The FHA wants a bigger stick for keeping mortgage lenders in line

Now that the Federal Housing Administration's cash reserves are below the legally required 2% of loans outstanding, the FHA has proposed new regulations to increase the net worth requirements of FHA-approved lenders and strengthen lender criteria. The agency will also make lenders liable for the practices of their correspondent mortgage brokers.

That's a relief for taxpayers because the FHA could become a financial black hole without improved risk management. In a related case, the FHA withdrew its approval of Ideal Mortgage Brokers, doing business as Lend America and Lending Key, and is seeking $512,000 in civil penalties related to its lending practices.

The proposed rules would give the FHA the stick it needs to deal with brokers that pose the greatest potential threat to its insurance funds. FHA-approved mortgagees would have to assume liability for all the loans they originate and/or underwrite. Mortgage brokers (loan correspondents) could continue to originate FHA-insured loans through approved mortgagees, but they would no longer receive independent approval for origin eligibility. Any loans that a mortgage broker originates would become the liability of the mortgagee that closes the loan.

While the FHA thinks this could increase the number of mortgage brokers that can originate loans, I have my doubts. Since the mortgagees must take on the liability for the loans originated by mortgage brokers, the FHA-approved mortgagees will likely get very cautious about who they allow to originate loans.

Higher Capital Requirements

The new rules would make it more difficult to become an FHA-approved mortgagee as well. Since 1993, the FHA has required mortgagees have a net worth of $250,000. Under the new rule, mortgagees would be required to maintain a minimum of $1 million in net worth within the first year and at least $2.5 million of net worth within three years of the effective date of the rule. The FHA wants to be certain that its lenders are sufficiently capitalized to meet potential needs, so the FHA can mitigate its losses and decrease risks to its insurance fund. That change has been needed for a long time.

FHA Commissioner David H. Stevens promised these moves back in September to strengthen risk management. "We are taking a number of aggressive steps to ensure that we are able to continue to support the housing market in the short term and provide access to home ownership to the underserved in the long term, while minimizing the risk to the American taxpayer," Stevens said in a press release announcing the proposals. The FHA will take public comments for 30 days before finalizing its new rules.

To give FHA mortgagees a clear sign that times have changed, the FHA separately withdrew its approval of Ideal Mortgage Brokers. In doing so, Stevens said in a press statement: "We have no tolerance for lenders who abuse their FHA approval. The evidence in this case points to a disturbing pattern of senior officials and underwriters either not knowing what they were doing, or not caring. Therefore, Ideal has been immediately withdrawn from participating in the FHA-insured mortgage program." Ideal also can no longer issue Ginnie Mae securities.

Ideal has 30 days to challenge the withdrawal and penalties.

Wiser Course

As the FHA's role in the housing market continues to grow, it's essential that it gets better control over its approved mortgagees. Right now, the FHA funds more than 20% of all mortgages. And private mortgage money has pretty much left the marketplace for subprime loans.

If the FHA were to pull back from lending, that would definitely slow down what is already a struggling housing market. Putting stronger controls in place is a much wiser course than cutting off lending.

Lita Epstein has written more than 25 books including The 250 Questions Everyone Should Ask About Buying Foreclosures.
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