Magazine article American Banker

FHA Plan Would Make Lenders Eat a Lot More Faulty Loans

Magazine article American Banker

FHA Plan Would Make Lenders Eat a Lot More Faulty Loans

Article excerpt

Byline: Kate Berry

The cost of doing business with the Federal Housing Administration could skyrocket if the agency adopts a new method for calculating lenders' liability for poorly underwritten loans that default.

The method under consideration would have the FHA examine a random sampling of each lender's loans, calculate the percentage of loans in the sample with underwriting defects, and then extrapolate that rate to the lender's FHA portfolio. Lenders would then have to compensate FHA for the "estimated total risk" to the agency's insurance fund.

Currently, the FHA, part of the Department of Housing and Urban Development, makes lenders eat the losses on specific loans when defects are discovered. The proposed method would remove the benefit of the doubt for lenders and bring FHA's policies closer to those of the government-sponsored enterprises, Fannie Mae and Freddie Mac

"If this goes through, it means it will be a lot more expensive to be an FHA lender," says Phillip Schulman, a partner at the law firm of K&L Gates. "If a lender runs the risk that every time he makes a mistake it will be multiplied against his entire portfolio, he has to be very cautious."

Schulman, a former assistant general counsel in the inspector general's office at HUD, calls the proposal "draconian" since it appears to adopt a theory of liability that the Justice Department has applied against the largest banks in FHA-related cases. HUD, which oversees the FHA, would now use the same enforcement techniques against every FHA lender, Schulman says.

In June, FHA provided a breakdown of 6,251 loans it reviewed in the first quarter and found that just 19% of loans were deemed acceptable, meaning they had no mistakes. But 44% were "unacceptable," with material loan defects, while another 37% were considered "deficient," with errors that could potentially be corrected. …

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