The Federal Housing Administration wants lenders to make fewer mistakes when writing mortgages for the government insurance program. The agency also wants to serve more borrowers with low credit scores. Getting both may be tricky.
FHA lenders already have felt the tension between these two demands. A hard line on defects means lenders are more likely to be on the hook for losses in the event of default, and lower credit scores make defaults more likely. Many FHA lenders such as JPMorgan Chase have been pulling back from the market for this reason.
The FHA expects 75% of the loans it insures from now on will be made to borrowers with FICO scores of 680 or below, an FHA official told a group of risk managers Monday. The housing downturn took many of these borrowers out of the home buying market and the FHA is looking for ways to bring them back.
“We do believe there are a lot of good mortgages, safe mortgages in the 640 to 680 [FICO] range and below,” Frank Vetrano, the deputy assistant secretary for risk management and regulatory affairs at the Federal Housing Administration, said at an industry conference in Miami.
Julie Shaffer, the director of the Department of Housing and Urban Development’s Philadelphia Homeownership Center, told the risk managers that the defect rate for FHA loans is still too high.
Shaffer said the problems can be fixed but lamented that so much paperwork and staff time is being used to address issues such as missing documentation. She told lenders to increase their pre-funding quality control reviews to reduce defects.
Defects on FHA loans appear to be on the rise. In June, the FHA provided a breakdown of 6,645 loans it reviewed in the first quarter and found that just 16% were deemed acceptable, meaning they had no mistakes. A whopping 48% were “unacceptable,” with material defects, while another 36% were considered “deficient,” with errors that could potentially be corrected. Those figures had worsened slightly from a year earlier, when the agency began publishing these figures in its Lender Insight newsletter.
“Make sure the documentation is in the file and that forms are complete,” Shaffer told industry executives Monday. “You will reduce your staff’s time in responding to ‘unacceptable’ letters – that’s your staff time and our staff time – if you look at it up front and make sure the documents are there and the boxes are checked. You don’t want us to start looking at additional loans to see if there is a pattern there.”
Lenders are still trying to get their arms around the FHA’s quality assurance plan announced in March. The FHA has said its “blueprint” for evaluating underwriting defects should reduce lenders’ fears of having to indemnify the agency for losses on loans to riskier borrowers.
Banks can be held liable for treble damages under the False Claims Act if they are found to have “falsely certified” that a mortgage met all FHA requirements.
“Doing the work upfront before you submit a file to us is actually safer for you,” Shaffer advised. “You will reduce the possibility of getting caught in a False Claims Act [lawsuit].”
FHA’s share of mortgage originations has fallen dramatically in the past year. Still, FHA officials have stressed that the agency will not roll back its 1.35% annual mortgage insurance premium1 or its 1.75% upfront premium. Though such a change would make loans more affordable, the FHA had to raise premiums to strengthen its insurance fund, which must maintain a 2% surplus.
“We did increase the fees and we think we did it responsibly,” Vetrano said.
He said he is far more concerned that the share of FHA borrowers with credit scores between 640 and 680 “is half the size of what it used to be.” Lenders have essentially retreated from lending to that segment of the market, resulting in “the loss of a borrower class over the last 10 years,” he said.
Since 2013, the FHA has intentionally pulled back from insuring loans to borrowers with strong credit scores. It has largely ceded market share to Fannie Mae and Freddie Mac to borrowers with FICO scores of 680 or more.
On Tuesday, FHA’s outgoing Commissioner Carol Galante said at a housing conference in Raleigh, N.C. that market share is an irrelevant metric for the FHA. The agency should be pricing for risk while meeting demand, she said.
The FHA should “not sit on the sidelines when there are qualified borrowers who are not being served,” Galante said.
As recently as 2011, 65% of FHA’s volume went to borrowers with FICO scores above 680. Those higher credit scores were something of a departure from the FHA’s mission and its history.
In 2007, at the beginning of the financial crisis, 55% of FHA-insured loans went to borrowers with FICO scores below 640. Moreover, 30% of those loans were to borrowers with scores below 580, which ultimately hit the agency with a massive wave of defaults.
“That was way too far on the risk spectrum,” Vetrano admitted. “We’re shooting for a happy medium between those two.”
The FHA now expects 25% of the loans it insures will be to borrowers with FICO scores of 640 or below. Another 50% will go to those in the middle ground of 640 to 680. The remaining 25% will be to those borrowers with scores above 680.
Efforts have been underway to get lenders to remove so-called credit overlays – FICO score requirements of 680 or more that are used to screen out borrowers with a higher probability of default.
Some lenders have lowered credit score requirements this year, largely to drum up business. Many others haven’t budged from imposing credit overlays out of fear they will ultimately be forced to eat losses for any FHA loans that default.