Once upon a time, long, long ago in a century past, there lived many, many people who wanted to buy a home for their family. However, they knew it would take more money than they had. Fortunately for them there also lived in the land, people who wanted to invest their money with people who wanted to own their homes. So to make this happen the good mortgage lenders of the land agreed that they would be the intermediary between these groups of people. But everyone wanted to know more before they agreed. “How will you protect us from buying a house that we cannot afford?” asked the people who wanted to buy houses. “How will you protect our money from going to people who won’t pay us back” ask the investor people. The good mortgage lenders answered the buyers this way: “We will only have loans that have consistent payments so you won’t be surprised when you get your bill. To make sure you can make those payments we will have guidelines that evaluate your ability to make the payments. Finally, to make sure we are doing this correctly, we will have a quality control review to ensure the reliability of our lending process.” Upon hearing this, the home-buying people cheered and rushed to find a home they wanted to buy. However, the investor people were still not happy since they could not see what the good mortgage lenders were going to do to protect them. So they said to the investor people, “When we told the home buying people about our QC that was also for you. You will know that the guidelines used to ensure they can make payments will be tested by QC as well and any problems that they find we will take action and make changes to ensure that the loans are good.” Once the investors heard this they were happy because they knew that having QC would protect them. And so all the home buying people in the land bought their houses and the investor people got loans that paid. Everyone was happy.
Well, almost ever body. There was also in the land an evil sorcerer named Greedy that was very unhappy. He wanted to make lots of money from these good and happy people, but everything was working too well. So Greedy created some new loans that were very bad and caused the good home buying people to stop making their payments. He also infected the good mortgage lenders with his greed potion and whispered into their ears that QC was BAD for them. “Why”, they asked. “Well”, he answered, “They see how poorly you are following the credit guidelines and are stopping you from making all the loans and lots of money.” So he cast a spell on the good mortgage lenders which caused them to ignore what QC was telling them. This made Greedy very happy.
Unfortunately, the happy times didn’t last. The good home-buying people couldn’t pay these new loans and they lost their homes. The good investors lost their money and were very mad. Finally, the ruler of the land said “Enough already! We are going to change this and make our QC people very strong and make sure that lenders listen to them. This will give us back what we lost because of the evil sorcerer.” And so it happened and everyone was happy again. Or were they? The evil sorcerer is still out there. Does he have more devious ideas? Will he bring back those loans that caused all the problems? Will he stop QC from doing its job? What will happen next? Can we afford to find out or should we stop the problems before Greedy becomes too powerful again?
A cautionary tale for sure, but this could happen again. During the past seven (7) years the industry has worked very hard to correct the problems that created the Great Recession. With guidance and/or dictates from new laws and regulators, changes have been made in our origination and servicing processes. Fannie Mae, Freddie Mac and FHA have made major improvements to their focus on ensuring quality loans are being produced and that QC departments are no longer ignored or dismissed when their testing shows problems. As a result, the agencies are pleased that the quality of the loans they are asked to purchase and/or insure is improving. A recent statement from Fitch also reflected that defaults are down to the lowest levels in many years. The loans being made are tested to ensure the borrower can pay and new requirements explaining the process is in place. Yet, there are signs that “Greedy” is still active.
Potential Warning Signs
Today lenders have adapted to the changes made in the aftermath of the Great Recession. Loans made are required to meet the “Ability to Repay” and “Qualified Residential Mortgage” if they are going to a federally insured entity. The secondary market is closely examining loans for TRID compliance and lenders are doing Pre-funding QC as well as using the agency taxonomies to establish the level of risk in the files. However, there are signs on the horizon that says this may not last.
Increasing number of homebuyers:
For several years now lenders have been waiting for the Millennial generation of 72 million to start buying homes. While there were many reasons for the delay it appears to be over. These individuals have now reached the age where they are getting married, having children and want a place to call their home. While the type of housing they are looking for may change, the sheer volume is bound to be good for lenders.
In addition, the largest generation, the Baby-boomers, are reaching retirement age and are looking to move away from large houses with lots of work to smaller homes that leave them more time to enjoy the fruits of their labors. Many more are looking for second homes in areas where they can get away from cold winters and relax or move away from the suburbs to larger cities with more cultural events and groups of people with common interests.
Also to be considered is the immigrant population that continues to grow. These individuals, whether brought here by companies seeking employees or by their own desire to make the move, they are increasing the population of people seeking to buy houses. All of these buyers are putting pressure on housing inventory and prices.
Increasing home values:
While anyone who already owns a home is aware of increasing values in their area, there are signs that values are steadily increasing. Zillow recently published the list of Top Ten Housing Markets with the highest increases in prices. The top five include Denver, Seattle, Dallas-Ft. Worth, Richmond and Boise with the highest have a 5.6% home appreciation rate.
New loan products:
While it has taken a while, private investors are reemerging in the marketplace. Just recently announcements were sent out from lenders offering products that are similar to those we saw prior to the mortgage meltdown. These product offerings include, DTIs up to 60%, LTVs as low as 10% for jumbos with no MI, alternative income offerings, non-warrantable condos, loans for borrowers with a bankruptcy or foreclosure within the past 24 months, loans with interest only options, investment property lending regardless of the number of properties owned, and the most concerning of all loans with credit scores to 580.
Government Pressure to increase homeownership
Despite all the accusations made by government officials during the last crisis, the political climate is once again focused on expanding home-ownership rates. Numerous articles have expounded on the fact that the homeownership rate is well below what was acceptable even before the crisis. A recent announcement from FHFA included a statement that they were directing Fannie Mae and Freddie Mac to determine what is preventing individuals from purchasing homes and to create programs to address those issues.
Degrading the importance of Quality Control
The new quality control requirements implemented by Fannie Mae, Freddie Mac and FHA are designed to ensure the adherence of loans to their guidelines and eligibility requirements. In fact, they require that any loan produced that is not eligible for sale to them or needs insurance provided by them be given the highest risk rating. However, other than that they allow lenders to determine how they define risk despite the fact that the two highest ratings are used to calculate the overall error rate. In other words, one lender can say that the second highest risk they identify are those loans where there is obvious fraud. Then all other issues, such as bad appraisals, inaccurate calculations of DTI, missed liabilities, title problems, regulatory faults and similar type problems are not considered significant enough to warrant being included in the overall error rate. Another lender may include these issues in their second tier rating and as a result have a higher error rate than a lender making numerous mistakes.
More discouraging is the fact that the very people who make the mistakes are the ones responsible for reviewing the findings and contradicting the issues so that they are wiped out of the reports. The pressure on QC staff has not abated at all.
Furthermore, none of the entities requiring these QC processes has the ability to test each lender to ensure they are complying with the guidelines. While it is bad enough for large lenders it is even worse for smaller ones. Here the QC reviews cannot show any problems since management is concerned that any investors they may have will terminate the relationship with them if the QC report is not perfect. This also applies to outsourcing firms as well.
Recently I was told about a loan where the appraisal had numerous flaws and the value of the property had increased from $120,000 to $190,000 in six months. When reported in the QC findings, the QC manager was told to remove that finding or they would be responsible for the company closing its doors since the loan had gone to their primary investor who wanted to see their QC report. This pressure on and intimidation of QC personnel is by far the most significant indicator of problems to come.
So while those of us still in the industry like to think we have progressed beyond the collapse of the industry and are once again living in the land of good mortgage lenders, the reality is that we are still susceptible to the enticements that caused the original problems. Maybe this time however, we will be smart enough and strong enough to resist the evil potion of greed and stay in the fairy tale land of good mortgage lenders. Otherwise we may very well end up with another Nightmare on Elm Street.
About The Author
rjbWalzak Consulting, Inc. was founded and is led by Rebecca Walzak, a leader in operational risk management programs in all areas of the consumer lending industry. In addition to consulting experience in mortgage banking, student lending and other types of consumer lending, she has hands on practical experience in these organizations as well as having held numerous positions from top to bottom of the consumer lending industry over the past 25 years.