Compliance Article
06/24/2008
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Introduction
The decline of the subprime mortgage lending market coupled with revamped regulations and processes have made Federal Housing Administration (FHA) lending gain in popularity. After years of shrinking market share, the FHA is seeing more lenders seeking to offer FHA-backed loans. The upside for lenders can be substantial with broadened mortgage product offerings, improved credit risk management and opportunities to help some struggling borrowers refinance with a government-backed loan.
With the opportunities come risks, and lenders seeking to offer FHA products should carefully consider their options and then take the time to plan accordingly. The FHA has very specific steps to becoming a licensed lender and has significant ongoing requirements for maintaining an FHA program.
Why FHA Lending?
As the subprime market declines and underwriting standards tighten, lenders are looking for opportunities to increase loan portfolios while managing credit risk. FHA programs give lenders the power to offer a government-backed alternative to borrowers who do not meet prime creditworthiness qualifications (as defined by Fannie Mae, “prime” loans have a borrower credit score of over 620, 45 percent or less debt-to-income ratio, and loan to value of 90 percent or less). In addition, FHA has responded to the subprime collapse and mortgage industry credit crunch by offering a new program, FHASecure, to help many borrowers refinance their adjustable rate mortgages into fixed rate mortgages and avoid foreclosure.
FHA lending is now more attractive because of changes in regulations, processes and loan features. FHA lending had declined over the years as subprime lending with private mortgage insurance offered greater flexibility without the additional hassles of an agency-backed loan. In response to the mortgage crisis, many subprime lenders failed and other lenders offering subprime loans tightened underwriting standards or exited the subprime market entirely. With the FHA’s new regulatory opportunities, FHA lending is increasingly attractive. For a discussion on the history of FHA lending and the details regarding these changes, please see the article FHA Lending is Back in Vogue.
FHA lending provides lenders with the ability to offer a government-backed loan with features that benefit a wider population of borrowers than conventional prime lending entails. Note that unlike other government agency lending such as Freddie Mac or Fannie Mae, FHA does not lend money or purchase loans. The FHA provides the insurance to help lenders mitigate credit risk. Some of the benefits of FHA lending include:
- Lower down payments (as low as 3 percent and down payment can be a gift)
- No cash reserves
- No credit score requirements, which can be especially important to new buyers who do not have established credit
- No income limits
- Higher qualifying ratios
- Simplified refinances
- Helps lender meet the Community Reinvestment Act requirements
- FHA-insured loans protect the lender from loan losses
FHA has many available programs, and part of the lender’s planning process is determining which programs to offer. Among the most popular is the Regular Fixed Rate loan under section 203(b). 203(b) loans are for financing for one-to-four unit properties and include planned unit developments (PUDs) but does not include condominiums (condominium financing is covered with section 234(c) loans and is also among the most commonly used FHA loans). 203(b) loans offer repayment terms ranging from ten years to 30 years. The FHASecure program that is helping hundreds of thousands of borrowers refinance adjustable rate mortgages is a 203(b) lending program, but 203(b) loans are also very popular for first-time homebuyers.
Another widely used FHA program is the section 251 loan programs. Section 251 loans are adjustable rate loans for one-to-four unit properties and include both PUDs and condominiums. These adjustable rate loans are tied to U.S. Treasury bills or London Interbank Offered Rate (LIBOR) and offer a 30-year term.
While FHA loans offer attractive features for lenders and borrowers alike, potential lenders should carefully review the FHA requirements to ensure it fits with their institution’s strategic plan. Although the requirements for creating and maintaining an FHA lending program have been streamlined, keep in mind that this is still a government program with significant licensing and ongoing compliance hurdles. Failure to properly follow FHA regulations and underwriting requirements may mean some loans may not be insured or may require lenders to indemnify FHA on certain loans, and repeated violations may result in the assessment of civil money penalties and even license forfeiture. In addition, lenders need to ensure an adequate loss mitigation process for delinquent loans or they risk receiving lower foreclosure expense reimbursement, additional required training, audits and even fines.
Becoming and Being an FHA Lender
If your institution is new to FHA lending, the first step is to secure licensing from U.S. Department of Housing and Urban Development (HUD) to become an FHA-approved lender. Lenders can become Title I lenders for home improvement loans, but the more common program is to become Title II lenders for home purchases, refinances and reverse mortgages. The licensing process takes approximately 90 days after the application submittal while HUD reviews the applicant’s qualifications, including financial qualifications such as net worth and liquidity, lending personnel (officers and employees), quality control (QC) plan and overall soundness of the lender.
Plan Before You Apply
Before applying to become an FHA-approved lender, prospective FHA lenders should first determine what they want their FHA lending program to look like. Which types of loans do you want to offer? Does your institution want to service FHA loans? Does your institution want to offer FHA loan servicing to other FHA lenders? What type of FHA lender do you want to be (e.g., a mortgagee which makes insured loans, a loan correspondent which acts more like a broker, or an investing mortgagee which purchases but does not service FHA loans)? What are some opportunities and risks of the various options? What are the underwriting standards for each type of loan? What do you need to do to ensure that your program meets FHA’s meticulous quality control requirements?
Institutions of all sizes are considering becoming FHA lenders or considering reviving their inactive FHA programs. While some institutions have personnel with FHA experience, others will have to navigate these challenging waters without in-house expertise. Wolters Kluwer Financial Services offers experienced consultants to walk the lender through the licensing process and address various concerns and considerations. Lenders benefit from having an experienced professional with HUD experience, and the services can save time in becoming licensed, help manage risk and alleviate frustration for those new to the government lending licensing process.
Steps Pending License Approval
Once a lender’s license application is pending, the lender should step into action to prepare for becoming an FHA lender. To maximize your investment in becoming an FHA lender, you will want to have your program hit the ground running once your application is approved (assuming you meet all of the requirements). Thus, the time when your application is pending is the time to work on internal policies and processes, training and ongoing maintenance that will be necessary to be an FHA lender. Lenders will need to determine what documents will be necessary for their proposed FHA program, including disclosures, notes, security instruments and FHA-specific documents such as transmittal forms. In addition, this is the time to determine what documents are needed to generate and at what time in the lending process. Also, lenders will need to understand what technology will work with their processes or whether pre-printed paper documents will suffice.
The license evaluation period is a great opportunity to work with your marketing and sales staffs to train them on FHA lending and to ensure that they develop compliant marketing materials and sales processes. FHA has very specific requirements on representations and logos. It is crucial that before you launch an FHA lending program, you ensure that your marketing campaigns and collateral materials comply with FHA requirements. Likewise, it is important that your customer-facing lenders understand your FHA programs and how to explain them to customers in the context of your overall product portfolio.
After Your Institution is an Approved Lender
Whether your institution is gaining licensing for the first time or dusting off a license that you have not used in several years (assuming you have still renewed the license each year), you will need significant advance planning, process development and training before offering new FHA loans. FHA loans may have some requirements that are different from your current loans. For example, if you have a fully electronic mortgage product, that may not accommodate FHA lending.
Lending staffs will need training on what FHA lending is, what the lender’s specific program entails, how applications are taken, FHA underwriting requirements and FHA insurance submittals. It is crucial to ensure that you are meeting FHA standards from the beginning of your FHA lending program. Violations early on can lead to heightened scrutiny from FHA as well as primary regulators, and violations may also cause additional time and expense as QC sample sizes may need to be enlarged.
Any FHA lending program will need a quality control program that was submitted during the application phase. Moving from the theory of the program to the reality of implementing the program can be challenging, and it is important to closely monitor your institution’s progress.
Since the FHA exists to help more people purchase homes, it follows that the FHA requires strong loss mitigation strategies that will help people stay in their homes while also minimizing the impact on the insurance fund. Any lending program is bound to have delinquencies, and the FHA provides incentives to lenders that have stronger loss mitigation processes and performance. The FHA has a tiered ranking system to rate each servicer’s loss mitigation program. Those with the strongest loss mitigation programs are eligible to earn increased incentives in the form of higher foreclosure expense reimbursement percentage. The FHA closely monitors market conditions to adjust the loss mitigation program, and it is important for servicers to stay abreast of the current details of the program.
Once you have become a licensed, FHA-approved lender, your institution will still need to maintain this credential. FHA requires annual reapproval and re-verification of licensure, and it is important that each institution comply with these detailed requirements.
Summary
FHA lending is gaining in popularity as a replacement or refinancing for some subprime lending and as a way to help meet the credit needs of communities. While there are significant opportunities, there are also risks. Proper advance planning, careful implementation and ongoing monitoring can ensure that your FHA lending program is a win-win for your institution and your community.
