Two federal agencies with far-reaching influence over the mortgage market are working on a problem that could affect the ability of many consumers to obtain a home loan: How to encourage private lenders to ease up on their underwriting restrictions that go beyond what the agencies themselves require for mortgage approvals.
Both the Federal Housing Finance Agency, which oversees giant investors Fannie Mae and Freddie Mac, and the Federal Housing Administration, which runs the low-down-payment FHA program, are considering steps they might take to persuade lenders to open the mortgage spigots a little wider. Together, Fannie, Freddie and FHA account for more than 90 percent of all home loan funding. The focus of their little-publicized reform projects: the “overlay” rules many lenders have adopted that lump extra fees, larger down payments and higher credit-score requirements onto home loans than Fannie, Freddie or FHA require.
For example, Fannie and Freddie may accept FICO credit scores of 660 to 680, and FHA will approve applications with scores as low as 580. Yet lenders originating loans for them often want to see scores 100 points higher. Another example: FHA recently inaugurated a “streamline refi” program designed to encourage widespread refinancings for borrowers with good payment histories by offering low mortgage insurance fees, no appraisals and no credit checks.
Great idea, but lenders have clamped their own more stringent underwriting restrictions on the program, frustrating consumers. Some banks require full appraisals, credit checks and add-on fees. Other lenders have announced that they are limiting eligibility for the program to customers they already service, despite the fact that FHA allows borrowers to seek streamline refinancings from any FHA-approved lender.
Why are lenders making it tougher than necessary for creditworthy applicants to obtain a mortgage? Tops on the list: They are practicing what one prominent mortgage industry consultant describes as “defensive lending.”
“Defensive lending is the mortgage equivalent of defensive medicine,” where doctors run more tests than needed to reduce litigation risk, says Brian Chapelle, principal at Potomac Partners in Washington, D.C. “Rather than more medical tests, mortgage lenders are adding underwriting requirements and program restrictions to avoid overstepping a sometimes ambiguous line” that will trigger penalties from Fannie, Freddie or FHA.
Even minor technical infractions in underwriting or documentation can cause “buyback” demands by Fannie or Freddie when loans go into default, with costs per loan for the lender sometimes soaring to hundreds of thousands of dollars. Plus the Justice Department is putting pressure on major banks to pay millions of dollars to settle allegations of systemic flaws in their mortgage practices — settlements the banks consent to not on the merits but to avoid protracted litigation and hits to their stock prices.
On top of this, banks and other originators are uncertain about upcoming mortgage regulations that stem from the Dodd-Frank financial reform law that will spell out the rules for future lending.
In a nutshell, says Chapelle, government agencies and Congress have fostered a play-it-ultra-safe environment, where the pressure is intense to lend only on the most conservative terms, even if that means turning down creditworthy applicants.
What to do? The two agencies are mum about specifics but are expected to announce reforms sometime in the coming weeks. Lenders, on the other hand, know precisely what they’d like to see. Steve O’Connor, senior vice president of the Mortgage Bankers Association, says lenders want several key changes in current procedures, including clear, point-by-point guidance on how the agencies will define reasonable grounds for buybacks or indemnifications going forward. Lenders also need assurance that after an agreed-upon period of time — say, 24 to 36 months — they will not be blamed for deficient underwriting on a loan that goes belly up. Some mortgage companies have been confronted with buyback demands on loans that defaulted for economic reasons after seven or eight years of on-time payments. “That’s crazy,” said O’Connor.
FHA lenders, said Chapelle, also want greater fairness in the way they’re treated when loans default, including revisions of lender monitoring standards that evaluate them poorly when they try to accommodate borrowers with lower credit scores and other blemishes.
Bottom line: Lenders say they could loosen up a little on underwriting when federal agencies ease their buyback demands. Since the two top agencies are trying to figure how to do this, homebuyers might see slightly less punitive “overlay” fees and underwriting later in the year.
Don’t hold your breath, but it could happen, and it just might help you get approved for a mortgage.