FHA Quality-Assurance Plan Assures Fewer Loans Get Made: Lenders
Mortgage lenders are balking at a quality assurance program proposed by the Federal Housing Administration—and not only because they would have to pay for it.
The increased scrutiny, mortgage bankers complain, would end recent attempts to provide home loans to borrowers with poor credit, something the FHA has been trying to spur for years. Those with FICO scores below 640 would be particularly hard hit, industry executives say.
"FHA says they are trying to encourage more lending to underserved borrowers, but the more they scrutinize lenders, the less eager lenders are to make loans," says Clement Ziroli Jr., president of First Mortgage Corp., an FHA lender in Ontario, Calif.
The plan comes at a particularly inopportune time for the industry. Mortgage originations have fallen 15% to 20% in the past four months compared with a year earlier, and some lenders are choosing to relax underwriting standards such as FICO scores to drum up more business.
On Tuesday FHA Commissioner Carol Galante described the agency's "quality assurance" framework on a conference call with Shaun Donovan, secretary of the Department of Housing and Urban Development, to discuss HUD's 2015 budget.
"The reason we are pursuing this work on quality assurance," Donovan said, "is that as FHA has stepped up enforcement to hold lenders accountable for mistakes that were made in the crisis…we are trying to…provide as much transparency and clarity about what that enforcement will look like."
Donovan described the administrative fee to lenders as a "direct cost," albeit a minimal one that would probably get passed on to consumers.
Ultimately, he argued, the program will help reduce costs and improve access to credit for some borrowers "because the work we are going to do will decrease uncertainty."
FHA has the authority to collect up to $30 million in fees from lenders to fund its proposed quality assurance program, which would allow the agency to conduct more loan reviews, typically within six to nine months of a loan's origination, to ensure lenders are following guidelines. Fannie Mae and Freddie Mac ramped up their quality control programs last year to help reduce the risk to lenders of costly mortgage buybacks.
FHA's proposed program, which will be open for public comment when it is published soon in the Federal Register, seeks to identify loans that are considered defective and to provide feedback to lenders so they can improve their processes.
Galante provided few details about how the fee would be structured, whether it would be assessed on all lenders based on volume or whether the agency had created a policy yet on the issue. The fee likely would be assessed as part of HUD's 2015 fiscal budget, starting in September.
Theoretically lenders are required to indemnify FHA for loans that are defective, essentially self-insuring the loan so taxpayers are not on the hook for potential losses. The increased focus on quality control stems from the inordinately large number of loans that went delinquent during the financial crisis and a lack of oversight by lenders to ensure loans meet underwriting standards.
David Stevens, president of the Mortgage Bankers Association and a former FHA commissioner, questions whether the quality assurance program would advance FHA's objective of providing financing to as many families as possible.
"No one can argue that the FHA shouldn't do more quality control," Stevens says. "But lenders can now view themselves at far greater risk, with more ongoing scrutiny and more time spent reviewing loan files."
Stevens wants the FHA to provide more guidance on which types of errors constitute what is known in the industry as a "material defect," the kind of problem that would prohibit the agency from insuring a loan. FHA loan files can be massive—up to 500 pages long—and a significant number are considered to be deficient in some way even if the mistake does not necessarily mean the borrower will default on their loan.
"This pursuit of the perfect loan file is a virtual impossibility," Stevens says. "We've been calling on FHA to better define what defects will create an obligation for indemnification."
Brian Chappelle, a partner at consulting firm Potomac Partners and a former FHA official, said the quality assurance fee came out of nowhere.
"I am worried that this fee and its purpose could send the wrong message to the industry," Chappelle says. "Rather than encouraging lenders to expand access to credit, I am concerned many lenders will respond to this program by tightening requirements further."
Surprisingly, Donovan told reporters that he has been "encouraged" by lenders' loosening of credit overlays, a term used to describe a requirement that an originator adds above and beyond what FHA demands.
FHA will accept loans with FICO scores as low as 580, but many lenders will only write loans to borrowers with a score of 640 or above.
"We are seeing early evidence—it's tentative—that lenders are beginning to remove some credit score screens that went above and beyond FHA’s own standards," Donovan said. "We are seeing in our data around FHA lending a broader group of first-time buyers that are actually getting access to credit."