On The Brink Of A Regulatory Crackdown

Error-drenched loans are an invitation to unwanted oversight

Insider

Contributing Writer

Interest rate hikes take time to work through the economy. Since the Fed started raising the rate last year, we have seen a massive decrease in mortgage business and major banks fall. We don’t know yet what other parts of the economy could fall under the strain of the higher rates, but it’s likely to come with some additional regulation. The IRS received $80 billion in funding, a majority of which is set to go towards auditing companies. As high inflation continues to be persistent, higher interest rates, higher home prices, limited housing stock, are all pushing home buyers and mortgage borrowers to the maximum qualifying ratios. According to a recent Fannie Mae report, many of those borrowers exceeded allowable ratios, requiring lenders to consider a more robust Quality Control (QC) program. Time to start increasing compliance across the board. Might I recommend making the first step a more robust QC policy.

“In the past 12 months, Fannie Mae has seen a notable increase in loans that have both loan-to-value (LTV) ratios over 90% and debt-to-income (DTI) ratios over 45%. We’re also seeing that borrowers are more likely to fall outside of traditional credit boxes; examples include purchasers whose credit approval is partially based on rental income history or borrowers who have no credit score at all. To meet this challenging environment, lenders are highly encouraged to maximize the benefits from their prefunding QC program and look closely at loans with little margin for error.” *

QC starts with building a relationship with the borrower, understanding what their intentions are in the next 12 months. Are they retiring, plan to change jobs, buy a new car, or become an entrepreneur? At the time of the loan application, everything may be 100% correct; however, this is the time to listen to your clients and their aspirations for the future. Guide the borrowers on a path of home ownership that has the opportunity for success.

The second most important QC component is processing and underwriter due diligence. This means developing a strategy that will identify high risk loans that will have additional reviews, and QC audits prior to funding. Some real-life examples of QC issues that I personally know of include:

The loan file was missing two rental receipts, which caused the DTI to exceed the eligibility guidelines.
A loan funded just shy of the cash out seasoning requirements; it was missed by five days.
The borrower quit their job after the loan funded.
The borrower retired after the loan funded.

These are critical defects that may lead to a request from the investor and require your mortgage company to repurchase the loan. Hopefully you are asking yourself how you can avoid the fate of a repurchase. While you may not have control over what the borrower does post-closing, you do have control over the quality of the loan file as it pertains to meeting the investor’s guidelines. Best practice is to set a QC standard for all high-risk loans. For example, self-employed income, rental income, loans with high DTI, or high LTV, limited credit profiles, or large cash out transactions, are all high-risk factors. While there remain some misconceptions that an effective QC plan is only to detect mortgage fraud, that is not the case. The real goal of QC is to ensure the mortgage loan file meets all the investor’s guidelines. Detecting mortgage fraud is a great bonus.

Hopefully you are asking yourself how you can avoid the fate of a repurchase.

Another essential component of QC is training, make sure that the mortgage loan originators, loan processor and underwriters are notified of any updates to guidelines, or eligibility requirements. Discuss the best ways to calculate complicated income sources. Create a culture within your organization that allows for collaboration, and the ability to ask for help when working on complicated loan files. Implement technology-based hard stops within your loan origination software programs that will detect potential investor guideline failures.

QC changes with the economy, the housing market, and the borrower. Following the trends will help your company to determine whether the QC failures are internal controls that need to be adjusted or external activities that need to be mitigated.

Fannie Mae recently updated their guidance on lender quality control efforts in the seller guide SEL-2023-2.

“In an effort to improve overall loan quality and reduce the number of loans requiring remediation by lenders, we have enhanced both our prefunding and post-closing quality control policies. Lenders must complete a minimum number of prefunding reviews monthly. The total number of loans to be reviewed must equal either: 10% of the prior month’s total number of closings or 750 loans.”

The seller guide also indicated that Fannie Mae will decrease the timeframe for the post-closing quality control efforts from 120 days to 90 days of funding the loan. This will also shorten the timeframe in which a loan with serious defects may be sent back to the lender for repurchase.

Even if you are not a direct seller to Fannie Mae or Freddie Mac you will be impacted by these changes because QC starts at the source of the loan application.

Regardless of the size of your mortgage company, your QC policy and procedures should reflect the best effort to control the quality of all your loan files. Protect your company against future buy backs that can potentially put you out of business with a robust QC plan that will ensure that all loans see the same level of scrutiny.