Respa Rule Has Lenders Balking on Preapprovals

The new mortgage disclosure rule is upending the first step in the process of lending to homebuyers.

Before shopping for a property, a prospective buyer typically gets a preapproval letter from a lender indicating how big a loan the person qualifies for. Real estate agents often ask for these letters so they can make sure the customer can afford the property before showing it.

Before writing the letters, lenders like to see proof of income, such as a pay stub or tax return. But under the Real Estate Settlement Procedures Act rule that took effect Jan. 1, lenders may not require such documents before giving the borrower a good-faith estimate of closing costs.

Since lenders are now being held to those estimates, they want to hold off on issuing them as long as possible. So some lenders are reconsidering or backing away from preapprovals. Without them lenders could end up wasting time on loan applications that fall out.

"If you don't have preapproval letters, then Realtors are going to have to show people houses whether they can afford them or not," said David Dickinson, president of Bankers Compliance Consulting Inc. in Central City, Neb.

Vicki Bott, the deputy assistant secretary for single family housing at the Department of Housing and Urban Development, said in an interview Tuesday that lenders are not barred from accepting documents, only from requiring them prior to issuing a GFE.

"If a consumer wants to receive a preapproval they can choose to have their information verified," she said, and HUD will clarify this in future updates to its "frequently asked questions" about the Respa rule.

HUD designed the rule to prevent lowballing on fees for services required to get a mortgage, such as appraisals and title insurance. The rule forbids lenders from increasing some charges at the closing table from the numbers in the good-faith estimate and limits them to a 10% increase on other charges. If charges rise more than allowed, the lender must eat the difference.

"Originators are fearful of being bound to fees which are sure to change," said Kevin Marconi, the chief operating officer of United Fidelity Funding, a wholesale and retail lender in Kansas City, Mo.

A lender can run into trouble if it issues "a binding good-faith estimate with a list of charges on an unknown property," he said.

This explains lenders' reluctance to issue good-faith estimates any earlier than is necessary.

HUD, in an update last month to the frequently asked questions, said it wants to prevent "overburdensome documentation demands on mortgage applicants." That is why it won't let lenders require documents from borrowers as a condition of providing a good-faith estimate. Likewise, HUD said, lenders may not charge consumers anything more than the cost of a credit report before supplying the good-faith estimate.

Chris Thomas, owner of Mortgage Support Services, a Westminster, Colo., correspondent lender, said he understood HUD's rationale.

"The spirit of the law is to prevent borrowers from being locked in to using unscrupulous lenders who demand original copies of income and asset documentation," Thomas said.

"If I tell a borrower that I need their original W-2's and pay stubs before I can give them a good-faith estimate, the less-educated borrower will then believe they must buy their loan from me."

Thomas also pointed out that it is possible to give the borrower a preapproval letter without seeing a proof of income, and therefore without triggering the requirement to issue a good-faith estimate under Respa.

"We cannot force the borrower to provide documentation before issuing a good-faith estimate," he said, "but it doesn't say we can't ask them for their income, assets or anything else" and then run that information through underwriting software. (A person is considered to be "preapproved" if the lender runs a borrower's information through Fannie Mae's or Freddie Mac's automated underwriting system.)

Moreover, Thomas said, if it turns out the customer misstated their income, that is considered a "changed circumstance" and the lender is allowed to change the good-faith estimate once it gets documentation.

Preapprovals are not to be confused with prequalification letters. These are nonbinding, back-of-the-envelope calculations of what a borrower might be approved for based on verbal information, and they have fallen out of favor because of market changes.

During the housing bubble, Thomas said, lenders got into the habit of giving out pre-qualification letters to anyone, "because everything got approved anyway."

"A preapproval letter means something, because you have to put in accurate information," he said. "A 'pre-qual' letter is almost useless these days, because the underwriting guidelines change so frequently."

Often a preapproval letter is included with a purchase offer that is given to the listing agent assuring the property's seller that the borrower is indeed able to buy the house.

HUD also said in its last update to the frequently asked questions that the Respa rule does not bar a lender from "using its own sources" to independently verify information provided by potential borrowers before issuing them a good-faith estimate.

Nevertheless, Larry Aronson, a senior vice president at Homeowners First Financial Corp., a mortgage bank in Atlanta, said some lenders that buy his loans are objecting to any form of preapproval letter "since they can't review a borrower's documents and do not want to provide the good-faith estimate before an actual application has been filed."

Once the borrower has provided a lender with the six pieces of information that HUD says constitutes a loan application and automatically triggers a good-faith estimate, Aronson said, they will issue the preapproval letter. (The six pieces of information are: name, Social Security number, monthly income, property address, estimate of the property's value and the proposed loan amount.)

Dickinson said a handful of banks have stopped issuing preapproval letters because of the risk, albeit slim, that the property a borrower ultimately chooses is "nonconforming," meaning it falls outside local zoning requirements and cannot be sold in the secondary market.

Last week HUD held a workshop with more than a dozen mortgage lenders to answer questions about the Respa rule.

Though HUD has offered a reprieve from enforcement actions for Respa violations in the first four months of this year, lenders still must make an honest effort to implement the new rule.

A HUD spokesman said that lenders adhering to the "spirit of the law" are those that are issuing good-faith estimates.

"Not using the form tells us a lot," the spokesman said.

Some mortgage lenders and brokers are avoiding issuing good-faith estimates to borrowers. Instead they are using nonstandardized good-faith estimate forms from last year, calling them "worksheets," and giving them to potential borrowers as informal loan offers.

HUD said emphatically this is not considered an honest attempt to implement Respa.