With the homebuyer tax credit ending at the end of this month, and the summer home buying season kicking off, many home buyers are looking to take advantage of lower housing prices and historically low interest rates. But many unsuspecting borrowers are going to get caught in new, even stricter underwriting guidelines being implemented by Fannie Mae starting June 1.
According to Fannie Mae's FAQ's posted on May 28,2010, the new Loan Quality Initiative is necessary because "in recent months we have seen a large portion of Fannie Mae's postpurchase file reviews with material differences between the loan data delivered to us and the actual facts of the loan (differences caused by data mismatch, calculation errors or other inaccuracies)."
Of course, in reality Fannie Mae is still dealing with losses from 2005, 2006 and 2007, and both Fannie Mae and Freddie Mac are bleeding red ink. As of May 25, 2010, Fannie and Freddie had received $145 billion in aid from the U.S. Treasury, and Edward De Marco, acting director of the Federal Housing Finance Agency, gave a report to Congress that more funds are needed in order to shore up the entities.
To prevent additional losses, Fannie Mae seems to be now placing the emphasis on guaranteeing fewer loans. The Loan Quality Initiative is a new overlay of scrutiny being applied to Fannie Mae loans to verify that no new debt has been acquired from the time of application to the time of the closing.
Back when I started in lending 12 years ago, discrepancies between the broker's credit report and the lender's credit report used to be a major source of problems. The broker would pull a trimerge credit report (one that accesses three credit reporting agencies) and think everything was fine, and then the lender would pull their own report which often looked quite different, and the entire loan would change. But with the advent of automated underwriting systems, the broker could pull a report, upload it to the automated system, and the credit report was valid for up to 90 days (at one time it was 120 days) so that no new pulls were necessary and everybody knew what credit score was being used for qualification.
Unfortunately, now we are regressing back to the old days of two credit reports. According to the Fannie Mae FAQ's, "The lender is responsible for implementing practices to identify undisclosed liabilities in a transaction. It is the lender's responsibility to develop and implement its own business processes to support compliance with Fannie Mae's requirements on loans delivered to us. Although many lenders already have such processes in place, Fannie Mae provides lender tips on efanniemae.com for compliance." Fannie Mae's suggestions for compliance with the loan quality initiative include the following:
1. Pulling a new credit report just before closing and reviewing the report for additional trade lines and new inquiries. (Fannie Mae states in a footnote that credit reports are still good for 90 days and that pulling a credit report just before closing does not let the lender off the hook for any additional debt incurred up to closing.) However, if the lender chooses to pull a new credit report, they must qualify the buyer with any new debt that appears on the report.
2. Utilizing new vendor services for borrower credit report monitoring from the time of loan application to closing to alert the lender if any new inquiries have occurred. For example, if Ted and Jane go out over the weekend to Furniture Mart to look at bedroom suites for their new home, and they allow Furniture Mart to do a credit check, the lender is going to need to know about it, and the inquiry will trigger a request for more information.
3. Direct creditor verification. If Ted and Jane get that credit check at Furniture Mart, the lender needs to verify with Furniture Mart directly that no additional credit has been opened. If the lender finds out that they actually purchased the bedroom suite over the weekend, then Ted and Jane now need to qualify with the new payment.
4. Running a report to verify that the borrower has not taken out another mortgage simultaneously. This would normally be an issue only with an investor who is purchasing multiple properties. When he closes the mortgage on one of the properties, it would trigger an alert.
The new system of verifications is going to give a whole new meaning to the phrase "buyer beware." In the new world of tightened credit guidelines, Fannie Mae typically does not allow debt to income ratios of over 45%, although ratios of up to 50% can be acceptable with enough reserves. For loans with mortgage insurance or second liens, debt to income ratios typically cannot exceed 41%. Since reserve requirements can vary depending on the product--for example, a person who already owns a home which is going to become a rental needs six months of principal, interest, taxes and insurance to cover the payments on the previous home and the new home, and since retirement accounts can no longer be used for reserves unless they have been liquidated, cash in the bank is more important than ever. For this reason, if the borrower who is having to wait 60 days for his loan approval has to take the car to the mechanic to get the brakes fixed, he would probably charge that work to his credit card after being warned by his loan originator not to spend any cash. But now, that brake job may still cost him the loan for his house, because it might raise his minimum monthly payment just enough to keep him from qualifying. (I have seen loans where ratios really are that tight.)
And even if the new debt is not sufficient to derail the loan, inquiries and higher balances on credit reports can lower credit scores. Since 30 year fixed interest rates are now based on credit scores, lowering a score one point could raise the interest rate .5%. Interest rates are based on 20 point credit score intervals, so a credit score of 660-680 has a higher interest rate than a credit score of 680-700. If the borrower has a 681 score at the time of the initial application, and he is locked in at a 4.99% rate, but then the final credit score in the second report is 679, his rate could go up to 5.25%. (And the higher monthly payment on the mortgage could keep him from qualifying.)
Buyers need to be counseled carefully at the time of application and at the time of contract to not use their credit cards at all, and to not apply for any new credit, no matter how tempting the offer. With new strict guidelines governing nearly every aspect of the mortgage loan process, the underwriting and closing turn times are longer than in the past. The new guidelines from Fannie Mae mean that at the very least, a final credit check can trigger a file going back to underwriting which can delay the process another week and result in a ready to close file being declined at the eleventh hour, or the borrower closing on a final loan which has less favorable terms than the one for which they were initally approved. And, in an era of supposedly protecting the consumer, that is the real irony of all of the new changes.
How Will Financial Reform Affect the Future of HVCC?
As the two financial reform bills (HR 4173 and SB 3217) go to conference committee this week, one of the major questions on the minds of those in various aspects of the real estate industry is how the bills will ultimately affect the future of the HVCC (Home Valuation Code of Conduct).
The Home Valuation Code of Conduct was the outgrowth of a settlement between New York attorney general Andrew Cuomo and Fannie Mae and Freddie Mac. Cuomo agreed to drop an investigation against the two mortgage giants if they would agree to accept the code. HVCC went into effect of May of 2009 and has presented a number of challenges for the industry ever since.
HVCC was supposed to guarantee appraisal independence by banning mortgage loan originators from ordering appraisals, choosing appraisers, or speaking to appraisers directly. Retail banks can have a separate department that is not compensated based on loan volume order the appraisals, but the code expressly states that no mortgage broker or employee of a mortgage broker can order an appraisal.
In order to ensure compliance with the code, the appraisal-ordering process was turned over to appraisal management companies who take down the order, charge the loan originator for the appraisal, select the appraiser, handle all interaction with the appraiser, and send the completed report back to the loan originator.
The problems arose as AMCs hired out of area appraisers who did not understand the real estate market, undervalued houses, and refused to acknowledge errors or look at different comps. The costs also rose for the consumer (in some cases dramatically) since the AMC added its fees for managing the process to the fees of the appraiser who was actually doing all of the work.
Both mortgage brokers and many appraisers have opposed the provisions of the code, and widespread industry opposition has led to lobbying efforts to include a "fix" in the financial reform bill. In fact, the house bill, HR 4173, section 4312, specifically deals with the Home Valuation Code of Conduct and appraisal independence issues. Under the provisions of the house bill a negotiated rulemaking committee would be set up to review and set in place new standards for appraisal independence. The Negotiated Rulemaking Committee: "shall not prohibit lenders, the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) from accepting any appraisal report completed by an appraiser selected, retained or compensated in any manner by a mortgage loan originator" (provided that the originator is properly licensed under the SAFE ACT). The bill also mandates appraisal independence, sets clear guidelines for maintaining the autonomy of appraisers and seeks to enforce, "state or federal laws that make it unlawful for a mortgage originator to make any payment, threat or promise, directly or indirectly, to any appraiser of a property, for the purposes of influencing the independent judgment of the appraiser with respect to the value of the property, except that nothing in this section shall prohibit a person with an interest in a real estate transaction from asking an appraiser to consider additional appropriate property information; provide further detail, substantiation or explanation for the appraiser's value conclusion, or correct errors in the appraisal report." The bill also covers appraiser compensation, which has become a huge issue since HVCC was enacted. Once appraisals on loans which were sold to Fannie Mae and Freddie Mac had to be ordered through third party AMCs, the AMCs could dictate how much money appraisers were paid. HR 4173 does address this issue, and states that "lenders and their agents [must] compensate appraisers at a rate that is customary and reasonable for appraisal services performed in the market area."
Effective on the date that the new rules are introduced, the problematic Home Valuation Code of Conduct will no longer remain in effect.
While the House bill spells out this section very clearly, the Senate bill ignores HVCC and appraisal independence totally, so it will be up to the conference committee to see whether the final bill includes the verbage from section 4173 or whether the current Home Valuation Code of Conduct is allowed to stand. But regardless of what happens in conference for the final bill, HVCC's days are probably numbered. The reason? HVCC is not federal law--it was a legal agreement among Fannie Mae, Freddie Mac and the attorney general of New York. Loans that are not sold to Fannie Mae and Freddie Mac are not governed by the agreement, although most lenders do require the use of AMCs on all loans now. And the Senate Bill does call for a study of exit strategies for Fannie Mae and Freddie Mac to be completed no later than January of 2011. Barney Frank and Tim Geithner have both stated that a whole new system of housing finance needs to be introduced. That new agency, whatever it turns out to be, will not be bound by HVCC; it will be subject to whatever laws and guidelines are set in place by its creators. So for everyone who is hoping for an end to all of the problems caused by HVCC, help appears to be on the way--one way or another.
The Home Valuation Code of Conduct was the outgrowth of a settlement between New York attorney general Andrew Cuomo and Fannie Mae and Freddie Mac. Cuomo agreed to drop an investigation against the two mortgage giants if they would agree to accept the code. HVCC went into effect of May of 2009 and has presented a number of challenges for the industry ever since.
HVCC was supposed to guarantee appraisal independence by banning mortgage loan originators from ordering appraisals, choosing appraisers, or speaking to appraisers directly. Retail banks can have a separate department that is not compensated based on loan volume order the appraisals, but the code expressly states that no mortgage broker or employee of a mortgage broker can order an appraisal.
In order to ensure compliance with the code, the appraisal-ordering process was turned over to appraisal management companies who take down the order, charge the loan originator for the appraisal, select the appraiser, handle all interaction with the appraiser, and send the completed report back to the loan originator.
The problems arose as AMCs hired out of area appraisers who did not understand the real estate market, undervalued houses, and refused to acknowledge errors or look at different comps. The costs also rose for the consumer (in some cases dramatically) since the AMC added its fees for managing the process to the fees of the appraiser who was actually doing all of the work.
Both mortgage brokers and many appraisers have opposed the provisions of the code, and widespread industry opposition has led to lobbying efforts to include a "fix" in the financial reform bill. In fact, the house bill, HR 4173, section 4312, specifically deals with the Home Valuation Code of Conduct and appraisal independence issues. Under the provisions of the house bill a negotiated rulemaking committee would be set up to review and set in place new standards for appraisal independence. The Negotiated Rulemaking Committee: "shall not prohibit lenders, the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) from accepting any appraisal report completed by an appraiser selected, retained or compensated in any manner by a mortgage loan originator" (provided that the originator is properly licensed under the SAFE ACT). The bill also mandates appraisal independence, sets clear guidelines for maintaining the autonomy of appraisers and seeks to enforce, "state or federal laws that make it unlawful for a mortgage originator to make any payment, threat or promise, directly or indirectly, to any appraiser of a property, for the purposes of influencing the independent judgment of the appraiser with respect to the value of the property, except that nothing in this section shall prohibit a person with an interest in a real estate transaction from asking an appraiser to consider additional appropriate property information; provide further detail, substantiation or explanation for the appraiser's value conclusion, or correct errors in the appraisal report." The bill also covers appraiser compensation, which has become a huge issue since HVCC was enacted. Once appraisals on loans which were sold to Fannie Mae and Freddie Mac had to be ordered through third party AMCs, the AMCs could dictate how much money appraisers were paid. HR 4173 does address this issue, and states that "lenders and their agents [must] compensate appraisers at a rate that is customary and reasonable for appraisal services performed in the market area."
Effective on the date that the new rules are introduced, the problematic Home Valuation Code of Conduct will no longer remain in effect.
While the House bill spells out this section very clearly, the Senate bill ignores HVCC and appraisal independence totally, so it will be up to the conference committee to see whether the final bill includes the verbage from section 4173 or whether the current Home Valuation Code of Conduct is allowed to stand. But regardless of what happens in conference for the final bill, HVCC's days are probably numbered. The reason? HVCC is not federal law--it was a legal agreement among Fannie Mae, Freddie Mac and the attorney general of New York. Loans that are not sold to Fannie Mae and Freddie Mac are not governed by the agreement, although most lenders do require the use of AMCs on all loans now. And the Senate Bill does call for a study of exit strategies for Fannie Mae and Freddie Mac to be completed no later than January of 2011. Barney Frank and Tim Geithner have both stated that a whole new system of housing finance needs to be introduced. That new agency, whatever it turns out to be, will not be bound by HVCC; it will be subject to whatever laws and guidelines are set in place by its creators. So for everyone who is hoping for an end to all of the problems caused by HVCC, help appears to be on the way--one way or another.
Financial Reform and the Future of Fannie Mae and Freddie Mac
What is conspicuously missing from the over 1500 page financial reform bill passed by the Senate last month (SB 3217) or any of its more than 100 pages of amendments, is a clear strategy to exit Fannie Mae and Freddie Mac from their conservatorship and either dissolve or re-privatize these two entities. Traditionally Fannie Mae (The Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) were public/private hybrids which meant that the U.S. government owned a minority interest in the two congressionally chartered, mostly private entities. In September of 2008, the U.S. government took both Fannie Mae and Freddie Mac into conservatorship in response to their huge losses, and since that time tax dollars have provided over $126 billion dollars to keep both entities open. Late last year, the Obama administration promised that it would cover unlimited losses through 2012 for both entities. (The pledged covered losses had been capped at $400 billion dollars prior to this.) Fannie and Freddie own or guarantee about $5.5 trillion dollars worth of U.S. residential mortgages or about 31 million mortgages, and in spite of recent credit and underwriting changes, they remain key players in the housing industry.
Both entities have been blamed in part for the financial meltdown and the problems with the mortgage crisis. Sharp criticism rose early this year when regulators announced that the CEO's of both Fannie Mae and Freddie Mac could be paid as much as $6,000,000 for 2009--a year when they were under conservatorship.
Many lawmakers agree that it is time to stop the bleeding on these two entities, which still provide an estimated 50-70% of mortgage loans in the United States. An amendment was offered to Senate bill 3217 which would have forced lawmakers to begin exiting Fannie and Freddie from conservatorship. This amendment was voted down. The one which passed, proposed by Harry Reid (D. NV) for Chris Dodd (D. CT) and Blanche Lincoln (D AR) calls instead for a Department of Treasury Study on "ending the conservatorship of Fannie Mae, Freddie Mac and Reforming the Housing System." The study is to include such options as "the gradual wind-down and liquidation of such entities; the privatization of such entities; the incorporation of the functions of such entities into a Federal Agency; the dissolution of Fannie Mae and Freddie Mac into smaller companies, or any other measures the Secretary (of the Treasury] deems appropriate." Other matters that this study is to consider include ways to restructure housing finance in the US to ensure that consumers will be able to access "30 year fixed rate prepayable mortgages and other mortgage products that have simple terms that can be easily understood; the role of the Federal Housing Adminstration and the Department of Veterans Affairs in a future housing system; the impact of reforms of the housing finance system on the financing of rental housing; the role of standardization in the housing finance system, and the options for transition to a reformed housing finance system." The study is to be completed no later than January 31, 2011 and it is to be delivered to the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services.
It is interesting that a bill which spends hundreds of pages creating and detailing the role of a new Bureau of Consumer Financial Protection, which has not previously existed, could not find space to do more than call for a study of two entities that are currently bleeding U.S. tax dollars. Although the amendment is laconic in its treatment of Fannie and Freddie, statements made by Treasury Secretary Tim Geithner and Congressman Barney Frank (D MA), who has been a major proponent of financial reform, suggest that actually the government does have plans for Fannie and Freddie--they just aren't telling us what those plans are yet.
For instance, the January 22, 2010 issue of the Wall Street Journal quotes Frank as saying that "The remedy here is...as I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance." In March, Frank went further and was quoted in the Washington Post warning investors that "People who own Fannie and Freddie debt are not in the same legal position as Treasury bonds, and I don't want them to be." According to the article, Frank says that he wants investors to understand that the Fannie and Freddie are not as safe as the U.S. government. The statement was unnerving to market analysts who feared that international investors would shy away from purchasing the debt. But Frank's comments are interesting in light of the current debate over whether the mortgage giants (or their replacements) should be privatized or owned completely by the government. One point on which everyone seems to agree is that a public/private hybrid, which the entities were before conservatorship, does not work. Frank has publicly expressed his dislike of public/private hybrids and Treasury Secretary Tim Geithner echoed his comments via Politico on April 9, 2010 when he called the hybrid concept "unworkable."
But the chances for privatization are not looking good. Former Fannie Mae CEO Daniel Mudd testified before the Financial Crisis Inquiry Commission in April of 2010 regarding the financial collapse of Fannie Mae. During his testimony Mudd was asked whether the government should be involved in the residential mortgage business. Citing the U.S. government's involvement in 90% of mortgage loans, Mudd's response was that "the notion that you could go back to a fully private structure cannot be accomplished within our lifetime." A study by Standard and Poor's released in January reaches a similar conclusion--it would be nearly impossible to attract enough capital to replace Fannie Mae and Freddie Mac with self-sustaining private companies which would offer affordable 30 year fixed rate mortgages.
That just leaves the government. This makes the parameters of the study particularly interesting, especially in light of Barney Frank's comments that we need to abolish Fannie and Freddie and come up with "a whole new system of housing finance."
What would such a system look like? No one is saying. But in a January interview with the Wall Street Journal Tim Geithner said that the process would not begin this year. "It's just a complicated thing to get right... But we are completely supportive and agree completely with the need to take a cold, hard look at what the future of those institutions should be in our country."
Both entities have been blamed in part for the financial meltdown and the problems with the mortgage crisis. Sharp criticism rose early this year when regulators announced that the CEO's of both Fannie Mae and Freddie Mac could be paid as much as $6,000,000 for 2009--a year when they were under conservatorship.
Many lawmakers agree that it is time to stop the bleeding on these two entities, which still provide an estimated 50-70% of mortgage loans in the United States. An amendment was offered to Senate bill 3217 which would have forced lawmakers to begin exiting Fannie and Freddie from conservatorship. This amendment was voted down. The one which passed, proposed by Harry Reid (D. NV) for Chris Dodd (D. CT) and Blanche Lincoln (D AR) calls instead for a Department of Treasury Study on "ending the conservatorship of Fannie Mae, Freddie Mac and Reforming the Housing System." The study is to include such options as "the gradual wind-down and liquidation of such entities; the privatization of such entities; the incorporation of the functions of such entities into a Federal Agency; the dissolution of Fannie Mae and Freddie Mac into smaller companies, or any other measures the Secretary (of the Treasury] deems appropriate." Other matters that this study is to consider include ways to restructure housing finance in the US to ensure that consumers will be able to access "30 year fixed rate prepayable mortgages and other mortgage products that have simple terms that can be easily understood; the role of the Federal Housing Adminstration and the Department of Veterans Affairs in a future housing system; the impact of reforms of the housing finance system on the financing of rental housing; the role of standardization in the housing finance system, and the options for transition to a reformed housing finance system." The study is to be completed no later than January 31, 2011 and it is to be delivered to the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services.
It is interesting that a bill which spends hundreds of pages creating and detailing the role of a new Bureau of Consumer Financial Protection, which has not previously existed, could not find space to do more than call for a study of two entities that are currently bleeding U.S. tax dollars. Although the amendment is laconic in its treatment of Fannie and Freddie, statements made by Treasury Secretary Tim Geithner and Congressman Barney Frank (D MA), who has been a major proponent of financial reform, suggest that actually the government does have plans for Fannie and Freddie--they just aren't telling us what those plans are yet.
For instance, the January 22, 2010 issue of the Wall Street Journal quotes Frank as saying that "The remedy here is...as I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance." In March, Frank went further and was quoted in the Washington Post warning investors that "People who own Fannie and Freddie debt are not in the same legal position as Treasury bonds, and I don't want them to be." According to the article, Frank says that he wants investors to understand that the Fannie and Freddie are not as safe as the U.S. government. The statement was unnerving to market analysts who feared that international investors would shy away from purchasing the debt. But Frank's comments are interesting in light of the current debate over whether the mortgage giants (or their replacements) should be privatized or owned completely by the government. One point on which everyone seems to agree is that a public/private hybrid, which the entities were before conservatorship, does not work. Frank has publicly expressed his dislike of public/private hybrids and Treasury Secretary Tim Geithner echoed his comments via Politico on April 9, 2010 when he called the hybrid concept "unworkable."
But the chances for privatization are not looking good. Former Fannie Mae CEO Daniel Mudd testified before the Financial Crisis Inquiry Commission in April of 2010 regarding the financial collapse of Fannie Mae. During his testimony Mudd was asked whether the government should be involved in the residential mortgage business. Citing the U.S. government's involvement in 90% of mortgage loans, Mudd's response was that "the notion that you could go back to a fully private structure cannot be accomplished within our lifetime." A study by Standard and Poor's released in January reaches a similar conclusion--it would be nearly impossible to attract enough capital to replace Fannie Mae and Freddie Mac with self-sustaining private companies which would offer affordable 30 year fixed rate mortgages.
That just leaves the government. This makes the parameters of the study particularly interesting, especially in light of Barney Frank's comments that we need to abolish Fannie and Freddie and come up with "a whole new system of housing finance."
What would such a system look like? No one is saying. But in a January interview with the Wall Street Journal Tim Geithner said that the process would not begin this year. "It's just a complicated thing to get right... But we are completely supportive and agree completely with the need to take a cold, hard look at what the future of those institutions should be in our country."
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