Carol Galante has a challenge: Spur lenders to take more care when originating Federal Housing Administration loans, without scaring them away or causing them to hike pricing to cover the additional risk.
When lenders first heard in early March about the FHA's initiative to revamp its approach to evaluating loan quality, it stirred a lot of apprehension. Quality control can result in penalties when loans don't meet the agency's standards, and lenders are naturally wary of any changes. Some industry participants fear the new loan review process might penalize them for petty technicalities.
At the same time, Galante, the FHA commissioner, wants lenders to be more confident in originating FHA-insured loans so they can serve more borrowers especially those with low credit scores. So she and other FHA officials have been meeting with industry groups and lenders to get their input and feedback on the quality assurance plan.
The FHA wants to make sure "lenders have confidence in how we are monitoring their performance," Galante says, noting that the new approach will be rolled out in stages.
"It is not something we can do in 30 days," she says. "I am hoping in the next 30 to 45 days to be able to put out a clearer schedule with some specifics."
So far, the outreach appears to have had a calming effect. The Mortgage Bankers Association is on board with FHA's goal of coming up with a new quality assurance program. "We are very much in favor of it," says Tamara King, MBA associate vice president of loan production.
However, she says, "we strongly encourage FHA to continue to work with industry first before making anything final." The MBA also wants the FHA to clarify what a loan defect is. "We should all be on the same page as to what constitutes a loan defect," King says. "And what defects rise to the occasion of indemnification" where lenders have to reimburse FHA for any losses.
The buzz is that FHA will establish four categories of errors but lenders will be liable only for the most serious underwriting errors. FHA is considering several approaches and nothing has been finalized yet, according to another FHA official, who spoke on condition of anonymity.
It will be important for everyone to agree on what underwriting mistakes deserve a significant penalty, says Brian Chappelle, a mortgage industry consultant and former FHA official. "Spelling out what is a risky loan and what are the criteria, I think that would be a good first step."
Galante says she is encouraged that more lenders are starting to lower their minimum credit score requirements. But there are millions of people with credit scores between 680 and 580 who are not being served by FHA lenders, she says. (The average FHA credit score was 685 in the fourth quarter.)
"We think one of the major issues in the market right now is that lenders have not been lending to FHA's full market spectrum," Galante says.
The overall availability of mortgage credit is being constrained, she notes. Meanwhile, interest rates and inventory of available homes for sale are "conspiring to keep purchase market somewhat depressed."
FHA officials are hoping its manual underwriting guidelines that go into effect April 21 will expand the spectrum of borrowers who get loans.
Most FHA lenders rely on Total Scorecard (FHA's automated underwriting system) to approve loans. The agency has adjusted Total Scorecard so all borrower applications with credit scores below 620 and debt-to-income ratios above 43% are referred for manual underwriting.
So far, it is unclear how many lenders will embrace this new manual underwriting approach, since lenders still have the same loan indemnification issues to deal with.
Galante says she believes FHA has provided sufficient guidance in terms of financial reserves and compensating factors to approve borrowers via manual underwriting.
"It goes back to the lender having the right guidance in terms of their comfort level in approving a FHA borrower," she says. "They will understand how we are going to judge them in terms of what underwriting they did."