There’s no question that “put back” risk – the prospect that the GSEs will require mortgage lenders to repurchase defaulted loans even years after origination – is a major factor contributing to excessively tight credit standards that have dampened the housing market. If the goal is to improve access to mortgage credit, then clarifying and easing the rules regarding put backs is a critical step.
That’s why FHFA Mel Director Watt’s recent speech announcing that the agency intends to refine the “Representation and Warranty Framework” defining the circumstances that justify a repurchase demand was so significant. More clarity about these circumstances should help ease lender concerns.
Also welcome was Director Watt’s statement that the FHFA will seek repurchase relief not for minor deficiencies on single loans but against those lenders who engage in a “pattern of misrepresentations or data inaccuracies” on multiple loans. The objective here, it seems, is not to nit-pick lenders for small underwriting errors but to reserve repurchase relief for the truly serious situations.
In addition, Director Watt indicated that the GSEs would be continuing their work to identify alternative remedies short of repurchase for loan defects that are less severe.
Similar concerns among lenders also exist in the FHA-insured segment of the mortgage market.
Like a GSE put back, the FHA has the right to seek indemnification from a mortgage originator for the insurance claims it pays out if the FHA subsequently determines the lender made errors in the initial underwriting.
Many FHA lenders insist the current underwriting and indemnification rules are murky and complex – not surprising since these guidelines are reflected in hundreds of mortgagee letters and other pieces of policy guidance drafted over the past decade. Lenders also complain of uneven enforcement by different regional offices within FHA as well as by the HUD Inspector General and the Department of Justice.
In response to these concerns, most FHA lenders have imposed additional credit overlays to protect themselves against potential indemnification claims down the road. For example, while the FHA can technically insure loans to borrowers with credit scores as low as 580, few such loans today are made today since most FHA lenders require a minimum score of 640.
These defensive measures, while understandable, have significantly narrowed the pool of eligible borrowers and shut out a large number of creditworthy families from the homeownership market. Consider that there are some 13 million people with credit scores between 580 and 640, according to the Urban Institute’s Jim Parrott. Many of these individuals are members of low-wealth households or would-be first-time homebuyers, the very groups that FHA has traditionally served.
Recognizing the problem, the FHA began work last year on combining the disparate policy guidance into a single handbook that will serve as the authoritative guide to all aspects of FHA’s single-family programs. The first major section of the handbook covering new loan originations has been completed, and further work continues.
This past March, the FHA also announced a “quality assurance” framework designed to reduce the uncertainty among FHA lenders by ensuring that loans are reviewed closer to the time of origination. And more recently, the FHA released a draft document outlining a new approach for evaluating underwriting defects that will provide more descriptive criteria and identify a limited number of specific defects that will lead to an indemnification claim.
The goal of all these efforts is to instill greater confidence in FHA lenders that they will be able to originate mortgages without fear of back-end enforcement actions.
As HUD Secretary Julian Castro has explained: “We all want a healthy and growing housing market. We all want credit flowing freely and responsibly. We all want to restore the trust between borrowers and lenders, industry and government.”
I am encouraged by what’s happening at both FHFA and FHA. There is a clear recognition that regulatory policies can have unintended and harmful consequences, including acting as an artificial barrier to homeownership.
Both agencies also recognize it is possible to manage risk with sound underwriting, while simultaneously expanding access to mortgage credit.
While it is too soon to tell whether the reform initiatives will achieve their desired results, the stakes are high. Ensuring greater access to mortgage credit is essential for a stronger housing market and a fuller, more lasting economic recovery.