Opinion

Lenders shouldn't waver on monitoring early payment defaults

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The Federal Housing Administration's temporary waiver of its required monthly early payment default quality control reviews was a welcome concession to the unique circumstances lenders and borrowers are facing during the COVID-19 pandemic.

However, other factors indicate that EPDs still pose risk for lenders in the months to come and should, therefore, be closely monitored.

The primary reason for the FHA's waiver is clear: the agency feels current QC review efforts will be expended on something blatantly obvious, as the vast majority (though not all) of EPDs during this period are related to the pandemic. In issuing its temporary waiver, the FHA noted the financial issues borrowers are experiencing as a result of the coronavirus, rather than any failure by lenders to comply with its single-family origination and underwriting requirements, as a potential cause for the recent spike in EPDs.

Furthermore, the FHA also cited the mortgage relief options provided by the CARES Act as a potential trigger for EPD "false positives." Thus, the agency opted to waive its loan-level QC requirement for EPDs from May through July. It has not been extended.

While the FHA's waiver is certainly the most generous guidance issued regarding EPDs, it is not the only federal mortgage-related agency to do so. Freddie Mac temporarily altered its requirements to allow lenders to sample EPDs through the end of June, rather than performing a 100% review per its usual requirement. Although Fannie Mae has only made a passing reference to lenders' EPD review efforts in relation to discretionary sampling, it has announced that it will be increasing its review of EPDs, thus signaling an increased awareness on its part of the increase in EPDs.

However, the key word lenders must keep in mind regarding these communications from FHA and the GSEs is "temporary." July was the last month in which FHA-approved lenders are not required to conduct QC reviews of their EPDs. While Freddie Mac didn't extend its relaxed EPD sampling requirements beyond June, both it and Fannie Mae issued updates on July 1 to their joint COVID-19 Frequently Asked Questions - Selling document, which states that the GSEs will not issue automatic repurchase requests for loans entering EPDs status. Instead, the GSEs "will follow existing QC practices to review any sampled loan against the requirements of the Selling Guide and any other agreements in place at the time of delivery."

Given this response, it is safe to assume that, as far as the GSEs are concerned, it is business as usual regarding EPDs, and without explicit continuation of the temporary measures issued by the GSEs and/or FHA, lenders can expect to be on the hook for EPDs moving forward. What's more, factors at work in the larger economic market only extend the risk of EPDs throughout the remainder of the year.

While the national unemployment rate in June declined by 2.2 percentage points as compared to May, the expiration of the Federal Pandemic Unemployment Compensation program at the end of July may cause the rate of EPDs to spike once more. In addition, some of June's decline was the result of a decrease in the number of temporary layoffs. This would seemingly indicate that businesses that had temporarily closed have reopened and, thus, recalled their workforce. However, the number of permanent job losses during this same period increased to 2.9 million, accounting for a total increase of 1.6 million workers since February 2020 at the start of the pandemic in the U.S.

As COVID-19 cases continue to rise in much of the country, it may become a matter of when, not if, state and local governments re-institute shut-downs to slow the spread of the virus — an action that would most certainly cause a surge in the unemployment rate. With congressional efforts to pass a second economic stimulus package seemingly stalled, the economic situation in the U.S. could get worse before it gets better, and as a result, many of the "false positive" EPDs lenders observed in the second quarter could become positives in the worst possible sense and ultimately result in a large uptick in foreclosures.

It is also worth noting that EPDs are one of the strongest indicators of possible mortgage fraud. With interest rates at all-time lows and consumers' economic concerns seemingly at an all-time high, the conditions are ripe for fraud for housing (as opposed to fraud for profit where loan proceeds are misappropriated) to occur, making monitoring for EPDs an important fail-safe for uncovering potential fraud that has, for one reason or another, gone undetected.

Given the larger economic conditions at play, as well as the general risk that EPDs pose, lenders should not waver from their ongoing monitoring of EPDs despite the FHA's temporary reprieve. To do so not only jeopardizes lenders' relationships with the FHA and the GSEs, but also exposes lenders to unnecessary risk.

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Mortgage fraud FHA Underwriting Compliance GSEs Fannie Mae Freddie Mac Coronavirus
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