HUD finally clarified its indemnification policies to give its largest FHA lenders a better understanding of when they might be on the hook for home mortgages losses. The Department of Housing and Urban Development generally requires lenders to reimburse the FHA for losses on defaulted loans when the agency can prove poor underwriting or fraud. Housing commissioner David Stevens said he wants to provide clearer guidance for FHA mortgage loan companies with “delegated lender insurance authority” by establishing new standards for “serious and material violations” that trigger indemnification.
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FHA lenders with lender insurance authority can self-insure FHA loans. They account for roughly 70% of FHA home loan originations and amass loans through correspondent purchases from mortgage bankers. In drafting the new policy, HUD did not change its “incontestability clause,” which exempts servicers from liability for errors made by the originator.
FHA consultant Brian Chappelle of Potomac Partners called this development “good news” for the industry. “Unlike Fannie Mae and Freddie Mac, the FHA will not hold the servicer accountable for origination errors.”
If the servicer were accountable, “it would have stopped FHA mortgage lending in its tracks,” Chappelle said. HUD has issued the new indemnification policies as a proposed rule. The comment period ends December 7th. “We need to clarify which circumstances we’ll require indemnification and the level of loan performance we expect lenders to maintain,” Stevens said.
Under the proposal, HUD will seek indemnification for “serious and material violations” of FHA origination requirements in cases where the loan never should have been endorsed by the lender or insured by the FHA.
The proposal requires lenders to analyze the borrower’s creditworthiness, and verify sources of income, assets and down-payment. Funders must also comply with FHA’s appraisal requirements, and address problems with the condition of the property. “It is a reasonable standard,” Chappelle said. If the FHA lender fails to verify the borrower’s income, HUD might seek indemnifications irrespective of the whether the violation caused the mortgage to default.
The proposed rule also sets a benchmark for lender performance in terms of default and claim rates. FHA lenders in the lender insurance program must maintain a claim and default rate that is at, or below, 150% of the national average. The national average for FHA claims and defaults on mortgages 24 months old was 3.66% at June 30.
The proposed rule is aimed specifically at lenders, which make up only 29% of all FHA-approved lenders. HUD claims it does not have explicit authority to require indemnification for bad loans from other FHA-approved lenders. “The FHA is asking that Congress grant explicit authority to require indemnification for loans that were improperly originated for the remaining 71% of approved FHA lenders,” Stevens recently told the Senate Banking Committee. The commissioner said the Obama administration supports an FHA reform bill, sponsored by Democratic Sens. Mark Begich, Sherrod Brown and Michael Bennet that extends FHA indemnification powers over all approved lenders. It is unclear when Congress will act on this legislation. The article was written by Brian Collins.
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