Will Setting Clear Rules Help Expand Credit?

When lenders originate a loan, they often sell these loans to investors rather than holding the loans in their portfolios.  These investors set requirements for the loans they will buy and if those requirements are not met, they may force the lender to buy back the loan.  In a similar way, the FHA sets rules for the loans that it insures.  If a lender originates a loan to be insured by the Federal Housing Administration (FHA), but the loan is later found not to comply with the rules, the FHA may ask the lender to indemnify the FHA.  In short, the FHA will not insure the loan and any losses must be covered by the lender.

Since the housing market bottomed, the FHA has increased indemnification requests, while the Department of Justice (DOJ) has sued some lenders for problem loans.  Originators have asserted that fear of indemnifications and DOJ actions have hampered lending to borrowers with lower credit scores and other non-prime factors.

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More than half of respondents to the 1st quarter Survey of Mortgage Originators indicated that they have been asked to indemnify the FHA for improperly originated loans since 2009 and 40% indicated that this occurred multiple times.  A significant 46.7% of respondents indicated that they were never the subject of an indemnification request.

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Despite only half of originators having had an indemnification request, two thirds indicated that they had restricted lending to borrowers with FICO scores less than 640 due to the FHA’s policy.

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Relative to the risk of Fannie Mae or Freddie Mac requesting them to repurchase a loan, 60% of respondents indicated that FHA indemnification was of equal concern while, 20% indicated that it was of greater concern.  However, 6.7% of respondents reported that indemnifications were significantly less of a concern than repurchase risk.

Lenders have been faced with several new regulations in recent years combined with changes and perceived changes in oversight.  Fannie Mae and Freddie Mac made important changes to their representation and warranties framework at the beginning of the year to clarify and to ease the rules of the road for lenders.  The FHA proposed new indemnification rules just a few weeks ago that will hopefully help to clarify indemnification risk for originators.  Clarification will help, but lenders may still wait to see how the DOJ behaves in the future.

Ken Fears, Director, Regional Economics and Housing Finance

Ken Fears is the Manager of Regional Economics and Housing Finance Policy. He focuses on regional and local market trends found in the Local Market Reports and the Market Watch Reports . He also writes on developments in the mortgage industry and foreclosures.

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