WASHINGTON -- Two federal agencies with far-reaching influence over the mortgage market are working on a problem that could affect many consumers' ability to obtain a home loan: How to encourage private lenders to ease up on their underwriting restrictions that go beyond what the agencies themselves require for mortgage approvals.
Both the Federal Housing Finance Agency, which oversees giant investors Fannie Mae and Freddie Mac, and the Federal Housing Administration, which runs the low-down-payment FHA program, are considering steps to persuade lenders to open the mortgage spigots a little wider. Together, Fannie, Freddie, and FHA account for 90 percent-plus of all home loan funding.
The focus of their little-publicized reform projects: the "overlay" rules many lenders have adopted that lump extra fees, larger down payments, and higher credit-score requirements onto home loans than Fannie, Freddie, or FHA require.
Some banks require full appraisals, credit checks, and add-on fees. Other lenders have announced that they are limiting eligibility for the program to current customers. Lenders are practicing what one prominent mortgage industry consultant describes as "defensive lending."
Even minor technical infractions in underwriting or documentation can cause "buyback" demands by Fannie or Freddie when loans go into default, with costs per loan for the lender sometimes soaring to hundreds of thousands of dollars. Plus, the Justice Department is putting pressure on major banks to pay millions of dollars to settle allegations of systemic flaws in their mortgage practices -- settlements the banks consent to not on the merits but to prevent protracted litigation and hits to their stock prices.
On top of this, banks and other originators are uncertain about upcoming mortgage regulations that stem from the Dodd-Frank financial reform law that will spell out the rules for future lending.
The two agencies are mum about specifics but are expected to announce reforms sometime in the coming weeks.
Steve O'Connor, senior vice president of the Mortgage Bankers Association, said lenders want several key changes in current procedures, including clear, point-by-point guidance on how the agencies will define reasonable grounds for buybacks or indemnifications.
Lenders also need assurance that after an agreed-upon period of time -- say, 24 to 36 months -- they will not be blamed for deficient underwriting on a loan that goes belly up. Some mortgage companies have been confronted with buyback demands on loans that defaulted for economic reasons after seven or eight years of on-time payments. "That's crazy," Mr. O'Connor said.
FHA lenders, said Brian Chapelle, principal at Potomac Partners in Washington, also want greater fairness in the way they're treated when loans default, including revisions of lender monitoring standards that evaluate them poorly when they try to accommodate borrowers with lower credit scores and other blemishes.