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FHA requires lenders to sign an annual and individual loan certification that basically states the lender originates loans for FHA insurance in compliance with all related FHA rules and requirements.
If the lender is found to have violated these rules, the lender may be fined and prohibited from further participation in the FHA lending program. In some cases, the lender may also be prosecuted by the Department of Justice under the False Claims Act.
These certifications are causing much consternation among lenders, especially in light of what happened to them after the recent housing crash in 2008. FHA, and the Agencies, carefully reviewed every problem loan trying to find some reason to require an indemnification, reimbursement for losses sustained, or flat out repurchase. This left lenders with a bad taste in their mouth when it comes to making lending certifications, reps, and warrants.
Even though a small data error may have nothing whatsoever to do with the reason for the loan’s non-performance, the fear is that the error or a mere mistake may expose the lender to a huge loss in the event of a loan or multiple loan defaults. Lenders have seen this movie and do not like the ending.
Ah, the old rule of the unintended consequences. As a direct result of these FHA Certs, the nation’s leading home lender, Wells Fargo, is increasing the minimum required credit score for FHA loans, both retail and wholesale, to 640. (Wells) It is projected by some consumer groups that this action will cut about 15% of potential FHA homebuyers out of the market. It’s hard to tell how that might affect home sales and the housing recovery, but it don’t sound so good to me.
I understand the move by Wells. They want to reduce their risk. One way to do this is to stop doing loans altogether. Okay, this is not a viable option for any mortgage lender.
That is why lenders, regardless of certs, reps, warrants and the use of overlays, need to develop systems and processes, supported by technology, to careful monitor loan quality throughout the lending and servicing life cycle. Loans must be monitored and reviewed to identify the defects that could cause problems if a loan defaults. This is when there is the biggest exposure.
The key is to identify the loans being made with the highest potential for default. Wells raised their credit scores to eliminate the origination or purchase of loans they found to have a higher potential for default; FHA loans with credit scores below 640. They could have continued to accept these loans and put in place the process to carefully review them prior to closing to ensure that all I’s are dotted and T’s crossed. That way if they did default, there would be less of a chance of a cause for action by FHA or DOJ.
There are 2 ways a lender can minimize risk: 1) restrict the loans they originate or 2) manufacture quality loans at every level. Okay, maybe a combination of the two. It’s up to each lender, but “a lender gotta lend” and in doing so, take some risk. So, make sure you check and double check any loans you make to protect yourself against actions down the road.
With Wells raising their credit score requirements on FHA loans comes an opportunity for other lenders to step in and do more FHA business. With that comes some increased risk. You can shy away from these loans, or you can train staff and implement systems to monitor these loans, to eliminate defects, improve quality and reduce the risks. Your call.
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