Friday, May 14, 2010

FHA Busts Red Tape, More Lender Responsibility

Obama's Federal Housing Administration cut red tape, and eliminated one of the least useful and most arduous processes for small businesses who wish to do business with the Federal Government. The direct link to FHA's final rule

Mortgage Insurer Turns to Lenders to Police Brokers by Nick Timiraos
excerpts from story published in the Wall Street Journal on May 8th, 2010

The Federal Housing Administration, the government agency that insures a bigger and bigger portion of home loans, plans to rely more heavily on lenders to police mortgage brokers.

The changes will put more of the onus on lenders to make sure there is no fraud or faulty underwriting in the loans they fund, and less on the FHA. The lenders could be held liable for losses if a loan insured by the FHA goes bad and there are signs of fraud or mistakes in the underwriting.

...the number of brokers approved to arrange FHA-backed loans swelled to 9,043 at the end of 2009, from 5,759 two years earlier. The FHA has required mortgage brokers to submit an annual audit to the agency and to maintain a $63,000 net worth. It also tracks the performance of brokers' loans.

...Under changes set to take effect May 20, the FHA will stop certifying mortgage brokers or tracking the individual performance of loans that they originate. Instead, it will require lenders to sponsor brokers and to assume responsibility for those loans, including losses from fraud or poorly underwritten loans, such as those in which the income stated on a loan application doesn't match accompanying financial documents.

Mortgage brokers have borne the brunt of blame for bad loans made during the housing bubble, and lenders have become more wary of dealing with them as a result.

The National Association of Mortgage Brokers generally supports the FHA's changes. Grant Stern, president of Miami brokerage Morningside Mortgage Corp., said they represented a "huge cut in red tape" that should produce better rates for consumers.

Why? Why would this produce a consumer benefit?

Mortgage lenders do not disclose to consumers the payments they receive for originating and then selling loans (service release premium" and yield spread premium) to GNMA, the secondary market maker for FHA insured loans. However, most investors reasonably know before closing what those premiums will be through the Rate Lock process - and many banks offer Rate Lock guarantees to their customers. The prior reasoning for non-disclosure is that banks couldn't know for certain how much they would earn upon sale - implying some rate risk. Some lenders do in fact have rate risk, but no loan correspondents would have rate risk.

Ginnie Mae (GNMA) performs the Mortgage Backed Security sales function of Fannie/Freddie but doesn't issue underwriting guidelines or portfolio loans. (a possible future model for the GSEs I would add)

Mortgage brokers must disclose to consumers any yield spread premiums earned - and have for some time - that are earned from lenders as a result of raising the loan's interest rate to obtain a bank payment.

FHA Loan Correspondents under the mini-eagle program acted like mortgage brokers, but probably table funded (the lender makes the loan with the lender's and immediately assigns the loan to the lender over the table) most of their loans, to gain the ablility to hide their Yield Spread premiums and so be noted as the lender of record on the mortgage itself and avoid disclosure.

Yield spread premiums are significantly higher for FHA insured loans, nearly 100 bps above agency premiums - which indicates that the market IS paying Originators a premium for insured loans. If you take a look at the Agency vs. FHA "loan level price adjustments", you'd see that the GSEs are paying substantially less to buy loans than FHA investors, which translates into higher payouts to originators for lower rates with FHA. Yet, FHA average rates are far higher than the Freddy Mac Weekly rate survey.

To give a couple of simple scenarios:

a) A First time homebuyer (FTHB) with a 680 credit score putting down 3.5% with a $100,000 FHA insured loan at 5.5% rate would give an originator's YSP of 4% or $4000 for originating the loan. Imagining that you have the same FTHB in a market with Private Mortgage Insurance available (let's imagine we're in Texas) and the borrower is getting a 95% LTV Fannie Mae loan: $2438

b) A First time homebuyer with a 680 credit score putting down 20% with a $100,000 FHA insured loan at 5.5% rate would give an originator's YSP of 4% or $4000 for originating the loan. Imagining that you have the same FTHB and the borrower is getting a 80% LTV Fannie Mae loan: $3188

The FHA loan carries an Up Front Financed Mortgage Insurance Premium of 2.25% currently (up from 1.75%) which the PMI loan lacks, but still, you can see why the interest rates on FHA loans have been higher, banks simply make more money writing them higher. If you don't have to tell anyone how much money you're making, and everyone is charging higher rates - then you charge the higher rate to make more money, regardless of the best interests of the consumer.
The GSE loans have so much more competition that banks and lenders simply can't act that way, since they'll lose market share to lower interest rate providers. There's a lot of premium built into the FHA loans that is being earned by FHA approved loan correspondents and not disclosed to consumers. Allowing more outlets to market these loans and outlets that have stronger consumer disclosures of the origination premiums should lower rates.

It's an important story in the housing finance markets that FHA rates could trend sideways or lower as mortgage rates rise due to this important procedural change. The FHA is really pushing for a more efficient market for its loans and reducing red tape! I'd say this is news considering that public perception might be strangely the opposite.

Postlude: To my loyal readers, I offer an apology for leaving a large gap in recent posts, but with the coming of the Summer, arrives the coming of a great many new posts to this blog.

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