5202.5: Adverse or derogatory credit information (03/02/16)

(a) Evaluating adverse or derogatory credit information

Adverse credit information in and of itself does not mean the Borrower's credit reputation is unacceptable. When there is adverse or derogatory information in the Borrower's credit history, the Seller must determine whether the derogatory information is significant.For Caution Mortgages with at least two Feedback Certificate messages related to nonpayment of obligations, the Seller must presume the derogatory information is significant. The Seller must document the extenuating circumstances or conclude that the difficulties were due to financial mismanagement.Similarly, for Manually Underwritten Mortgages underwritten using Fair Isaac Corporation (FICO®) scores with at least two reason codes related to nonpayment of obligations, the Seller must presume the derogatory information is significant and the Seller must document the extenuating circumstances or conclude that the difficulties were due to financial mismanagement. See Sections 5202.3 and 5202.4 for additional information regarding the requirements necessary to determine a Borrower has an acceptable credit reputation for Manually Underwritten Mortgages using FICO scores in underwriting.For all other Manually Underwritten Mortgages with or without FICO scores, the Seller must weigh the amount of derogatory information against the rest of the credit history and decide whether it is significant. In making its determination, the Seller should not ignore any derogatory credit, but must give more weight to late housing payments and to derogatory information or late payments occurring within the past two years. Generally, the more recent the adverse or derogatory credit information, the more likely it is significant.The Seller must consider all of the following:

The number, timing and extent of the adverse or derogatory credit information
The number, type and size of accounts with adverse or derogatory credit information
Public record information, such as judgments and collection accounts
Other characteristics listed in this section

For example, Freddie Mac considers a 30-day late housing payment to have more weight than a 30-day late nonhousing payment, and a collection account to have more weight than a 30-day late payment on a revolving account.

Although there may be many situations involving derogatory credit information that are less clear, especially when disputes about obligations are involved, the derogatory credit information is not significant when it consists only of isolated late payments, even if several accounts show sporadic late payments, provided all of the following exist:

The late payments were not recent
The late payments did not extend beyond one month
The number and size of delinquent accounts is not large in relation to the overall credit
The credit history does not show multiple revolving accounts with high balances-to-limits or high overall utilization of revolving credit
All other credit has been paid as agreed

However, the derogatory information is significant if any of the following exist:

There are several accounts showing recent late payments
There are multiple 60- or 90-day late payments
There is more than one 30-day late housing payment in the last 12 months
There are more than two 30-day or more than one 60-day late housing payments within the most recent two years
The number and size of the delinquent accounts are large in relation to the overall credit
There are multiple episodes of late payments extending over a period of time
The credit history shows derogatory credit information within the two most recent years combined with multiple revolving accounts with high balances-to-limits
The public record information reveals several occurrences of derogatory credit information, including judgments, tax liens and/or collection accounts
There is a bankruptcy, foreclosure, deed-in-lieu of foreclosure, or short sale within the last seven years that is disclosed on a credit report, disclosed by the Borrower on the Form 65, Uniform Residential Loan Application, or is evidenced by other documentation contained in the Mortgage file

If the Seller decides that the derogatory information is not significant, it must provide documentation supporting its conclusion in the Mortgage file. If the Seller decides that the derogatory information is significant, it must determine whether the problems were due to extenuating circumstances or to financial mismanagement.

(i) Handling significant adverse or derogatory information caused by extenuating circumstances for Manually Underwritten MortgagesFreddie Mac considers an extenuating circumstance to be a nonrecurring or isolated circumstance, or set of circumstances, that was beyond the Borrower's control and that significantly reduced income and/or increased expenses and rendered the Borrower unable to repay obligations as agreed, resulting in significant adverse or derogatory credit information.In addition, if the Borrower's credit history includes significant adverse or derogatory credit within the most recent two years, even if it was caused by extenuating circumstances, the Borrower's credit reputation cannot be considered acceptable.When the Seller uses extenuating circumstances to justify that the Borrower's credit reputation is acceptable despite significant adverse or derogatory information, the Seller must confirm the extenuating circumstances and that the Borrower has reestablished an acceptable credit reputation. If the Seller cannot obtain third-party documentation confirming the extenuating circumstances and reestablishment of credit, it cannot consider the extenuating circumstance as an acceptable offset to significant adverse or derogatory credit information.The Mortgage file must contain all of the following documentation:

A written statement from the Borrower attributing the cause of the financial difficulties to outside factors beyond the Borrower's control that are not ongoing and are unlikely to recur
Third-party documentation confirming that the events related by the Borrower in the explanation were an isolated occurrence and significantly reduced the Borrower's income and/or increased expenses and rendered the Borrower unable to repay as agreed
An underwriting analysis on Form 1077, Uniform Underwriting and Transmittal Summary, or on a separate document in the Mortgage file, relating the Borrower's explanation to the Mortgage file documentation and leading to a reasonable conclusion that:
- The events causing the financial difficulties were beyond the Borrower's control, are not ongoing and are unlikely to recur; and
- The Borrower has reestablished an acceptable credit reputation

Evidence on the credit report and other documentation in the Mortgage file of the length of time since completion of the significant derogatory event to the date of application and of completion of the recovery time period requirements below. In addition to the recovery time period requirements, the following additional requirements below must also be met:

Significant Derogatory Event	Recovery Time Periods for Reestablishment of Credit with Extenuating Circumstances	Additional Requirements
Foreclosure	36 months from the completion date as reported on the credit report	Whenever a Borrower has had a previous foreclosure, deed-in-lieu of foreclosure or a short sale within the last seven years, the Mortgage must either be: A purchase transaction Mortgage secured by a Primary Residence with a maximum loan-to-value (LTV)/total LTV (TLTV)/Home Equity Line of Credit TLTV (HTLTV) ratio of the lesser of 90% or the maximum LTV/TLTV/HTLTV ratio for the transaction, or A "no cash-out" refinance Mortgage that meets the requirements of Chapter 4301 Additionally, the Mortgage file must contain evidence of the completion of the foreclosure, deed-in-lieu of foreclosure or short sale.
Deed-in-lieu of foreclosure	24 months from the execution date
Short sale	24 months from the completion date
Bankruptcy (all bankruptcy actions)	24 months from the discharge or dismissal date	Whenever a Borrower has had a bankruptcy within the last seven years, the Mortgage file must also contain: Copies of the bankruptcy petition, schedule of debts and discharge or dismissal Evidence to indicate that all debts not satisfied by the bankruptcy have been paid or are being paid Any other evidence necessary to support the Seller's determination that the Borrower has reestablished and maintained an acceptable credit reputation
Other significant adverse or derogatory credit information	24 months from the most recent significant adverse or derogatory credit information	N/A

(ii) Handling significant adverse or derogatory information caused by financial mismanagement for Manually Underwritten Mortgages

If the Seller is unable to document extenuating circumstances in accordance with Freddie Mac's requirements, then it must conclude that the problems were due to financial mismanagement.In order to conclude that the Borrower's credit reputation is still acceptable despite the previous financial mismanagement, the Seller must explain on Form 1077 or on a separate document in the Mortgage file, the rationale supporting its determination that the financial mismanagement is unlikely to recur and the Borrower's credit reputation is acceptable. Making a case that the Borrower is sufficiently willing to repay obligations when significant derogatory information was caused by financial mismanagement is very difficult. It will take a longer and more convincing reestablishment period to overcome derogatory information caused by financial mismanagement than would be needed if the Borrower had experienced financial difficulties due to extenuating circumstances.When the Seller determines that the Borrower's credit reputation is acceptable despite significant adverse or derogatory information caused by financial mismanagement, the Mortgage file must contain all of the following documentation:

Evidence that the Borrower has reestablished an acceptable credit reputation as required in Topics 5100 and 5200 for Manually Underwritten Mortgages

Evidence on the credit report and other credit documentation in the Mortgage file of the length of time since completion of the significant derogatory event to the date of the application, and of completion of the recovery time period requirements below. In addition to the recovery time period requirements, the following additional requirements below must also be met:

Significant Derogatory Event	Recovery Time Periods for Reestablishment of Credit with Financial Mismanagement	Additional Requirements
Foreclosure	84 months from the completion date as reported on the credit report	N/A
Deed-in-lieu of foreclosure	48 months from the execution date	Whenever a Borrower has had a previous deed-in-lieu of foreclosure or a short sale within the last seven years, the Mortgage must either be: A purchase transaction Mortgage secured by a Primary Residence with a maximum LTV/TLTV/HTLTV ratio of the lesser of 90%, or the maximum LTV/TLTV/HTLTV ratio for the transaction, or A "no cash-out" refinance Mortgage that meets the requirements of Chapter 4301 Additionally, the Mortgage file must contain evidence of the completion of the foreclosure, deed-in-lieu of foreclosure or short sale.
Short sale	48 months from the completion date
Bankruptcy (other than a Chapter 13 bankruptcy)	48 months from the discharge or dismissal date	Whenever a Borrower has had a bankruptcy within the last seven years, the Mortgage file must also contain: Copies of the bankruptcy petition, schedule of debts and discharge or dismissal Evidence to indicate that all debts not satisfied by the bankruptcy have been paid or are being paid Any other evidence necessary to support the Seller's determination that the Borrower has reestablished and maintained an acceptable credit reputation
Chapter 13 bankruptcy	24 months after the discharge date 48 months from the dismissal date
Multiple bankruptcy filings in the past seven years	60 months from the most recent discharge or dismissal date
Other significant adverse or derogatory credit information	48 months from the most recent significant adverse or derogatory credit information	N/A

(b) Documenting Borrower explanation of adverse or derogatory information

As part of its review of Manually Underwritten Mortgages, the Seller may need to request that the Borrower provide a written explanation of the circumstances causing the payment difficulty. The decision to require an explanation letter should be based on such factors as the age of the delinquent account, the frequency and severity of late payments, the size of the account balance and payment, when the late payments occurred and the status of the Borrower's other credit accounts.For example, a Borrower's credit history shows a 30-day late payment on a single charge account ten months ago. The Borrower has several other charge accounts, an installment loan and a Mortgage, all showing timely payments. The Seller may decide not to obtain a letter of explanation. However, if several of the Borrower's credit accounts showed late payments, or the Borrower's Mortgage or installment loan were also late, the single late on the charge account ten months ago may be considered significant, so the Seller should obtain a letter of explanation from the Borrower and include it in the Mortgage file.A written explanation is required for significant derogatory information. The purpose for requiring a written explanation is to assist the Seller in determining whether the Borrower's credit problems were due to extenuating circumstances (factors clearly beyond the control of the Borrower) or whether they reflect financial mismanagement (the Borrower's disregard for the payment of obligations when due).In order to accomplish this purpose, it may be necessary to allow someone to assist the Borrower in preparing the explanation. If the Borrower needs assistance in preparing a written explanation, another party, such as the real estate agent or loan officer, should be encouraged to assist the Borrower in preparing the explanation. As long as the explanation accurately reflects the facts as related by the Borrower (as evidenced by the Borrower's signature attesting accuracy), the Seller should accept the explanation as documentation for its review.A written explanation in and of itself does not satisfy the Seller's responsibility to determine the Borrower's willingness to repay. When adverse or derogatory information is considered significant, as explained in Section 5202.5(a), the Seller must relate the reasons for the late payments, as stated by the Borrower, to the other information about the Borrower's credit history contained in the Mortgage file. The Seller must reasonably be able to conclude that:

The explanation is consistent with the adverse information reported and the other information in the Mortgage file
The explanation establishes a credible cause for the late payments
The Borrower represents an acceptable credit risk and exhibits the ability and willingness to repay the Mortgage