It seems hard to believe that the FHA has gone from an unused relic to one of the hottest mortgage programs in the market in a mere matter of months. In 2006, many brokers had turned in their FHA approval. Many wholesalers didn’t even offer FHA. All of that was before the financial meltdown. Now, many borrowers who could choose any conventional program are choosing FHA.
Everyone who had given up their FHA approval scrambled to be re-approved. Now, brokers are reporting over 50 percent of their production is FHA. If one simply looks at rates and fees, it is easy to send most of your loan production through FHA. A good mortgage originator will dig a little deeper. The current legislative and regulatory climate is already introducing a new concept to many originators, a Duty of Care. Already included in some state legislation and in HR 1728, Duty of Care means “presenting consumers with appropriate mortgage loans.” That duty requires any originator to take the time to see if they are actually giving the borrower the loan a person who had done due diligence would have given them.
Consider a borrower who only expects to live in the house for three years. If the private mortgage insurance (PMI) is available, it is often much less costly than FHA insurance. If the borrower has a 700-plus score and 10 percent down, PMI often is the better choice. Make certain you have checked to see if the loan meets USDA Rural Housing guidelines or if the borrower is a veteran. As home prices stabilize, as they will, presenting the appropriate loan will become even more challenging.
One of the most common reasons originators have avoided Fannie Mae and Freddie Mac has been due to a tightening of guidelines and ever-increasing add-ons. Add-on fees have reached unbelievable levels. PMI rates have soared, if you can get PMI for the loan at all. Meanwhile, the FHA has maintained normal MI premiums that seem downright cheap in today’s market. FHA credit, income and reserve requirements are not significantly different than they were in the heyday of the sub-prime market. There are none of the add-ons from FHA that have become commonplace for the government-sponsored enterprises (GSEs). While FHA is not charging add-ons, it has not made FHA loans immune from radical add-on fees from lenders.
Supposedly, there is some logic to these fees, but they all seem to stand independently rather than as a component of a grading scale. It is not clear what justifies such massive fees since FHA loans are 100 percent guaranteed. Lenders tell me that it is because their compare ratio in Neighborhood Watch is at risk. Others claim loans that are less than perfect are difficult to market. Still others claim servicing costs are greater. If that is the case, one must wonder one why the fees vary so greatly between lenders.
Lenders generally take two different approaches to what is perceived to be greater risk. Some lenders take the approach that fees are inappropriate and they simply don’t take loans with certain features. Some go so far as making across-the-board restrictions for all loans whether conventional or FHA. At least one lender accepts no loans below a 680 score, irrespective of what GSE or FHA guidelines allow. Most of the largest wholesale lenders have set 620 as the minimum acceptable score. A second approach to risk has created a huge cottage industry of smaller wholesale lenders who are willing to accept lower scores, but have considerably higher rates and fees. Although FHA allows maximum financing down to a 500 credit score, it is very difficult to find any lender willing to take an FHA loan with a score below 580.
There are so many additions to FHA guidelines and additional fees that the following list is far from inclusive of them all. Scores below 620 can be very costly to the borrower. Not only do some investors charge a point or two more in general than the premium investors, they may charge as much as two points more for the 580 score. This begins to rival or exceed fees charged by Fannie Mae or Freddie Mac. By the time the originator takes even a basic origination fee, the borrower may be paying three to four percent of the loan amount upfront.
The credit score fees are only the tip of the iceberg. Consider some of the other add-ons:
► A borrower with a very high score may still be unacceptable to many investors because their qualifying ratio is in excess of 45 percent or 50 percent. A fee of one percent is very common for loans with a ratio over 55 percent. If the borrower has no score, tack on another half- point, and if non-traditional credit is used, another half-point. Manual underwriting varies greatly from a quarter of a point to 1.5 points.
► Many lenders will not accept a borrower with any mortgage lates. More liberal lenders will simply add on another point. If the property being purchased is an FHA real estate-owned property, expect to add a half-point to a full point. Many investors charge additional fees for certain states and loan amounts.
This list is hardly exhaustive. It is entirely possible to have an FHA loan that could exceed HOEPA fee triggers. That would be the extreme. While it would be nice to avoid these fees, the stark reality is that millions of borrowers would receive no loan at all if these were not offered. Perhaps as property values stabilize, lower-score or high-ratio borrowers will be able to obtain more attractive financing.
The tightening is far from over. Appraisal reviews are becoming commonplace. Even when not required by FHA, some investors will call for a second appraisal. Mandatory appraisals on streamlined refinances are becoming increasingly common. Some investors require full income verification on streamlines, while others simply want to verify employment. The most conservative want a fully documented loan, even for streamlines.
It is not uncommon to see lenders stop offering a program before it is necessary to do so. An example is the 95 percent cash-out refinance program. While 95 percent of refinances only needed the FHA case number pulled by April 1, most lenders pulled the plug much earlier. The same cutoff happened with FHA Secure.
Despite the profit incentive, some programs offered for insurance by FHA are going wanting. Very few lenders offer FHA’s manufactured housing program. Try to find a lender that will allow your borrower to keep open a Chapter 13 bankruptcy or do an Inter-Vivos Trust. FHA allows them, but there seems to be no market.
One must question what will happen when FHA’s legislated moratorium on risk-based pricing expires on Oct. 1. Can we imagine Upfront Mortgage Insurance Premium (UFMIP) possibly doubling combined with the fees lenders will charge? Upfront fees to borrowers could easily exceed five percent and potentially approach 10 percent. That makes sub-prime look cheap.
FHA faces its own worries. Downpayment assistance (DPA) defaults continue to grow according to the U.S. Department of Housing and Urban Development (HUD). Perhaps that FHA’s biggest new problem is the “immediate default.” Borrowers were taking cash out of a property and simply walking away. The lender is usually the one stuck, but FHA could also be on the line. Vacant properties are blighting neighborhoods and require significant costs to maintain.
If you think lenders vary greatly now, wait until they start reviewing appraisals that include Fannie Mae’s 1004-MC Form regarding declining markets. In the Mortgagee Letter implementing the 1004-MC, HUD states, “Direct endorsement lenders are reminded that if the appraiser they selected provides a poor or fraudulent appraisal that leads FHA to insure a mortgage at an inflated amount, the lender is held responsible, equally with the appraiser, for the integrity, accuracy and thoroughness of an appraisal submitted to FHA for mortgage insurance purposes.” You can be certain that means a lot of direct endorsement underwriters are going to nitpick appraisals to death. If you ordered the appraisal, you may be liable as well.
A final word to brokers and correspondents … remember, you are liable for the accuracy of all information that was used to underwrite the loan. You are certifying that the bank statements, pay stubs and other forms of verification are accurate. If the lender pulls a 4506-T and your borrower’s pay stub doesn’t reflect their income, you may be called upon to indemnify the lender.
I realize that loans are difficult to do now. But be careful. The federal government can appear as though it has fallen asleep for a long time. If they suddenly awake, very few can afford the legal fees to fight them. Certainly that figures into the increased costs that lenders making more difficult loans anticipate.
John Councilman, CMC, CRMS is FHA Committee Chair for the National Association of Mortgage Brokers and president of AMC Mortgage Corporation in Fallston, Md. He may be reached by phone at (410) 557-6400.