With subprime practically gone and lending down across the board, lenders are jumping on the Federal Housing Administration (FHA) bandwagon as an alternative. The share of government-insured mortgages tripled from 8.4 percent in July 2007 to 29.1 percent in July 2008. Increases in FHA loan limits, the dearth of conventional financing options and the agency's low down-payment requirements are prompting the shift from conventional to FHA lending.
But many lenders are rushing headlong into FHA products without knowing what they're getting into. Many think FHA lending is just conventional lending with government paperwork. They are seriously mistaken. FHA's underwriting, loan processing, secondary marketing and loss-mitigation requirements are unlike anything in the private conduit world. FHA takes a more formal and disciplined approach. Its requirements for everything from lender approvals to handling late payments are specific and inflexible.
The agency's inflexible procedures and numerous requirements need not be overwhelming for lenders with the proper quality-control procedures in place. But if they don't know what they're doing, they could find themselves in trouble.
Mortgage firms not following those rules can suffer severe penalties, including debarment and triple damages. In addition, if lenders fail to follow FHA guidelines, the agency may reject loan applications, leaving lenders with loans that have no good alternative in today's market. Without FHA insurance, the lender may end up selling the loan as scratch-and-dent for 50 cents on the dollar.
Lenders used to the whatever-you-can-get-away-with world of the now-defunct subprime environment may be surprised by FHA's rigid approach to loan applications. Unlike private lenders, the agency does not accommodate people. Lenders new to FHA lending may not understand that they cannot reason with the agency, they cannot negotiate underwriting criteria. If one aspect of a loan falls outside the agency's criteria, lenders cannot simply pay an extra point or argue that other characteristics make up for the shortcoming.
Getting your Eagle
The strict requirements and tough penalties that are an essential part of this program make strong operational risk-management an imperative for successful FHA lending. Lenders must allot time to complete the labor-intensive job of gathering FHA paperwork and make sure their staff is properly trained in FHA requirements for documentation, certifications and servicing.
Mortgage firms--including lenders, brokers and servicers--intending to work with FHA must obtain an FHA approval commonly known as "getting your Eagle." This can be either a mini-Eagle for doing originations or a full Eagle for servicing as well as originating FHA loans.
Keeping a close watch over lenders, FHA audits them through on-site visits and external audits. Brokers are also tracked and held accountable. Using lenders' Eagle numbers, FHA closely tracks the delinquency and default rates of lenders' loans using Neighborhood Watch, Web-based software that monitors FHA mortgage delinquency patterns by geographic area, lender or loan details. Lenders with delinquency rates 200 percent higher in any given area will be investigated and most likely called before FHA's review board.
Lenders cannot have an employee on any debarred or limited denial of participation list of any government agency--not just FHA. That means any agency, from the Department of Agriculture to the Department of Labor. FHA checks to ensure that lenders have a process for checking that their employees are not on one of those lists. Lenders must also report monthly on defaults and show they properly manage vendors.
Lenders showing a pattern of approving certifications that affirm false information face significant penalties, including fines, being placed on the debarment list that bans the lender from ever again providing government services, or being placed on a limited denial of participation list that restricts the lender's business, typically temporarily banning it from FHA lending. …