In an effort to serve the “underserved” and gain more market share, numerous mortgage lenders have, in recent months, rolled out new low-down-payment programs allowing qualifying borrowers to put as little as 0% to 3% down in order to get a 30-year, fixed-rate mortgage. Big banks, including Bank of America, Wells Fargo and JPMorgan, have launched 3% down programs, and non-banks, including Quicken Loans and Guaranteed Rate, recently introduced 1% down programs. More recently, Fifth Third Mortgage announced that it is now offering 100% loan-to-value (LTV) mortgages by offering down payment and closing cost assistance to qualified borrowers. Helping to pave the way for these programs are the 97% LTV (i.e., 3% down) programs rolled out by Fannie Mae and Freddie Mac in 2014.
Lenders are marketing these loans to first-time home buyers and consumers with FICO scores as low as 620.
The widespread availability of these new products, however, is raising new questions about the future of the Federal Housing Administration (FHA), which offers government-insured loans to first-time and low- to medium-income borrowers for as little as 3.5% down – and which has played a critical role in supporting the U.S. housing market in times of financial crisis. Many of the large banks have, in recent years, been reducing their participation in the FHA program out of fear that they could get fined or sued as a result of not following the FHA’s now-stricter underwriting guidelines to a tee. Worse yet is the threat of loan buybacks in the event loans were not properly underwritten.
As a result of this new fear of FHA restrictions, and in an effort to capture their own share of the underserved market, lenders are increasingly looking to offer their own low-down-payment loans that are tailored for lower-income, higher-risk borrowers – in effect, eating into the FHA’s market share.
Although some say these banks’ new FHA-less mortgages could mean the end of the agency, others say the FHA is still important but needs to adapt to a changing environment.
David Stevens, president and CEO of the Mortgage Bankers Association, says the new product offerings suggest an exodus of larger financial institutions trying to avoid FHA loans and all of their related problems. “It’s the deliberate effort of lenders with an aversion to the extraordinary legal risk of doing loans within the FHA program, forcing them to find alternative ways to create a product suite to match it,” Stevens tells MortgageOrb.
The legal risks stem from the False Claims Act, a Civil War era law that was designed to protect the government from fraud from vendors. According to a U.S. Department of Justice blog post, the False Claims Act “allows the department to investigate and sue entities that submit false statements and claims to the government, recover losses caused by those entities, and deter similar misconduct by others.” The post also notes that the False Claims Act is used to protect America’s taxpayers and homeowners and is used against lenders that knowingly made false statements, such as failing to verify the borrower’s employment status or overstating the borrower’s income. The department notes that the False Claims Act has been successfully used in some high-profile cases in which lenders made significant errors and maintains that insignificant violations that would not affect the borrower’s eligibility for a loan would not trigger a lawsuit. “In the FHA context, this means that no lender will face False Claims Act enforcement based on an unknowing mistake or an immaterial requirement.”
Not so, says Stevens, who was FHA commissioner until 2011. He says recently, the False Claims Act has become a sledgehammer used against lenders for any minor underwriting error. “The government can assess treble damages against any error in the FHA loan file,” he says. “We never had to deal with this extraordinary and somewhat outrageous enforcement mechanism that is making lenders not walk, but run from the program. The largest banks are leaving because they have the biggest penalties.”
So, though it is unclear what will happen to the FHA as lenders make this move, it doesn’t help that the FHA is currently underfunded. “We are going to need the FHA, particularly in the next recession,” Stevens says. “I don’t see it going away. It serves the higher-risk end of lower-down-payment borrowers.”
In order to survive, he says, the FHA will have to become smaller and much more conservative and have the ability to service a broader segment of the market. “It will continually diminish in the years ahead unless they fix these things,” he says. “It has to modernize and become more nimble.”
Some lenders say they are still offering FHA loans and have put procedures in place to prevent problems. Carrington Mortgage Services in Anaheim, Calif., offers various mortgage products, including FHA programs for borrowers with lower credit scores, and has lower-down-payment requirements at 3.5% and conventional loan programs that have a 3% down payment requirement and are for borrowers with a better credit profile. Over the past two years, the lender has focused much of its lending efforts on the underserved population – borrowers who have FICO scores of less than 650. “The reality, is after the debacle, most lenders have made an effort to swing quite far to the right, still well north of 700, closer to 720,” says Ray Brousseau, executive vice president of Carrington’s mortgage lending division. “Very few lenders are doing business with the average everyday borrower.”
This “average borrower,” Brousseau says, is a very large market – about one-third of U.S. consumers. Carrington is uniquely positioned to do business with those borrowers, he says, because the underwriting resources are in-house, and Carrington offers specialty servicing. “We are very high-touch,” he says. “We specialize in keeping borrowers in their homes, so you’ve got an organization that has a servicing platform for that borrower and skilled underwriting in that type of loan.”
Carrington began offering FHA-backed loans in 2011, so the bank did not have the legacy issues that other lenders had, Brousseau says. Also, Carrington uses strict quality control. “We invest in the kind of resources needed to be able to do it the right way,” he says. “We manually compile a binder and ask HUD to review it.”
The FHA, he says, has an important mission. “If you are a lender attempting to meet the needs of middle-income America, that average everyday citizen, the FHA and the product they offer are best-in-class,” he says.
Others agree that the key is to closely review the riskier loans and not make mistakes. “We have never aggressively approved loans that did not first go through the automated underwriting engines,” says Jeff Bode, president of Mid America Mortgage in Addison, Texas. “Obviously, the larger banks are moving away from FHA, as they have been hit with large fines for previous mistakes, but for those of us that did not have large government exposure through the last meltdown, we’ll continue to operate in government lending.”
Bode adds that although some of these larger lenders have made big announcements about their new, non-FHA loans, these loans are not going to see substantial volume. “Unless these loans can be securitized, they are probably more of an attention-grabber than a product that will see lots of activity,” he says.
He has no doubt the FHA will have a place in the future. “The same question was asked in 2006 when the subprime market was making loans that were even below the FHA standard. In fact, after the crash, FHA loans were the only game in town for quite a while. FHA loans weren’t supplanted then, and they won’t be now,” he says.
According to the Ellie Mae Origination Insights Report, among the closed loans in May, 23% were FHA, 64% were conventional, 9% were Veterans Affairs (VA), and 4% were other. That doesn’t differ much from May 2015, when 24% of the loans were FHA, 63% were conventional, 10% were VA, and 3% were other.
Mat Ishbia, president and CEO of United Wholesale Mortgage in Troy, Mich. – which recently launched its own 1% down program – says the FHA will continue to be relevant, but it will become less relevant than it is today. “Originators are comfortable using FHA loans because they have done it for several years, but there are 3% down programs out there from Fannie Mae and Freddie Mac that are actually better programs for borrowers in most situations,” he says. “Over time, originators are going to realize that getting the cheapest payment for the borrower is the most important thing, so I believe that FHA will become a less widely used product over the next couple years.”
He adds that the FHA will continue to be important for home buyers with FICO scores from 620-680 who want to use a 3.5% down payment. “It’s a solid program, but I can see it declining to make up only 5%-10% of the market, as opposed to being 15%-25% of the market. It’s a valuable program, and it’s been a very good program for many years.”