Today's secondary market looks dramatically different from the one that fueled the mortgage industry just a couple of years ago. Not too long ago, investors were willing to choose from a financial buffet of loan products, ranging from conforming to jumbo to subprime to stated income. Innovation was the name of the game, and the secondary market was ready, willing and able to accommodate the new products that were being developed for homeowners.
But after the historic 2008 market crash, the financial buffet table was wheeled away. What had been considered innovative was suddenly viewed as dubious and toxic. The private-label market collapsed, and the federal government stepped in to keep the secondary market alive.
In today's recession-moored environment, Fannie Mae's and Freddie Mac's conforming loan purchases dominate the secondary market. Actually, ‘dominate’ is a relatively mild word to use in describing this circumstance.
According to recent congressional testimony by Michael Berman, the Mortgage Bankers Association's vice chairman, the government-sponsored enterprises (GSEs) ‘currently participate in over two-thirds of all single-family mortgage transactions and about 75 percent of all multifamily mortgages.’
As a result of this meltdown, secondary marketers are under pressure to ensure that every loan they try to sell conforms with stricter lending standards – both from the GSEs and from the surviving private investors who are adopting tighter underwriting guidelines. Loans that fail to meet conforming standards are much harder to sell, and investors are pouring over loans to find discrepancies before funding the purchase. Loans that do not pass muster are rejected, or in some cases, already purchased loans are sent back to the lender for a buyback.
Take it back
There are many causes for buyback requests, but one of the most common scenarios involves loans that contain fraudulent information or that fail to comply with consumer protection regulations. These regulations dictate the standards that loans must comply with to ensure the borrower is educated about the true terms of the loan and can repay the loan based on information available at the time of purchase.
Buybacks are a costly problem for lenders, and investors return loans for buybacks for two primary reasons.
The first is a default shortly after the sale, typically within the first six months. However, investors can also force buybacks of older loans if the note violates the representation and warranties. Investors demand loans that are compliant with all laws, have accurate documentation and are free from fraud.
Repurchase requests can be settled in arbitration, or investors and lenders can become involved in litigation to determine who is responsible for the loan. In the worst cases, a lender may have to close its doors when it cannot afford the buybacks.
For secondary marketers selling new loans, investors are also analyzing every loan for the same standards before agreeing to purchase the loan. Noncompliance can sink a loan's funding before it even reaches the closing table.
Compliance checks can make an impact on a lender's bottom line by providing protective and preventative measures to reduce potential buybacks.
Regulations protecting borrowers from predatory lending practices can contain provisions that allow the investor to force a buyback if not in compliance. With the Obama administration tackling the question of regulatory oversight, there are many revised and new rules lenders must account for to ensure that every loan meets the standards required by investors – whether it is a GSE or a private buyer.
One of the most pressing issues is the adoption of the final Truth in Lending Act (TILA) disclosure requirements, which were approved on May 8 and went into effect on July 30.
According to the Federal Reserve, the Mortgage Disclosure Improvement Act requires creditors ‘to give good-faith estimates of mortgage loan costs within three business days after receiving a consumer's application for a mortgage loan and before any fees are collected from the consumer, other than a reasonable fee for obtaining the consumer's credit history.’
Adding to the confusion is the update to the Real Estate Settlement Procedures Act (RESPA). The update to RESPA includes additional rules governing initial disclosures and further regulates the fees that lenders can charge borrowers.
Take a byte
How can lenders strive to keep their sanity while trying to comply with this myriad of regulations, not only on the federal level, but also at the state level? A combination of automation and good-faith efforts provides the easiest path to staying compliant and reducing the risk of buybacks.
Regulations such as the Home Mortgage Disclosure Act, preliminary disclosures and fee calculations can be automated by software that is integrated into the loan origination system. These applications contain features that flag incomplete applications and keep a loan from closing if all the steps have not been followed.
For laws with more subjective requirements, lenders must combine their best good-faith efforts with documentation and reports from their automation tools. Marketers who use available software to analyze income and document how and why decisions are made will be in a stronger position to defend their offerings on the market.
As regulations become more complex and require lenders to provide more analytical support to loans prior to underwriting, software has been developed that assists lenders in making accurate decisions. In some cases, investors are even encouraging their lenders to automate the underwriting process to ensure the quality of a loan prior to funding.
Secondary marketers have the responsibility of ensuring that their originators are underwriting loans that are compliant and salable. It is important not to wait until post-closing to discover mistakes. An ounce of prevention now can save a company a pound of buyback requests or refused loan purchases later.
Leonard Ryan is president of Laguna Hills, Calif.-based QuestSoft, a provider of automated compliance solutions and geocoding services to the mortgage industry. He can be reached at (800) 575-4632 or firstname.lastname@example.org.