The cost to originate a home loan is skyrocketing as lenders try to comply with stricter rules to catch problem loans, and some community banks and independent mortgage lenders are now facing a stark choice: invest in technology that would help automate the loan process or exit mortgage lending entirely.
Origination costs are expected to rise 11% this year from a year ago, to nearly $5,900 per loan, as lenders scramble to meet tough new requirements from the Consumer Financial Protection Bureau, the Federal Housing Administration and Fannie Mae and Freddie Mac that take effect in January. That's on top of costs lenders have already incurred in recent years as they have added staff to better ensure the accuracy of loan files. In 2007, the average cost of originating a loan was about $3,700.
Large banks can justify investments in technology and can hire more staff because they spread the costs across more loans. But small banks with fewer than 100 employees may only have a handful of employees doing the work, which means relying even more on technology, says Sam Vallandingham, senior vice president and chief information officer at the $298 million-asset First State Bank in Barboursville, W.Va.
First State, which originates roughly $300 million a year in home loans and services 6,600 mortgages that have been sold to Freddie Mac, recently hired third-party vendors to evaluate loan files and in August it upgraded its origination software system to one that has built-in checkpoints and controls.
"It's now harder for one individual person to carry a loan from beginning to end with all of these changes," says Vallandingham. "Those days are over if you want to get it right. There are all these checks, adding steps to the process, so we're lengthening the time it takes to close a loan because we've added more steps."
"Lenders are beginning to realize that more technology or better technology is a key part of the way forward," adds Garth Graham, a director at mortgage consulting firm Stratmor Group. "Now, we have checkers checking the checkers... because the agencies are ratcheting up requirements to be more accurate and more perfect."
Vallandingham has documented 921 compliance changes from various agencies since the housing market crashed in 2008. Particularly challenging for small lenders are new requirements from Fannie and Freddie that require lenders to deliver loans with as few defects as possible.
The government-sponsored enterprises are now electronically validating 100% of the loans they purchase as part of a broader initiative to improve loan quality. The Federal Housing Administration has proposed similar changes and may set a maximum threshold for the percent of loans it will allow to have defects.
"Survival is dependent on improving quality control standards otherwise they won't be able to compete or to sell loans that the GSEs will be willing to buy," says Craig Focardi, CEB TowerGroup's senior research director.
Focardi estimates that $11 billion in additional costs have been added in the past six years simply to process individual loan files. A good portion of those costs are devoted to the manual or semi-automated checking of loan files.
Anthony Hsieh, CEO of loandepot, a Plano, Texas, mortgage lender, says he believes many small lenders cannot justify the cost of investing in technology and, as a result, many are looking for an exit strategy.
"Between technology costs and labor costs... the industry will see massive consolidation," he says. "Smaller players don't have the infrastructure to invest, they don't have a chief risk officer or chief compliance officer so if you have a lighter balance sheet, it's more problematic."
Those that remain in the business have to be extra-vigilant about originating quality loans that pose little risk to Fannie, Freddie, the FHA and investors, Hsieh adds.
"Compliance is the top area that keeps me awake at night," he says. "Everybody is extremely nervous because if you don't dot your i's and cross your t's in compliance, you're going to get a lot of repurchases and will be out of business. Everything in a loan file has to follow the letter of the law."
Annemaria Allen, president and CEO of The Compliance Group in Carlsbad, Calif., says most lenders currently have a 15% loan defect rate, meaning a high percentage of loans have underwriting or collateral problems that could result in a buyback, resulting in losses for lenders. Lenders are being told to whittle their defect rates to 3% to 5%.
"Many lenders don't want to invest in the labor and technology that it takes for [quality control] and compliance," says Allen, noting that such requirements have never really been enforced to the degree that they are now. "You have to be able to slice the data and we know that business units are screaming about this. But if you're going to sell to Fannie and Freddie and you do a [lousy] job ... they will be in your house non-stop and make sure you have the processes in place and embrace quality.
Upgrading or replacing loan origination software is expensive and can take from nine months to a year. CEB Tower's Focardi says lenders that are hesitant to invest in new technology may want to consider switching from licensed software to a cloud-based model, Focardi says. "Mortgage lenders are in the business of lending, not technology, and if compliance is king and no defects is the new standard, lenders should focus on their core mortgage expertise, not try to create the perfect mortgage lending mousetrap," he says.
No matter what technology they choose, newer systems allow for better reporting, collection and storage of loan data, so lenders can identify loan defects and change their processes when problem loans occur, Focardi adds.
Still, Vallandingham at First State Bank says he spends so much of his time on compliance that many days he doesn't even feel like a banker anymore.
"Every hour I spend on compliance is an hour I could be spending with customers and potential customers, acquiring new deposits and making new loans," he says.