Originating Mortgage Loans

I'll admit upfront, I LOVE FHA LOANS!

Fortunately I'm in an area that 70% of the housing stock is within the FHA loan limits. Sadly, I know originators in California who also love FHA loans. Problem is, with the average price of a home in Orange County at $560,000, the FHA loan limits are too low.

What I love most about FHA is an "A minus" borrower can get a prime paper rate. This means borrowers with marginal credit scores can get approved at "A" paper rates. Best of all, they are underwritten to sound underwriting principles. There are no stated income guidelines, no interest-only options, and no negative amortization.  FHA however does have reduced documentation requirements for FHA-to-FHA refinances, yet, only if a borrower is going to lower their rate or term.  Best of all, in our current matrix driven world of underwriting, FHA loans are common sense in their underwriting approach.

Did I tell you love FHA loans?

Here's the problem.  HUD has loan limits that are too darn low in high cost markets that desperately need the program.  For example. San Diego has a median home price exceeding $540,000 with an FHA loan limit at $362,000.  This also holds true for the California Bay Area, Los Angeles. Boston,  NYC, Connecticut...and our nations captital, Washington, DC (where HUD is located).

What the heck, in our nations capital (again, where HUD is located), the median priced home stands at $470,000 with an FHA loan limit of $362,000? Is it just an anomaly?  If HUD, a US government agency established to provide affordable housing and financing can't provide its own clerical help a good loan program, then there is definitely something wrong.

But..I still love FHA loans.

With the  FHA Modernization Act of 2006 expiring in Congress last year, Congress is again expected to re-introduce legislation this year that will:

1. Assess the mortgage insurance premium (MIP) according to credit risk.  Better borrowers will pay less.
2. Eliminate the 3% downpayment requirement (100% financing).
3. Index loan limits to reflect market prices.

There seems to be no real opposition to FHA modernization from either the President or Congress on both sides of the aisle. Barney Frank and Hillary Clinton both seem determined to get the legislation through in 2007. President Bush has publically stated he will sign it and FHA Commissioner Brian Montgomery is ardently backing it.

If FHA Modernization passes this year, I do believe it will help stimulate the real estate markets across the nation (especially in the high cost markets). Additionally, it will fill a void for borrowers who as of recent had to get a subprime loan.

Yep, I love FHA loans!

 

If you have been reading the industry news or even my Blog site recently, you know the sub-prime sector is reeling. Put that together with inflationary concerns and you have a lot of worried loan originators.

Yet, after talking to top producers throughout the country, they are excited about 2007. They all report they have had to step up their marketing based activities; however, they are uniformly saying they fully expect to exceed their 2006 numbers. In December, I posted a Blog titled, "Yes, The Mortgage Business Is Going Through A Shake-Up - Be Thankful." It aligns exactly with what top producers have been telling me lately, I suggest you read it.

For example, one of the best originators in the country is Mike Grace out of Athens, Georgia. Mike not only originates loans very successfully, he also manages three very profitable branches for Wells Fargo Home Mortgage. If you know anything about Athens real estate, you know Mike Grace is a dominant force in that market.

Even though Mike has been in the business twenty years and is a top producer, he sensed the market shifting last fall and realized he had gradually stopped doing some of the marketing activities that had made him successful. If you hang around Mike for any length of time, here are a few things you will notice about him:

1. He is brutally HONEST (even with himself)
2. He LOVES his daughters
3. He will take the shirt off his back to HELP anyone
4. He is PASSIONATE about the mortgage business
5. He KNOWS his underwriting guidelines as well as any underwriter
6. He is a DIEHEART University of Georgia Dawg fan (Don't hold that against him)

That said, Mike made an honest self-assessment and realized the market was returning to normal (not the boom period our industry recently experienced) and it was essential he also return to the fundamentals that had originally made him successful. Mike always tells his team not to rest on their laurels and he took his own advice. Since September, Mike has been working like a man possessed. Guess what, unlike his competitors, he had a great December and January and the rest of the year is shaping up to exceed 2006.

I can go on and on with additional examples, however it boils down to one thing:

You know what you need to do; the secret is doing it and doing it consistently over a prolonged period.

Below are previous postings that relate to this discussion. Take the time to review them and may 2007 be a great year for you!

Yes, The Mortgage Business Is Going Through A Shake-Up - Be Thankful

Sub-Prime Market Tightening - Yes There Is a Positive Side

To Get Rich, Just Follow the Instructions

Are You Mining the "Acres of Diamonds" in Your Database?

Ten Things an Originator Must Master

Predictions for the Mortgage Lending Industry 2007

Mortgage Planning for Mortgage Professionals

Over the weekend numerous people contacted me regarding the 2/23/07 National Mortgage News Online story titled "HUD Cracking Down on Downpayment Assistance." Honestly, when I first read it, my initial reaction was concern. However, I wanted to digest the story and research further before making a public statement. For a better understanding, below is the story that I'm referencing:

National Mortgage News, February 23, 2006
The Department of Housing and Urban Development has initiated a rulemaking process to crack down on downpayment assistance programs that have bolstered Federal Housing Administration single-family loan originations but also led to rising FHA defaults and foreclosures, according to the HUD inspector general. Read on...

In a nutshell, the story outlines FHA's initiation of a rulemaking process for downpayment assistance program acceptability. It also states that the rule has been submitted to OMB for pre-publication review.

The key question is how long would it be before the final rule is published IF approved?

To help you understand the process and timetable required before publication, I will walk you through it:

• OMB Review - 60 to 120 days
• Congressional Review - 30 days
• Normal Operational Delays - Varies
• 60 Day Comment Period - 60 days
• HUD Review of Comments - 60 to 90 days

Bottom line is the final ruling (if approved) is unlikely to be published until 2008.

In my opinion, this gives Congress the necessary motivation and time needed to reintroduce and pass the 2007 version of the "FHA Modernization Act" before said final ruling is published.

American Banker (02/23/07) P. 17; Terris, Harry
A top priority for the National Association of Mortgage Brokers this year, according to Legislative Chairman Joe Falk, will be pushing for a federal government study of the causes of foreclosures and what actions should be taken to curtail them. Falk says the causes of the most recent wave of foreclosures are unclear, but originators, investors, brokers and borrowers all played a role. The group continues to voice opposition to a suitability standard that would force lenders to ensure that borrowers obtain loans that fit their budgets, with Falk insisting that "the ultimate decision maker" is the consumer. Among other things, the group will also push for increased government loan limits and the development of a reverse mortgage backed by the Department of Veterans Affairs.
(More - Subscription Required)

New Jersey Star-Ledger (02/21/07); Kristof, Kathy
HUD Secretary Alphonso Jackson underscores the importance of revamping the Federal Housing Administration at a time when rising home prices have made it difficult for many low- to moderate-income buyers to obtain mortgages backed by the agency. The number of loans financed by the FHA slid to 425,493 last year from 1.3 million in 2003, with the number originated in pricey California down to 4,443 from nearly 100,000 over the same time span. Much of the decline can be blamed on soaring residential prices, as Los Angeles County's median of $516,000 at the end of last year is significantly higher than the FHA's loan limits of $200,000 to $362,790. Jackson's reform proposal calls for loan ceilings to be raised to a market's median price, downpayment requirements to be lowered from 3 percent to zero down and mortgage insurance premiums to be based on the borrower's downpayment or credit score.
(More)

For further insight, refer to blog posted February 20, 2007 titled:

Sub-Prime Market Tightening - Yes There Is a Positive Side

With the real estate market showing signs of stabilizing in 2007, will the recent jump in mortgage default rates with higher risk borrowers put a crimp in this stabilization? In a nutshell, sub-prime lending has grown substantially over the last six to seven years and can be partially credited with the real estate boom we experienced during that same time period. Will the recent tightening and demand for higher yields from investors in the sub-prime realm put a damper on the real estate market? In my humble opinion, this is a bad news-good news situation for the real estate industry.

When you talk to proponents of sub-prime lending, they will tell you:

1. Sub-prime products allow many individuals to purchase a home that in the past they may not have been able to do so.
2. Provides purchase and refinance financing alternatives to individuals that may have experienced events that prevented them from getting a traditional prime home loan.
3. Allows time for individuals to build a credit history to eventually refinance and qualify for a prime home loan while building equity in their home and realizing significant tax savings.
4. Sub-prime loan products allow credit worthy borrowers a financial vehicle to qualify for a home loan.

All four of the statements above are true and powerful justifications for sub-prime loans. However, there are also negatives to sub-prime lending, such as as:

1. Many borrowers are put into what my good friend Dennis Geist calls "Neutron Loans." Much like the Neutron Bomb, these loans leave the home intact yet destroy the homeowner putting them in foreclosure and/or bankruptcy court.
2. Borrowers put into loans they cannot afford (closely related to #1).
3. Borrowers are not put into best-fit loan products. Instead, loan originator puts borrower in a sub-prime loan product that provides them the path of least resistance and highest pay-off. 
4. Higher default rates
5. "Fogged mirror" underwriting guidelines in the pursuit and frenzy of loan volume and keeping up with competition.
6. Artificially drives real estate values upward.

Last week, serious problems cropped up due to rising defaults. Several major lenders announced tightening of sub-prime underwriting guidelines and HSBC announced its bad debt charge last year would be about $1.8 billion higher than expected as problems grew in U.S. mortgage securities it had purchased, particularly loans to borrowers of less than top credit (sub-prime mortgages).

Officials with Mortgage Bankers Association argue the impact will be limited. The trade group estimated that about 17 percent of home purchases are now made using sub-prime loans. If those buyers get squeezed out, that's bound to be felt throughout the real estate market, according to experts, although Sandler O'Neill analyst Mike McMahon  and others say it's tough to quantify by how much.

"It's not like subprime loans are going to go away completely - it won't be anything that drastic," said McHahon. "But I think there is going to be an impact on home purchases, even if it's hard to quantify at the moment. In the past few years there's been an explosion in mortgage credit. It makes sense there would be some retrenchment."

Mike Fratantoni, senior economist with the Mortgage Bankers Association, said there would be a greater risk to the housing market if defaults were rising across the board, noting that so far the rise in borrowers who are late on mortgage payments is still mostly in the subprime sector. And he said even the growing problem in the subprime sector is not a big shock for the market.

The rate of subprime borrowers who are more than a month late on a mortgage payment was 13.2 percent in the third quarter of 2006, the latest numbers available, up from a 10.5 percent delinquency rate in the third quarter of 2005.

The overall mortgage delinquency rate was 4.7 percent in the third quarter, just slightly above the 4.4 percent rate of a year earlier, when it was a historic low.

"We don't agree they (subprime home buyers) are all going to be cut off from mortgage credit," said Fratantoni. "It is going to have something of a negative effect, but that's not a big enough part of the market to be a macro concern."

Additionally, the unknown is how many high LTV sub-prime borrowers that are currently in default were placed in high rate loans when they would have qualified for a prime rate FHA loan? FHA market share has been decreasing substantially over the past decade and it is my suspicion at the benefit of sub-prime market share gain. I don't have any data from a controlled study, however over the last few years I have seen hundreds of borrowers placed into sub-prime products that would have qualified for a prime FHA loan.

Why would originators and real estate agents allow their borrowers to be placed in a sub-prime loan instead of FHA financing? Based upon my research and findings, below are a few of the major reasons:

1. Lack of knowledge of FHA underwriting guidelines
2. Broker or lender not approved to make FHA loans
3. Sub-prime loan provided path of least resistance for loan originator and real estate agent
4. Real estate agents advised sellers not to accept an FHA purchase offer

In my estimation, with the recent FHA enhancements and proposed FHA Modernization Act in Congress, loan originators and real estate agents that embrace and take the time to understand FHA loan products will be positioned to capture significant market share from those originators and realtors that don't evolve with the current market environment.

As previously stated, currently 17% of all purchase transactions are made utilizing sub-prime mortgage products.  Even if sub-prime purchase volume were to drop 25-30%, I believe a significant portion of it could be funded under alternative prime loan products. This predicted decrease in sub-prime lending falls into three categories:

1. Qualifies for alternative loan product
2. Does not qualify for alternative prime product
3. Won't qualify for mortgage that set's them up for failure (Neutron Loan)

Of the three categories listed above, one and three are positive. Number two, provides an opportunity for the financial markets to resolve.

In conclusion, I believe the impact from the recent sub-prime changes will have somewhat of a negative effect, but for reasons noted above, will not be a big enough part of the market to be of macro concern.

The Federal Housing Administration is willing to consider backing acquisition, development, and construction loans for single-family houses. FHA Commissioner Brian Montgomery did not mention the possibility of insuring ADC loans to builders during his talk at the National Association of Home Builders Convention in Orlando, Fla. But Dallas builder Kent Conine, a former NAHB president, said Mr. Montgomery was "intrigued" by the idea when the two met in Washington recently. The FHA commissioner "asked for a cost-benefit analysis," Mr. Conine said. "If we can show him how it would work and how it would benefit consumers, he said he would do a pilot." According to the Dallas builder, Mr. Montgomery "made no promises." Nevertheless, he called the commissioner's willingness to entertain a proposal "good news." "If we can get our nose under the tent, sooner or later we can get a full-scale program," he told an NAHB leadership committee. Mr. Conine said he believes ADC funding is "an area where the FHA could really shine," especially in rural markets and places where builders find it difficult to secure financing from conventional lenders.