number can then be

used when referring to IRS Circular E and any appropriate similar State

withholding charts to arrive at the amount of Federal and State income

tax to be deducted from gross income.

(14) Mortgage credit certificates. (i) The Internal Revenue Code,

as amended by the Tax Reform Act of 1984, allows states and other

political subdivisions to trade in all or part of their authority to

issue mortgage revenue bonds for authority to issue MCCs. Veterans who

are recipients of MCCs may realize a significant reduction in their

income tax liability by receiving a Federal tax credit for a percentage

of their mortgage interest payment on debt incurred on or after January

1, 1985.

(ii) Lenders must provide a copy of the MCC to VA with the home

loan application. The MCC will specify the rate of credit allowed and

the amount of certified indebtedness; i.e., the indebtedness incurred

by the veteran to acquire a principal residence or as a qualified home

improvement or rehabilitation loan.

(iii) For credit underwriting purposes, the amount of tax credit

allowed to a veteran under an MCC will be treated as a reduction in the

monthly Federal income tax. For example, a veteran having a $600

monthly interest payment and an MCC providing a 30-percent tax credit

would receive a $180 (30 percent x $600) tax credit each month.

However, because the annual tax credit, which amounts to $2,160 (12 x

$180), exceeds $2,000 and is based on a 30-percent credit rate, the

maximum tax credit the veteran can receive is limited to $2,000 per

year (Pub. L. 98-369) or $167 per month ($2,000/12). As a consequence

of the tax credit, the interest on which a deduction can be taken will

be reduced by the amount of the tax credit to $433 ($600--$167). This

reduction should also be reflected when calculating Federal income tax.

(iv) For underwriting purposes, the amount of the tax credit is

limited to the amount of the veteran's maximum tax liability. If, in

the example in paragraph (f)(14)(iii) of this section, the veteran's

tax liability for the year were only $1,500, the monthly tax credit

would be limited to $125 ($1,500/12).

(g) Credit. The conclusion reached as to whether or not the veteran

and spouse are satisfactory credit risks must also be based on a

careful analysis of the available credit data. Regulation B (12 CFR

part 202), promulgated by the Federal Reserve Board pursuant to the

Equal Credit Opportunity Act, requires that lenders, in evaluating

creditworthiness, shall consider, on the applicant's request, the

credit history, when available, of any account reported in the name of

the applicant's spouse or former spouse which the applicant can

demonstrate accurately reflects the applicant's creditworthiness. In

other than community property states, if the spouse will not be

contractually obligated on the loan, Regulation B prohibits any request

for or consideration of information about the spouse concerning income,

employment, assets or liabilities. In community property states,

information concerning a spouse may be requested and considered in the

same manner as that for the applicant.

(1) Adverse data. If the analysis develops any derogatory credit

information and, despite such facts, it is determined that the veteran

and spouse are satisfactory credit risks, the basis for the decision

must be explained. If a veteran and spouse have debts outstanding which

have not been paid timely, or which they have refused to pay, the fact

that the outstanding debts are paid after the acceptability of the

credit is questioned or in anticipation of applying for new credit does

not, of course, alter the fact that the record for paying debts has

been unsatisfactory. With respect to unpaid debts, lenders may take

into consideration a veteran's claim of bona fide or legal defenses.

Such defenses are not applicable when the debt has been reduced to

judgment. Where a collection account has been established, if it is

determined that the borrower is a satisfactory credit risk, it is not

mandatory that such an account be paid off in order for a loan to be

approved. Court-ordered judgments, however, must be paid off before a

new loan is approved.

(2) Bankruptcy. When the credit information shows that the borrower

or spouse has been discharged in bankruptcy under the ``straight''

liquidation and discharge provisions of the bankruptcy law, this would

not in itself disqualify the loan. However, in such cases it is

necessary to develop complete information as to the facts and

circumstances concerning the bankruptcy. Generally speaking, when the

borrower or spouse, as the case may be, has been regularly employed

(not self-employed) and has been discharged in bankruptcy within the

last one to two years, it probably would not be possible to determine

that the borrower or spouse is a satisfactory credit risk unless both

of the following requirements are satisfied:

(i) The borrower or spouse has obtained credit subsequent to the

bankruptcy and has met the credit payments in a satisfactory manner

over a continued period; and

(ii) The bankruptcy was caused by circumstances beyond the control

of the borrower or spouse, e.g.,

[[Page 24884]]

unemployment, prolonged strikes, medical bills not covered by

insurance. Divorce is not generally viewed as beyond the control of the

borrower and/or spouse. The circumstances alleged must be verified. If

a borrower or spouse is self-employed, has been adjudicated bankrupt,

and subsequently obtains a permanent position, a finding as to

satisfactory credit risk may be made provided there is no derogatory

credit information prior to self-employment, there is no derogatory

credit information subsequent to the bankruptcy, and the failure of the

business was not due to misconduct. If a borrower or spouse has been

discharged in bankruptcy within the past 12 months, it will not

generally be possible to determine that the borrower or spouse is a

satisfactory credit risk.

(3) Petition under Chapter 13 of Bankruptcy Code. A petition under

chapter 13 of the Bankruptcy Code filed by the borrower or spouse is

indicative of an effort to pay their creditors. Some plans may provide

for full payment of debts while others arrange for payment of scaled-

down debts. Regular payments are made to a court-appointed trustee over

a 2-to 3-year period (or up to 5 years in some cases). When the

borrowers have made all payments in a satisfactory manner, they may be

considered as having reestablished satisfactory credit. When they apply

for a home loan before completion of the payout period, favorable

consideration may nevertheless be given if at least 12 months' worth of

payments have been made satisfactorily and the Trustee or Bankruptcy

Judge approves of the new credit.

(4) Foreclosures. (i) When the credit information shows that the

veteran or spouse has had a foreclosure on a prior mortgage; e.g., a

VA-guaranteed, or HUD-insured mortgage, this will not in itself

disqualify the borrower from obtaining the loan. Lenders and field

station personnel should refer to the preceding guidelines on

bankruptcies for cases involving foreclosures. As with a borrower who

has been adjudicated bankrupt, it is necessary to develop complete

information as to the facts and circumstances of the foreclosure.

(ii) When VA pays a claim on a VA-guaranteed loan as a result of a

foreclosure, the original veteran may be required to repay any loss to

the Government. In some instances VA may waive the veteran's debt, in

part or totally, based on the facts and circumstances of the case.

However, guaranty entitlement cannot be restored unless the

Government's loss has been repaid in full, regardless of whether or not

the debt has been waived, compromised, or discharged in bankruptcy.

Therefore, a veteran who is seeking a new VA loan after having

experienced a foreclosure on a prior VA loan will in most cases have

only remaining entitlement to apply to the new loan. The lender should

assure that the veteran has sufficient entitlement for its secondary

marketing purposes.

(5) Federal debts. An applicant for a Federally assisted loan will

not be considered a satisfactory credit risk for such loan if the

applicant is presently delinquent or in default on any debt to the

Federal Government, e.g., a Small Business Administration loan, a U.S.

Guaranteed Student loan, a debt to the Public Health Service, or where

there is a judgment lien against the applicant's property for a debt

owed to the Government. The applicant may not be approved for the loan

until the delinquent account has been brought current or satisfactory

arrangements have been made between the borrower and the Federal agency

owed, or the judgment is paid or otherwise satisfied. Of course, the

applicant must also be able to otherwise qualify for the loan from an

income and remaining credit standpoint. Refinancing under VA's interest

rate reduction refinancing provisions, however, is allowed even if the

borrower is delinquent on the VA guaranteed mortgage being refinanced.

Prior approval processing is required in such cases.

(6) Absence of credit history. The fact that recently discharged

veterans may have had no opportunity to develop a credit history will

not preclude a determination of satisfactory credit. Similarly, other

loan applicants may not have established credit histories as a result

of a preference for purchasing consumer items with cash rather than

credit. There are also cases in which individuals may be genuinely wary

of acquiring new obligations following bankruptcy, consumer credit

counseling (debt proration), or other disruptive credit occurrence. The

absence of the credit history in these cases will not generally be

viewed as an adverse factor in credit underwriting. However, before a

favorable decision is made for cases involving bankruptcies or other

derogatory credit factors, efforts should be made to develop evidence

of timely payment of non-installment debts such as rent and utilities.

It is anticipated that this special consideration in the absence of a

credit history following bankruptcy would be the rare case and

generally confined to bankruptcies that occurred over 3 years ago.

(7) Consumer credit counseling plan. If a veteran, or veteran and

spouse, have prior adverse credit and are participating in a Consumer

Credit Counseling plan, they may be determined to be a satisfactory

credit risk if they demonstrate 12 months' satisfactory payments and

the counseling agency approves the new credit. If a veteran, or veteran

and spouse, have good prior credit and are participating in a Consumer

Credit Counseling plan, such participation is to be considered a

neutral factor, or even a positive factor, in determining

creditworthiness.

(8) Re-establishment of satisfactory credit. In circumstances not

involving bankruptcy, satisfactory credit is generally considered to be

reestablished after the veteran, or veteran and spouse, have made

satisfactory payments for 12 months after the date of the last

derogatory credit item.

(9) Long-term v. short-term debts. All known debts and obligations

including any alimony and/or child support payments of the borrower and

spouse must be documented. Significant liabilities, to be deducted from

the total income in determining ability to meet the mortgage payments

are accounts that, generally, are of a relatively long term, i.e., 10

months or over. Other accounts for terms of less than 10 months must,

of course, be considered in determining ability to meet family

expenses. Certainly, any severe impact on the family's resources for

any period of time must be considered in the loan analysis. For

example, monthly payments of $300 on an auto loan with a remaining

balance of $1,500 would be included in those obligations to be deducted

from the total income regardless of the fact that the account can be

expected to pay out in 5 months. It is clear that the applicant will,

in this case, continue to carry the burden of those $300 payments for

the first, most critical months of the home loan.

(10) Requirements for verification. If the credit investigation

reveals debts or obligations of a material nature which were not

divulged by the applicant, lenders must be certain to obtain

clarification as to the status of such debts from the borrower. A

proper analysis is obviously not possible unless there is total

correlation between the obligations claimed by the borrower and those

revealed by a credit report or deposit verification. Conversely,

significant debts and obligations reported by the borrower must be

dated. If the credit report fails to provide necessary information on

such accounts, lenders will be expected to obtain their own

verifications of those debts directly from the creditors. Credit

reports and verifications must be no more than 120 days old (180 days

for new

[[Page 24885]]

construction) to be considered valid. For loans closed automatically,

this requirement will be considered satisfied if the date of the credit

report or verification is within 120 days (180 days for new

construction) of the date the note is signed. For prior approval loans,

this requirement will be considered satisfied if the date of the credit

report or verification is within 120 days of the date of the

application is received by VA. Of major significance are the

applicant's rental history and outstanding or recently retired

mortgages, if any, particularly prior VA loans. Lenders should be sure

ratings on such accounts are obtained; a written explanation is

required when ratings are not available. A determination is necessary

as to whether alimony and/or child support payments are required.

Verification of the amount of such obligations should be obtained,

although documentation concerning an applicant's divorce should not be

obtained automatically unless it is necessary to verify the amount of

any alimony or child support liability indicated by the applicant. If

in the routine course of processing the loan application, however,

direct evidence is received (e.g., from the credit report) that an

obligation to pay alimony or child support exists (as opposed to mere

evidence that the veteran was previously divorced), the discrepancy

between the loan application and credit report can and should be fully

resolved in the same manner as any other such discrepancy would be

handled. When a pay stub or leave-and-earnings statement indicates an

allotment, the lender must investigate the nature of the allotment(s)

to determine whether the allotment is related to a debt. Debts assigned

to an ex-spouse by a divorce decree will not generally be charged

against a veteran-borrower.

(11) Job-related expenses. Known job-related expenses should be

documented. This will include costs for any dependent care, significant

commuting costs, etc. When a family's circumstances are such that

dependent care arrangements would probably be necessary, it is

important to determine the cost of such services in order to arrive at

an accurate total of deductions.

(12) Credit reports. Credit reports obtained by lenders on VA-

guaranteed loan applications must be either a three-file Merged Credit

Report (MCR) or a Residential Mortgage Credit Report (RMCR). If used,

the RMCR must meet the standards formulated jointly by the Department

of Veterans Affairs, Federal National Mortgage Association, Federal

Home Loan Mortgage Corporation, Federal Housing Administration, Farmers

Home Administration, credit repositories, repository affiliated

consumer reporting agencies and independent consumer reporting

agencies. All credit reports obtained by the lender must be submitted

to VA.

(h) Borrower's personal and financial status. The number and ages

of dependents have an important bearing on whether income after

deduction of fixed charges is sufficient to support the family. Type

and duration of employment of both the borrower and spouse are

important as an indication of stability of their employment. The amount

of liquid assets owned by the borrower or spouse, or both, is an

important factor in determining that they have sufficient funds to

close the loan, as well as being significant in analyzing the overall

qualifications for the loan. (It is imperative that adequate cash

assets from the veteran's own resources are verified to allow the

payment (see Sec. 36.4336(a)(3)) of any difference between the sales

price of the property and the loan amount, in addition to that

necessary to cover closing costs, if the sales price exceeds the

reasonable value established by VA.) Verifications must be no more than

120 days old (180 days for new construction) to be considered valid.

For loans closed on the automatic basis, this requirement will be

considered satisfied if the date of the deposit verification is within

120 days (180 days for new construction) of the date of the veteran's

application to the lender. For prior approval loans, this requirement

will be considered satisfied if the verification of employment is dated

within 120 days of the date the application is received by VA. Current

monthly rental or other housing expense is an important consideration

when compared to that to be undertaken in connection with the

contemplated housing purchase.

(i) Estimated monthly shelter expenses. It is important that

monthly expenses such as taxes, insurance, assessments and maintenance

and utilities be estimated accurately based on property location and

type of house; e.g., old or new, large or small, rather than using or

applying a ``rule of thumb'' to all properties alike. Maintenance and

utility amounts for various types of property should be realistically

estimated. Local utility companies should be consulted for current

rates. The age and type of construction of a house may well affect

these expenses. In the case of condominiums or houses in a planned unit

development (PUD), the monthly amount of the maintenance assessment

payable to a homeowners association should be added. If the amount

currently assessed is less than the maximum provided in the covenants

or master deed, and it appears likely that the amount will be

insufficient for operation of the condominium or PUD, the amount used

will be the maximum the veteran could be charged. If it is expected

that real estate taxes will be raised, or if any special assessments

are expected, the increased or additional amounts should be used. In

special flood hazard areas, include the premium for any required flood

insurance.

(j) Lender responsibility. (1) Lenders are fully responsible for

developing all credit information; i.e., for obtaining verifications of

employment and deposit, credit reports, and for the accuracy of the

information contained in the loan application.

(2) Verifications of employment and deposits, and requests for

credit reports and/or credit information must be initiated and received

by the lender.

(3) In cases where the real estate broker/agent or any other party

requests any of this information, the report(s) must be returned

directly to the lender. This fact must be disclosed by appropriately

completing the required certification on the loan application or report

and the parties must be identified as agents of the lender.

(4) Where the lender relies on other parties to secure any of the

credit or employment information or otherwise accepts such information

obtained by any other party, such parties shall be construed for

purposes of the submission of the loan documents to VA to be authorized

agents of the lender, regardless of the actual relationship between

such parties and the lender, even if disclosure is not provided to VA

under paragraph (j)(3) of this section. Any negligent or willful

misrepresentation by such parties shall be imputed to the lender as if

the lender had processed those documents and the lender shall remain

responsible for the quality and accuracy of the information provided to

VA.

(5) All credit reports secured by the lender or other parties as

identified in paragraphs (j)(3) and (j)(4) of this section shall be

provided to VA. If updated credit reports reflect materially different

information than that in other reports, such discrepancies must be

explained by the lender and the ultimate decision as to the effects of

the discrepancy upon the loan application fully addressed by the

underwriter.

(k) Lender certification. Lenders originating loans are responsible

for determining and certifying to VA on the appropriate application or

closing form that the loan meets all statutory and regulatory

requirements. Lenders will

[[Page 24886]]

affirmatively certify that loans were made in full compliance with the

law and loan guaranty regulations as prescribed in this section.

(1) Definitions. The definitions contained in part 42 of this title

and the following definitions are applicable in this section.

(i) Another appropriate amount. In determining the appropriate

amount of a lender's civil penalty in cases where the Secretary has not

sustained a loss or where two times the amount of the Secretary's loss

on the loan involved does not exceed $10,000, the Secretary shall

consider:

(A) The materiality and importance of the false certification to

the determination to issue the guaranty or to approve the assumption;

(B) The frequency and past pattern of such false certifications by

the lender; and

(C) Any exculpatory or mitigating circumstances.

(ii) Complaint includes the assessment of liability served pursuant

to this section.

(iii) Defendant means a lender named in the complaint.

(iv) Lender includes the holder approving loan assumptions pursuant

to 38 U.S.C. 3714.

(2) Procedures for certification. (i) As a condition to VA issuance

of a loan guaranty on all loans closed on or after October 27, 1994,

and as a prerequisite to an effective loan assumption on all loans

assumed pursuant to 38 U.S.C. 3714 on or after the effective date of

these regulations, the following certification shall accompany each

loan closing or assumption package:

The undersigned lender certifies that the (loan) (assumption)

application, all verifications of employment, deposit, and other

income and credit verification documents have been processed in

compliance with 38 CFR part 36; that all credit reports obtained or

generated in connection with the processing of this borrower's

(loan) (assumption) application have been provided to VA; that, to

the best of the undersigned lender's knowledge and belief the (loan)

(assumption) meets the underwriting standards recited in chapter 37

of title 38 United States Code and 38 CFR part 36; and that all

information provided in support of this (loan) (assumption) is true,

complete and accurate to the best of the undersigned lender's

knowledge and belief.

(ii) The certification shall be executed by an officer of the

lender authorized to execute documents and act on behalf of the lender.

(3) Any lender who knowingly and willfully makes a false

certification required pursuant to Sec. 36.4337(k)(2) shall be liable

to the United States Government for a civil penalty equal to two times

the amount of the Secretary's loss on the loan involved or to another

appropriate amount, not to exceed $10,000, whichever is greater.

(l) Assessment of liability. (1) Upon an assessment confirmed by

the Under Secretary for Benefits, in consultation with the

Investigating Official, that a certification, as required in this

section, is false, a report of findings of the Under Secretary for

Benefits shall be submitted to the Reviewing Official setting forth:

(i) The evidence that supports the allegations of a false

certification and of liability;

(ii) A description of the claims or statements upon which the

allegations of liability are based;

(iii) The amount of the VA demand to be made; and

(iv) Any exculpatory or mitigating circumstances that may relate to

the certification.

(2) The Reviewing Official shall review all of the information

provided and will either inform the Under Secretary for Benefits and

the Investigating Official that there is not adequate evidence, that

the lender is liable, or serve a complaint on the lender stating:

(i) The allegations of a false certification and of liability;

(ii) The amount being assessed by the Secretary and the basis for

the amount assessed;

(iii) Instructions on how to satisfy the assessment and how to file

an answer to request a hearing, including a specific statement of the

lender's right to request a hearing by filing an answer and to be

represented by counsel; and

(iv) That failure to file an answer within 30 days of the complaint

will result in the imposition of the assessment without right to appeal

the assessment to the Secretary.

(m) Hearing procedures. A lender hearing on an assessment

established pursuant to this section shall be governed by the

procedures recited at 38 CFR 42.8 through 42.47.

(n) Additional remedies. Any assessment under this section may be

in addition to other remedies available to VA, such as debarment and

suspension pursuant to 38 U.S.C. 3704 and part 44 of this title or loss

of automatic processing authority pursuant to 38 U.S.C. 3702, or other

actions by the Government under any other law including but not limited

to title 18, U.S.C. and 31 U.S.C. 3732.

(Authority: 38 U.S.C. 3703, 3710.)

[FR Doc. 97-11808 Filed 5-6-97; 8:45 am]

BILLING CODE 8320-0-P