Origination in the Era of COVID-19: the GSEs, FHA, and VA Issue Guidance for Appraisals and Income Verification

There is no question that COVID-19 has strained all aspects of life in the United States, including the housing and mortgage industries.  Social distancing, stay-at-home orders, and business closures have disrupted the abilities of many workers to complete their duties on a “business as usual” basis.  In the mortgage market, there is a direct impact on a mortgage lender’s ability to originate a residential mortgage loan when a borrower’s employment and income status may quickly change, appraisers may have difficulties gaining access to the interior of homes to complete their reviews, and gathering around a closing table could violate state or local health directives.  As a result, each of Fannie Mae, Freddie Mac (together, the “GSEs”), the Federal Housing Administration (“FHA”) and the Department of Veterans Affairs (“VA”, and, collectively with the GSEs and FHA, the “Housing Agencies”) have announced guidance regarding changes to their normal origination guidelines during the COVID-19 emergency. 

On March 23, 2020, Fannie Mae published Lender Letter 2020-03¹ and Lender Letter 2020-4,² and Freddie Mac published Bulletin 2020-5,³ which outlined the GSEs’ revised requirements.  Fannie Mae Lender Letter 2020-3 and Lender Letter 2020-04 were revised March 31, 2020 with additional guidance, and simultaneously Freddie Mac issued Bulletin 2020-8.⁴  On March 27, 2020, FHA issued Mortgagee Letter 2020-05 (the “FHA Mortgagee Letter”), which outlined certain revisions to FHA’s origination requirements with respect to the FHA Single Family Title II Forward and Reverse Mortgage Programs.⁵  Finally, on March 27, 2020, the VA published Circular 26-20-10⁶ and 26-20-11,⁷ which detailed temporary changes to the VA’s employment verification and valuation practices, respectively.  Each of the Housing Agencies’ letters include temporarily-relaxed standards with respect to appraisals and employment/income verification requirements to accommodate social distancing guidelines and the fact that many employers are temporarily closed or employees are working from home.  At the same time, the GSEs tighten certain underwriting requirements to ensure borrowers have continuity of income for new originations.  While the guidance issued by the GSEs cover several other topics, including use of powers of attorney remote online notarization, quality control requirements, and e-signatures, this Legal Update focuses on the appraisal and employment income verification guidance provided by each of the GSEs, FHA, and VA.

Appraisals

The GSEs

In Fannie Mae Lender Letter 2020-04, Freddie Mac Bulletin 2020-5 and Freddie Mac Bulletin 2020-8 (collectively, the “GSE Appraisal Letters”), the GSEs acknowledge that, due to the COVID-19 emergency, lenders may be unable to obtain appraisals based on a full inspection of the interior and exterior of the property, and as a result the GSEs are implementing temporary flexibilities to their appraisal requirements, most notably through allowances for use of desktop and exterior-only appraisals.  The appraisal guidance in the GSE Appraisal Letters is effective immediately, applicable to appraisals conducted for loans with application dates on or before May 17, 2020.

Under the GSE Appraisal Letters, the GSEs will allow either a desktop appraisal or an exterior-only appraisal if an interior inspection is not feasible due to COVID-19 concerns, although desktop appraisals are preferred for purchase transactions.  Most purchase transactions are eligible for desktop or exterior-only appraisals, and certain refinance loans are eligible for exterior-only appraisals. 

Specifically, a lender originating one of the following transactions may obtain either a desktop appraisal or an exterior-only appraisal in lieu of a traditional interior appraisal:

• A purchase loan to be secured by a borrower’s principal residence; or
• A purchase loan to be secured by a second home or investment property with a loan-to-value ratio less than or equal to 85%.

A lender originating one of the following transactions may obtain an exterior-only appraisal:

• A no-cashout refinance loan where the loan being refinanced is already owned by Freddie Mac; or
• A limited cash-out refinance loan where the loan being refinanced is owned by Fannie Mae.

In FAQs issued by the GSEs (the “GSE FAQs”),⁸ Fannie Mae and Freddie Mac make clear that desktop appraisals are not permitted for refinance loans because the information available in the Multiple Listing Service may be dated, if available at all.  “Having the appraiser complete an exterior inspection provides current information about the home’s condition that might not be available otherwise.”

A lender originating one of the following transactions may obtain a desktop appraisal:

• A purchase loan for new construction properties where the appraisal is “subject to completion per plans and specifications”; or
• A purchase loan for new construction properties that are 100% complete and an interior appraisal cannot be completed. 

This is an update from the GSEs original appraisal guidance on March 23, 2020, which had required interior appraisals for new construction transactions. 

The following transactions will still require a traditional interior appraisal:

• Purchase loans secured by second homes with greater than 85% loan to value ratios;
• Limited cash-out refinance loans where Fannie Mae does not already own the loan;
• No-cash-out refinance loans where Freddie Mac does not already own the loan;
• Cash-out refinance loans;
• With respect to Fannie Mae, construction-to-permanent loans;
• With respect to Freddie Mac, Construction Conversion and Renovation transactions; 
• Fannie Mae HomeStyle^® Renovation loans during the underwriting process; and
• Freddie Mac CHOICERenovation^SM Mortgages. 

The GSE guidance identifies the specific forms that appraisers should use when completing desktop or exterior-only appraisals per property type.  In addition, the GSEs created a set of revised scope of work documents for desktop appraisals and exterior-only appraisals.  When submitting either a desktop appraisal or an exterior-only appraisal in accordance with the new flexibilities provided by the applicable GSE, the lender must ensure the applicable scope of work document is attached to the appraisal.  Further, when submitting either a desktop appraisal or an exterior-only appraisal on a form for an interior and exterior inspection, the appraisal report must include, in the Map Reference field, text identifying the reports as either “desktop” or “exterior.”

In conducting a desktop appraisal, the GSEs instruct that the appraisal should rely on public records, Multiple Listing Service information and other available third-party data sources (an inspection of the subject property or comparable sales is not required).  Each desktop appraisal must include a location map indicating the location of the property and comparable sales, as well as photographs of the property.  At a minimum, the desktop appraisal report must include a photo of the front of the property, although the GSE FAQs note that it may be necessary for the report to include all photos required for an appraisal based on an interior and exterior inspection in order to pass through automated review systems.  In such cases, an appraiser should include all available photographs, which the GSE FAQs indicate may be obtained from third-party web sites, owners of the property, or listing services (as long as any use restrictions on photos are honored).  Desktop appraisals will be scored by Collateral Underwriter^® or Loan Collateral Advisor^®, as applicable, and loans with a risk score of 2.5 or less will receive value representation and warranty relief.   

Where an appraiser conducts an exterior-only appraisal, the appraisal report must include specific exhibits, including a street map that shows the location of the property and comparable sales used by the appraiser, clear and descriptive photos of the front of the property, and any other data necessary to provide an adequately-supported opinion of market value.  Representation and warranty relief is not available with an exterior-only appraisal.

As noted above, the GSEs will now allow desktop appraisals for purchase transactions on new construction properties.  For appraisals on completed properties, the report must be completed “as is,” and for appraisals on new properties where construction is not complete, the report must be noted as “subject to completion per plans and specifications.”  In either case, either the lender or builder must provide the appraiser with specific documentation regarding the property, including plans and specifications, current photos of the build site or completed property, a survey and/or plot plan, and a copy of the completed sales contract.  Note that where an appraisal report was completed “subject to completion per plans and specifications,” and the lender is unable to obtain a completed Form 1004D or Form 442, as applicable, due to COVID-19 related issues, Fannie Mae or Freddie Mac will accept a Completion of Construction Certification.  The lender also must obtain a signed Builder Certification form attesting that all information is true and correct.  If a Completion Certification is not available due to issues related to COVID-19, the lender may instead obtain a letter signed by the borrower confirming the work was completed, accompanied by other evidence of completion (photographs, paid invoices, etc.).  All completion documentation must be retained in the loan file.

With respect to HomeStyle® Renovation Loans, while Fannie Mae continues to require traditional appraisals during the underwriting process, Fannie Mae has implemented certain flexibilities with respect to inspection requirements for loans in process, including the use of a Completion of Construction Certification (in lieu of an inspection) to advance renovation funds.  The lender must include with the Completion Certification sufficient supporting evidence of completion (photographs, paid invoices, etc.) and retain all evidence in the loan file. 

Similarly, Freddie Mac reminds lenders that CHOICERenovation^SM Mortgages require an interior and exterior inspection appraisal and a completion report on Form 442, and confirms that it does not permit the appraisal flexibilities discussed above with respect to such mortgages.  Lenders may, however, e-mail Freddie Mac at CHOICERenovation@freddiemac.com to discuss an extension if the lender determines the construction may be delayed due to COVID-19 concerns, or if a completion report cannot be obtained.  With respect to GREENChoice Mortgages^SM, Freddie Mac will permit a signed letter from the applicable borrower confirming work was completed, in lieu of Form 442, which should be accompanied by evidence of completion (including photographs, paid invoices, etc.).

Finally, the GSEs encourage lenders to accept appraisal waiver offers as eligible, and suggest that a lender submit each case to Desktop Underwriter® or Loan Product Advisor®, as applicable, to determine whether a waiver is offered before ordering an appraisal to determine eligibility.

FHA

The FHA Mortgagee Letter is effective immediately and applicable to appraisal inspections completed on or before May 17, 2020.  As described in the FHA Mortgagee Letter, FHA will accept both desktop and exterior-only appraisals for:

• Forward purchase loans;
• Home Equity Conversion Mortgage (“HECM”) for Purchase transactions; and
• Appraisals obtained in connection with the servicing of forward and HECM reverse mortgage transactions. 

FHA will accept exterior-only appraisals for:

• Traditional HECM loans;
• HECM-to-HECM refinances;
• Rate and Term refinances; and
• Simple refinances. 

FHA will continue to require traditional interior appraisals for:

• New construction purchase transactions;
• Construction-to-permanent purchase loans;
• Building on Own Lands purchase loans;
• Section 203(k) purchases;
• Cash-out refinances; and
• Section 203(k) refinance loans.

When completing an exterior-only or a desktop appraisal, the appraiser may rely on supplemental information from Multiple Listing Services, tax assessor’s records, and from an interested party to the transaction, including the borrower, real estate agent, or property contact.  The appraiser must make clear disclosure of these sources of information in the appraisal report.  HUD published an FAQ after the release of the FHA Mortgagee Letter that makes clear that the appraisal does not need to be subject to an inspection at a later date solely because an interior or physical inspection was not performed. 

The appraisals are conducted “as is,” unless minimum property requirements deficiencies are known (or, in the case of exterior-only appraisals, deficiencies can be seen from the street).  In each case, the appraiser may utilize extraordinary assumptions if necessary.  No sketches, interior photographs or rear exterior photographs are required (photographs of the front should be taken in the case of an exterior-only appraisal).  For a desktop appraisal, no comparable viewing or photos are required.  Appraisers must continue to use FHA approved appraisal forms with amended certifications and scope of work disclosures, including a signed certification from the appraiser indicating whether the appraiser made a personal inspection of the property and the scope of such inspection.  FHA-approved forms do not include exterior appraisal forms Fannie Mae 2055 and Fannie Mae 1075. 

Finally, the FHA Mortgagee Letter notes (similar to the GSE guidance) that, to the extent there is a transaction where an Appraisal Update and/or Completion Report Part B (Form 1004D) is required to evidence completion of property repairs, FHA will permit a letter signed by the borrower affirming the work was completed.  That letter must be accompanied by additional evidence of completion (photographs, paid invoices, occupancy permits, or other similar documentation), which must be retained in the case binder.  This flexibility does not apply to new construction purchase loans, construction-to-permanent transactions, Building on Own Lands purchase loans, or Section 203(k) transactions.

VA

The VA issued Circular 26-20-11 to relax appraisal requirements, and generally takes a different approach, as compared to the GSEs and FHA, in the analysis required to determine when VA fee panel appraisers may forego interior appraisals.  The guidance in Circular 26-20-11 applies to all loans closed on or after March 27, 2020 and permits exterior-only or desktop inspections in certain circumstances. 

The guidance requires appraisers to view the interior of the property for purchase transactions involving a vacant property, provided the applicable jurisdiction does not have mandatory quarantine or stay-at-home restrictions.  In addition, appraisers must review the interior of the property for purchase or refinance transactions where the subject properties are occupied (again, where the applicable jurisdiction does not have mandatory quarantine or stay-at-home restrictions), provided all parties agree to the interior inspection and (i) no party has been instructed by health authorities to stay home or practice social distancing; (ii) no party has flu-like symptoms; (iii) no party has been quarantined under the direction of a public health authority; and (iv) no party is within the Center for Disease Control guidance of high risk, as described on their website.⁹ 

Accordingly, VA does not require an interior inspection in connection with occupied properties if either party does not wish to move forward with one.  Even if the parties are willing to permit an interior inspection, to the extent either party is ill, has been instructed by health authorities to stay home, or is in the high-risk category for the virus, an interior appraisal is not required.  In these cases, the appraiser may conduct an exterior-only inspection with enhanced assignment conditions.  Even though the VA guidance expresses preference for interior inspections, if any party is uncomfortable conducting such an appraisal, that is enough to revert to an exterior-only appraisal, which ultimately provides flexibility similar to that of the GSEs and FHA. 

In the event an interior inspection is not possible, the VA provides detailed requirements for an exterior-only appraisal.  Circular 26-20-11 identifies the appropriate form to be used for each property type, and requires that the appraiser boldly and conspicuously state on the form “Per Department of Veterans Affairs, no interior inspection was provided due to COVID-19.”  Appraisers must make every effort to complete the following enhanced assignment conditions:

• The appraiser must review the full exterior of the property, and take photographs of all sides with detailed notes of the exterior and any visible minimum property requirements related deficiencies.  If access or ability to view is restricted, the appraiser may use Multiple Listing Service photographs of the area, as long as the appraiser notes the use of such photographs in the appraisal report;
• If available, the appraiser must provide a measurement of the footprint of the home, and reconcile such with the public records;
• The appraiser must conduct a detailed phone interview with the occupant, veteran, or other real estate professional regarding the property.  Records must be kept of interview questions and items that may impact market value; and
• The appraiser may utilize any and all photos from the Multiple Listing Service, including those provided by the occupant, veteran or real estate professional.

The VA is allowing the use of desktop appraisals in very limited circumstances.  Desktop appraisals may be conducted only when the geographic jurisdiction has restrictions imposed by authorities prohibiting individuals from leaving their homes (mandatory quarantine or stay-at-home or similar restrictions).  It is up to lenders to inform the appraiser if they will accept desktop appraisals.  If not, the appraiser must place the assignment on hold for thirty days and subsequently cancel it if the status of the area has not changed in that time.  Circular 26-20-11 identifies the appropriate form to be used, and requires that appraisers boldly and inconspicuously state on the form “Per Department of Veterans Affairs, no interior inspection was provided due to COVID-19.”  In general, appraisers are not required to accept desktop valuation orders, and if an appraiser believes they cannot produce a credible report based on available information, they may place the assignment on hold.  Desktop appraisals are not permitted to be used for liquidations.

Regardless of the type of appraisal conducted, appraisers must follow the procedures of the VA appraisal process and deliver appraisals meeting Uniform Standards of Professional Appraisal Practice and state requirements.  Due to COVID-19, an appraiser may be required to make an extraordinary assumption about the interior of the subject property, which is permitted if the appraiser has a reasonable basis for such assumption and can still perform a credible analysis.  The appraiser must note all extraordinary assumptions in the report, and will complete the report “as is” unless there are minimum property requirements deficiencies observed by the appraiser in their review of the property.  The appraiser must gather enough information to provide a creditable report, and should rely on all publicly discoverable records, Multiple Listing Service photographs and commentary, real estate professionals, and homeowners.  Appraiser must document and retain all information received, noting key items that impact market value and details about what was provided and by whom.

Circular 26-20-11 addresses a few additional topics.  Reconsideration of value requests are suspended for cash-out finance and liquidation transactions until further notice.  Reconsideration of value requests for purchase transactions are restricted to no greater than 5% from the appraisers opinion, and no field reviews will be completed.  Finally, renovation and repair assignments are to be suspended until further notice. 

Verification of Employment, Assets, and Continuity of Income

The GSEs

Just as COVID-19 is having an impact on the ability of appraisers to review properties, it is also affecting the abilities of underwriters to confirm employment and income of borrowers.  As a result, the GSEs have issued guidance to provide lenders with flexibility to reconfirm employment prior to closing, while also tightening their requirements for the age of income and asset documentation. 

Re-Verifications of Employment

Effective with the issuance of Fannie Mae Lender Letter 2020-3, Freddie Mac Bulletin 2020-5 and Freddie Mac Bulletin 2020-8, and until May 17, 2020, the GSEs will permit lenders to, in lieu of the standard approaches to obtaining pre-closing verification of employment, obtain one of the following:

• A written verification of employment, such as an email directly from the employer’s work email address that identifies the name and title of the verifier and the borrower’s name and current employment status;
• An asset account statement showing the payroll deposit for the period immediately preceding the note date; or
• A year-to-date paystub from the pay period that immediately precedes the note date.

While a verification of employment may be obtained after closing and prior to delivery of a loan to the GSEs, Fannie Mae and Freddie Mac strongly encourage lenders to obtain the re-verification prior to the note date.  Moreover, we note that, in the case of Fannie Mae, if the lender has validated employment using the Desktop Underwriter® validation service, the validation of employment will remain eligible for representation and warranty relief as long as the lender complies with the “close by” date in the Desktop Underwriter^® message.

Income and Asset Documents for New Originations

Moreover, given the extension until July 15, 2020 for the filing of federal income tax statements, the GSEs are eliminating the requirement for a copy of the application for an automatic extension to file and the IRS Form 4506-T confirming that no tax transcripts are available for the 2019 tax year.  These documents are not required for those income types that normally require copies of federal income tax returns when the mortgage has an application or disbursement date between April 15, 2020 and July 15, 2020.

In light of widespread business closures due to COVID-19, the GSEs also are requiring additional steps to verify the operating status of businesses for self-employed borrowers.  When a borrower will use self-employment income to qualify for a loan between April 14 and May 17, 2020, the lender must verify existence of the borrower’s business within one hundred and twenty days prior to the note date, as well as confirm that the borrower’s business is open and operating within ten business days of the note date (or after closing but prior to delivery of the loan to Fannie Mae or Freddie Mac).  Lenders may verify the current operating status of the borrower’s business by: (i) obtaining evidence of current work (for example, contemporaneously executed contracts or signed invoices); (ii) obtaining evidence of current business receipts within ten days of the note date; (iii) providing a lender certification, confirmed through phone call or other means, that the business is still operating; or (iv) viewing a business website demonstrating activity supporting current operations.  The GSE FAQs confirm that if a lender determines that a borrower’s business is not currently open or operating, the borrower’s self-employment income cannot be used for qualifying purposes.

Finally, where a borrower is using stocks, stock options, or mutual funds for assets in a mortgage transaction, the GSEs recognize the impact of current market volatility.  On or after April 14 and through May 17, 2020, if a borrower is using these assets for a down payment or closing costs, the lender must obtain evidence of the borrower’s actual receipt of funds from the sale or liquidation.  If the borrower is using these assets as evidence of reserves, the GSEs will not require liquidation, but only 70% of the value of the assets may be considered by the lender.

FHA

The FHA Mortgagee Letter grants temporary modification of the requirements for re-verification of employment through May 17, 2020 for forward and reverse mortgages due to the COVID-19 emergency.  Unlike the GSEs, FHA has not issued other guidance that would temporarily modify income and asset documentation requirements for new originations, although it’s certainly possible that such guidance may be forthcoming. 

As part of its temporary modifications, FHA has relaxed the requirement for mortgagees to provide re-verification of employment within ten days of the note date or disbursement, as applicable, as long as the mortgagee satisfies two requirements.  First, the mortgagee must not be aware of any loss of the borrower’s employment.  Second, the mortgagee must obtain either (i) a year-to-date paystub or direct electronic verification of income for the pay period immediately preceding the note date, or (ii) a bank statement showing direct deposit from the borrower’s employment for the pay period immediately preceding the note date.  For forward purchase mortgages, a third requirement applies: the mortgagee must also obtain evidence the borrower has a minimum of two months’ principal, interest, taxes, and insurance payments in reserves.

VA

• Use third-party employment and income verification services, provided that any fees for the use of these services may not be passed on to the borrower; 
• If third party verification is not possible, use evidence of direct deposit from a bank statement reconciled against paystubs for at least one full month of employment within thirty days of closing; and 
• If neither third party verification nor direct deposit and pay stub evidence is available, use evidence of the borrower’s cash reserves of at least two months’ mortgage payments post-closing covering principal, interest, taxes and insurance.

Lenders must document the methods used to verify employment and income on the VA’s Loan Analysis form and maintain the supporting documentation if the lender uses any of the described flexibilities aside from third-party verification. 

Circular 26-20-10 also includes flexibilities with respect to continuity of income, including that a COVID-19 impact (furlough, curtailment of income, etc.) should not be considered negatively as a break in employment or income if the employee returned, or is anticipated to return, to work in the same capacity and income levels as existed prior to the impact.  This provides some flexibility in applying the general requirement that borrowers have stable income for two years.  Ultimately, regardless of whether there is a clear impact from COVID-19, the VA encourages lenders to proactively document and upload evidence of their income analyses and underwriting justifications for all borrowers.

The COVID-19 emergency is a rapidly evolving situation, and the Housing Agencies responses to it continue to evolve.  In addition to the appraisal and income verification guidance described herein, the GSEs have issued guidance expanding use of powers of attorney for new originations, provided guidelines for loans sold to Fannie Mae and Freddie Mac where remote online notarization is used, clarified when electronic signatures are acceptable, loosened documentation requirements for post-closing quality control reviews, and reminded lenders of the acceptability of gap coverage for title insurance.  And that’s in addition to the Housing Agencies’ servicing-related guidance on foreclosure and eviction moratoria and forbearance and other loss mitigation relief.  The Housing Agencies have acted quickly to ease some of their guidelines in response to this health crisis, and we expect that response to continue.  Certainly the availability of desktop and exterior-only appraisals, as well as relaxed requirements for employment and income verification, will assist appraisers and lenders in continuing to provide necessary services to support the residential mortgage market. 

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And for any legal questions related to this pandemic, please contact the authors of this article or Mayer Brown’s COVID-19 Core Response Team at FW-SIG-COVID-19-Core-Response-Team@mayerbrown.com.